“… after the laws of physics, everything else is opinion.“
— Neil deGrasse Tyson, Astrophysics for People in a Hurry
The View From 30,000 Feet
Last week was a continuation of the major themes that have marked the fourth quarter: A softening of the labor markets, a downshifting in the trajectory of growth, a slowdown in inflationary pressures and a Federal Reserve that is coming around to the view that they have crested the top in rates and may be looking towards beginning normalization in the new year.
These themes have opened the door for risk assets to appreciate in anticipation that the coming slowdown will resemble a gradual decline towards the mean (soft-landing), versus the more typical non-linear decent through the mean that has more typically been associated with interest rate hiking cycles (hard-landing).
This week we provide our outlook for 2024, which doesn’t focus one case as the primary possibility, but rather outlines what we see as the possible outcomes and probabilities for each. We believe it will be very difficult to forecast the exact route, because the outcomes will ultimately depend on variables that interact with each other based on the strength of feedback loops that are created. As the economy progresses through the new year, we anticipate the exact glide path will become clearer, and as that happens the probabilities will begin to shift towards one of the potential scenarios.
- Inflation, employment, growth and Fed rhetoric all feeding the soft-landing story
- Focus Point Leading Market Indicator signals Neutral Conditions
- 2024 Outlook – Scenarios and Probability Estimates
- What to watch in 2024 for hints of which scenario is unfolding
Inflation, Employment, Growth, Fed Rhetoric Feeding Soft-Landing Story
- PCE, the Fed’s preferred measure for inflation, surprised to the downside with the headline number measuring flat month-over-month, and the year-over-year now below the Fed’s most recent Summary of Economic
- Headline CPE YoY 0%
- Core CPE 5%
- Continuing Jobless Claims hit 1927k, extending to the highest level since the interrupting the downward trend, and up 200k over the last 6 weeks, the second highest 6 week rise since the pandemic.
- ISM Purchasing Manager Survey Employment component surprised to the downside hitting the second lowest level since the post-pandemic recovery
- The Atlanta Fed GDPNow forecast is now projecting 19% GDP growth for the Q4 and Conference Board’s Coincident Index measured 1.28% YoY, touching its lowest level post-pandemic, signaling a sharp cooling of activity in Q4.
- Fed President Waller, who had previously been known to be a hawk, ignited a rally with is speech titled, “Something Appears to be Giving”, which is in stark contrast to his speech in October, titled “Something’s Got to Give.”
Fed’s Getting Its Wish List: Cooling Growth, Tightening Labor Market
Focus Point Leading Market Indicator Signals Neutral Conditions
QUANTITATIVE VIEW: The Focus Point Leading Market Indicator (LMI), signaled Neutral Conditions for December, as looser financial conditions, tighter credits spreads and resilient earnings – versus expectations – combined with strengthening technicals to nudge the model forward.
QUALITATIVE VIEW: With rates restrictive, growth and employment both deteriorating, and market expectations for the Fed to embark on an aggressive rate cutting campaign in 2024, financial markets are primed for disappointment if the growth slowdown trickles into earnings, or the Fed doesn’t deliver on expectations.
High Frequency Data Signaling Risk Environment Strong, Despite Deteriorating Fundamental Data
2024 Outlook – Scenarios and Probability Estimates
Takeaways From 2024 Outlook
- Although the probabilities are roughly evenly split between financial markets that trend higher, on a relatively smooth course versus bumper outcomes with more variability, volatility and drawdowns, the upside/downside return disparity is tipped towards more pain to the downside in the negative Said another way, we expect the drawdowns from the negatively weighted outcomes in the lower half to exceed the upside from outcomes in those that are positively weighted. However, we do anticipate that in the event of most negative outcome scenarios related to slowdowns, the policy response should ultimately drive higher returns for risk assets.
- There are three main things to keep in mind that should make investors wary of the path of potential outcomes for 2024:
- Rates are restrictive
- The majority of data from historical analogs indicate that soft-landings when rates are restrictive are hard to come by
- The Fed would rather risk a recession than risk a recurrence of inflation (what does Powell want his legacy to be?)
- The investment implications include maintaining risk asset exposure but hedging or remaining nimble and aware of which way the data is As data rolls in, the probabilities will migrate between scenarios and potential outcomes for asset values.
What to Watch in 2024 for Hints of Which Scenario Is Unfolding
- The Fed has a dual mandate: Fully Employment (growth) and Price Stability (inflation), with a tacit third, and overarching, mandate of Financial Things to watch out for in the coming year are those things that drive the Fed’s mandates.
- Labor Markets
- Credit Conditions and Use of Credit
- Consumer Spending
- Depletion of Excess Savings
- Commercial Real Estate
- Corporate Credit Health
- Oil Prices
- Goods and Services Supply and Demand
- Supply Chain Pressures
- Other data and events that are likely to influence the markets in 2024
- Demand for Government Bonds
- Geopolitical Events
- U.S. Election
- Investment Themes
Wall Street Expectations Across the Spectrum, Driven Partially by Survey vs Hard Data Divergence
Putting It All Together
- The risk asset rally of 2023 has been driven by a host of factors but there were two that stood out:
- Excess consumer and corporate savings
- The Artificial Intelligence investment theme and the Magnificent 7 effect
- Going into 2024 the two main drivers of 2023 are unlikely to repeat.
- Pandemic savings on consumer Balance Sheets peaked between $2.0t and $2.5t, and now probably stand at somewhere between $500b and $800b. Saving are being drawn down by $50b to $60b per month, with the lower income cohorts likely already exhausted.
- Although AI will to be a continuing theme in 2024. The average return of the Magnificent 7 for 2023 currently stands at 101% though the close on Friday. It is very unlikely that there will be a repeat of this performance in 2024.
- Although there are potential scenarios that provide for positive outcomes in 2024, it bears reiterating that restrictive rate environments have historically caused recessions, with very few instances where this was not the case. Although it has become fashionable to forecast a soft-landing, investors should be aware a soft-landing is betting against the odds based on how things have typically played out in the past.
- The soft-landing narrative is predicated on the notion that the data that is currently falling towards the mean will level off near the mean with a little help from the Fed. Although this is always plausible, it is also plausible that the data falls through the mean, as it has done in the majority of past analogs. This is why we see Wall Street strategist falling on either side of the argument.
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