Market news is everywhere — but what does it all mean for you, and how should you react?
Market Compass helps keep you in the know but also looks ahead to what may be down the road. In this video series, our investment strategists share their thoughts on the latest market and economic developments, and offer investing tips you can use as you work toward your long-term financial goals.
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Market inertia: Will 2024 continue where 2023 left off?
The markets finished last year on a high note. Will 2024 continue where 2023 left off? Senior Strategist Craig Fehr breaks down the current state of the markets and the economy for you.
So in our January edition of Market Compass, we take a look at the handoff from 2023 to 2024. And more specifically, let's talk inertia, which we'll all remember from science class, is the principle that objects in motion tend to stay in motion until acted upon by another force. So with last year finishing on a strong upswing, the question is, will 2024 continue where 2023 left off? And what are the forces that are going to influence that direction? Here's our take.
Let's start with our view on the economy, which we think will lose some momentum in 2024 but won't come to a halt. So if we think about the handoff from '23, the economy was exceptionally strong as we mentioned defying gravity in 2023. Particularly because consumer spending remained quite robust. Now as we look forward to '24, we think some of that momentum can continue, but we do think we're going to see some softness emerge.
The Fed put the brakes on last year and consumer tailwinds like wages and accumulated savings are now starting to fade. But both should start to show up a little bit more acutely this year. But we do think that there's still gas left in the tank for the economy. In particular, unemployment is still low, just a shade above a 50-year low on the unemployment rate. And is only likely to rise moderately this year in our opinion.
And importantly, parts of the economy like manufacturing and housing construction and investment are now starting to show some signs of turning higher after contracting last year. So all told, we think that conditions will start to soften in the economy, but then begin to reaccelerate in the latter part of 2024. The Fed has been a key influence on the markets for the past several years, that's not likely to change in 2024.
We think that the Fed will stay on hold for a while longer, but eventually start to cut rates later in 2024. Now let's quickly reference back to the handoff because as we came through the tail end of '23 and into '24, the Fed was on the sidelines holding rates steady coming into the year. We think that will persist in the first half of 2024 before the Fed eventually begins to start cutting rates in the second half. Now more broadly, 2024 will be a year in which monetary policy settings get less restrictive.
And importantly, that tends to be quite favorable for the stock market, the bond market, and the economy. Interestingly though, we do think some misaligned expectations between what the market is anticipating and what the Fed is likely to do can produce some volatility. And more specifically, markets are expecting the Feds to start cutting rates early in '24 and steadily throughout the year. We think that the commencement of those rate cuts is probably to start a little bit later.
The broader takeaway, however, is that heading up to the first rate cut and in the period after the first rate cut, we do tend to see the stock market perform quite well. Now if we look at a broader picture of interest rates beyond just the short-term policy rate, what we'll see is, since 1960, we have seen rates rise but then declined steadily for almost 40 years since the early '80s.
More recently, we've seen rates rise off of those lows over the past couple of years, that's what drove market performance in '22 and in '23. So as we head into 2024, we don't think that sharp decline in rates at the tail end of '23 will continue into this year. And in fact, we think rates could probably moderate over the course of this year before ultimately migrating slightly lower as we move through the year.
So let's talk about the stock market. We think the bull market in equities will continue in 2024, but we doubt it will match the vigor of 2023. And importantly, if we think about that handoff from last year, stocks rallied sharply in the final two months of the year to ultimately cap off what was a very, very strong year for the US stock market. We think volatility could probably be the same as we saw in '23.
Meaning we saw a few episodes in March and again throughout the fall where stocks pulled back, but broadly produced overall gains for the year. We think we'll build on those gains in 2024. But importantly, we think the complexion and the leadership of the market can start to rotate. So let's take a look at a graphic and we'll bring this to life a little bit more. This is what we refer to as our jelly bean chart.
And really what it captures is the performance of different-- what we would call asset classes or investment areas throughout each year, in this case over the last 10 years. If we just focus in for a second on the box titled US large cap stocks, I think about that as the S&P 500 or the US stock market for large companies. You'll see it doesn't consistently live at the top or the best performer or at the bottom or the worst performer, and instead can bounce around.
If we focus in on 2023, we saw there were strong gains for the US stock market. As I mentioned, we think those can continue as we move through 2024. But the leadership is going to rotate. And I'll point out, importantly, we think we're going to see a broadening out of stock market gains in 2024. Looking back in '23, the gains were primarily led by large technology companies.
And in fact, so-called Magnificent Seven, so the seven largest tech companies in the US, accounted for about 90% of the stock market's gains in 2023, which is remarkable. As we move into '24, we think that leadership in those gains can broaden out across the stock market, and importantly, across other asset classes which really speaks to the importance of having a well-diversified, well-balanced portfolio as we move through this year.
The performance of the stock and bond markets have obviously been in focus in recent years. But interestingly, it's CDs that have returned to the spotlight more recently. Now importantly, as we look into 2024 as strong and as high as CD and cash yields have been more recently, we think they're going to be outshined moving forward. Let me explain what I mean.
While cash and CD yields rose to their highest levels in decades more recently, and interestingly what we saw was, as stocks and bonds pulled back in 2022, cash was one of the better performers in a diversified portfolio. That switched in 2023 with stocks and bonds outperforming and cash trailing. Now as we head into '24, that handoff means that we're probably going to see, in our opinion, stronger returns from stocks and bonds in the coming year with some lagging returns in cash.
Now, importantly, those higher yields for CDs and cash might feel risk free, but those strong gains in stocks and the sharp drop in interest rates toward the tail end of '23 highlight two things. One, the opportunity cost of hiding out in cash. And two, the reinvestment risk of CDs meaning that as CDs mature and that money comes due, it has to be reinvested and potentially at lower yields.
So let's dive deeper. If we look back over the last 40 years, equities or stocks on average have delivered healthy returns following the peak in CD yields. And importantly, we do think that CD yields have peaked more recently. And so the moments when CD yields looked particularly alluring were actually more compelling opportunities to diversify into things like stocks and bonds.
Now importantly, this is not to suggest that there isn't a place for cash or CDs in a well diversified strategy. But based on our outlook, we think now's a good time to ensure you're not overweight to those areas. To us, this looks like a good time to systematically redeploy maturing CDs or your excess cash to help you keep your entire portfolio aligned to your longer-term needs.
So as we lean back and look out over the entirety of 2024, we think that the bull market for stocks as well as the rebound in bonds can remain headed in a positive direction. That inertia, so to speak, that we built coming out of 2023. But unlike the sharp and steady rally in the months leading into this year, we do expect a bumpier path higher as we advance.
We think the shape of 2023's gain creates a compelling opportunity to rebalance portfolios back to intended targets across an array of asset classes and sectors within your portfolio. Kicking off 2024 with an appropriate portfolio balance and alignment with your long-term goals can help position you to navigate the year ahead. As always, you can access all of our views and market content at edwardjones.com, and by connecting with your Edward Jones financial advisor.
Hello, everyone, and welcome to the December Market Compass. Now, as we head into year end, perhaps to enjoy some well-deserved holiday cheer, we’re all hopefully reflecting on a successful 2023, and looking forward to 2024.
Now, in this edition of Market Compass, we’ll focus on our outlook for 2024, what we see happening in the economy with the Fed, with inflation, and of course, how do we think about portfolio positioning as we enter the new year. You can go to edwardjones.com to watch the full episode.
What happens with economic growth? The U.S. economy was quite resilient in 2023. Economic growth was at or above trend levels of 2%. Now, in 2024, we expect the US economic growth to remain positive, but soften in the first half of 2024. Growth rates will likely fall to below 1.5% annualized.
Now, we do believe that somewhat weaker consumption, lower government spending, and a cooler labor market will translate to slower growth. The consumer faces some challenges heading into 2024. Those include declining excess savings and rising credit card debt. In addition, we believe some loosening in the labor market may put downward pressure on wage gains. But on the positive side, a slowdown in growth could potentially support lower inflation and less need for further Federal Reserve tightening.
Now, as we look toward the second half of 2024, we do expect the economy to gradually accelerate once again. We believe lower inflation rates, a Fed that is possibly signaling rate cuts and better earnings growth will lead to improving economic growth later in 2024. And remember, markets are forward-looking, they can start moving higher even before economic growth stabilizes and improves.
Does the Federal Reserve cut rates in 2024? Now, at the core of our outlook for the markets is the trajectory of Fed policy. We believe that after the most aggressive tightening campaign in 40 years, the hiking cycle is now complete.
The Fed will likely proceed with caution, perhaps even signaling an extended pause, and keeping that Fed funds rate at 5:00 and 1/4% to 5.5% early in the year. But we believe that easing inflation pressures, a cooling labor market and a slowdown in growth will likely pave the way for interest rate cuts in 2024.
In our view, the Fed will likely cut more than the two cuts it outlined at the November FOMC meeting, but perhaps less than the 5 to 6 cuts that markets have priced in.
We believe that if the Fed funds rate is at 5 and 1/4 to 5.5%, longer term neutral rates are closer to 2 and 1/2 to 3%, and inflation is moderating, then there’s less need for the Fed to remain this restrictive. All this to say, we see a Fed rate cutting cycle emerging in 2024.
Can inflation continue to moderate? The trajectory of inflation is another key driver of our outlook in 2024. Now, we’ve seen progress in 2023 thus far. Headline CPI inflation in the US has fallen from a high of 9.1% in June of 2022, all the way down to 3.2% at the November reading. Core inflation also moved lower from 6.6% to 4%.
Now, while the last mile down to the Fed’s 2% target may be gradual, and even a bit bumpy, we do see core inflation heading towards 2.5% in 2024. Now, there are a couple of reasons for this.
First, the shelter and rent components of inflation, which make up nearly 40% of the basket, have softened in real time, and typically show up with a lag in the CPI figures. So we believe this will put downward pressure on inflation in the months ahead. And secondly, we believe wage gains will continue to moderate. That will help cool services inflation as well. So overall, we see the downward trend in inflation that began in 2023 continuing in 2024.
What does this mean for your portfolio in 2024? So after solid returns in 2023, we do see opportunities in both equities and bonds for 2024. Now, keep in mind, bear markets, like the one we saw in 2022, are historically followed by positive returns. In fact, often, these periods can last for several years.
So how do we think about portfolio positioning as we head into the new year? For stocks, if a key theme in 2023 was narrow leadership with large cap technology, or the so-called Magnificent Seven driving much of the gains, then perhaps we would view 2024 as the year when laggards play some catch up.
So we recommend complimenting growth investing with some of these lagging assets. That include cyclical and value sectors, as well as small cap stocks, which could play some catch up in 2024.
Now, with artificial intelligence still in the early innings of multiyear growth. We still view this space favorably. But we do see diversification beyond technology more critical to portfolio returns in 2024, especially as valuations are more favorable outside of these areas as well.
And in bonds, we do recommend complementing your cash-like investments, including CDs, money market funds, with longer term investment grade bonds. These bonds can help you lock in these historically high yields for a longer period, and they may also appreciate as the Fed makes further progress towards its 2% inflation, and over time, cuts rates as well.
Using volatility to your advantage. So as we look ahead to the next 12 months, we do expect 2024 to be a positive year in markets. But like any other year, it will have its share of volatility as well. We believe balance and diversification in your stock portfolio and bond portfolio can help you position to maximize return potential for the year. And this is also where your financial advisor can come into play. They can help ensure you have exposure in your stocks and bonds that is tailored to your specific financial goals and risk tolerance.
At the end of the day, you can use market volatility to your advantage to rebalance, diversify, and add quality investments at better prices, ultimately to meet or exceed your long-term financial goals.
So if you are interested in our 2024 market outlook, head to edwardjones.com to read the full report. And thank you again for your viewership. We wish you all a very happy and healthy holiday season. And we’ll see you back here in the new year for the January Market Compass.
Hello, and welcome to the November edition of Market Compass. Today we'll focus on performance and the outlook for fixed income. Specifically, we'll talk about first how the rise in yields differs in 2023 versus the rise we saw last year. Second, we're going to talk about some reasons why the November rebound might be the start of a sustainable recovery in bonds and, finally, how to position fixed income portfolios to take advantage of the potential inflection point that we see ahead.
Let's start with performance. After a disappointing year for investors last year, balanced portfolios are on track to end this year on a positive note. But US mega-cap tech stocks have largely driven the gains while bonds remain under pressure. Though they have started to recover recently, up until the end of October, US investment-grade bonds were on track for their longest stretch of losses.
Since the start of the US Aggregate Bond index in 1976, there has never been two or more back-to-back negative years. Last year, long-term rates surged as inflation spiked to a four-decade high. And the Federal Reserve responded with aggressive rate hikes. This year, however, inflation is declining. And the Fed is most likely done with rate hikes.
So why the lackluster performance? We would attribute the move higher in rates for most of the year to first the stronger-than-expected economy, which implies the Fed might keep rates elevated for longer, second, higher Treasury issuance to fund the fiscal deficit, and third, technical factors, such as negative investor sentiment. In our view, we've seen the perfect storm for bonds. But conditions now seem ripe for a rebound.
In November, the 10-year Treasury yield fell from a 16-year high of 5% to around 4.5%, providing much needed relief. The November gains could be the first step in a sustainable recovery that could materialize in 2024 and beyond.
Here are four reasons to be optimistic despite the disappointing performance of bonds over the past three years. First, inflation remains on a downward path. The last two readings of the Fed's preferred measure of inflation have fallen below 4% for the first time in two years.
At 3.7%, core inflation is still a long way from the Fed's 2% target. But we think the downside pressures will persist. Wage growth is decelerating. Housing inflation is cooling. And oil prices are back into their recent range of around $75, which is 20% below their late September high.
Second, growth will downshift in the quarters ahead. The economy proved to be surprisingly resilient in 2023, supported by a strong consumer and a tight labor market. We don't expect growth to fall off a cliff. But we think pressure is building on the consumer as the labor market is gradually cooling, and lending standards are tight. The silver lining is that the expected slowdown, modest slowdown, will also keep inflation in check.
This brings me to the third and very important reason why we believe bonds are likely to perform better next year. The Fed might not hike further given the slowdown in inflation and a cooling labor market. We think the Fed will likely stay on pause as it evaluates the impact of prior rate hikes before cutting rates likely in the second half of 2024.
This graph shows that over the past 40 years, bond returns were muted and in some cases negative before the Fed hiked rates for the last time in a cycle. But yields have always fallen after the Fed's last hike with bonds achieving above-average returns six months later. This highlights that the end of tightening can be a positive catalyst for bonds with yields potentially having already reached the peak level for this cycle.
And, finally, valuations are attractive. Historically, one of the best predictors of forward bond returns is current yields. Here you can see that returns for investment-grade bonds over a five-year period have tended to match their starting yield. For example, yields were around 5.6% in 2007, a similar level to today. And bonds returned a little over 6% on average per year in the five-year period between 2007 and 2012.
We believe the high starting yield in 2023 could produce high returns, setting the stage for a bond market comeback in 2024. At a minimum, the larger income component can better offset price declines, making a repeat of last year's losses less likely.
With bonds potentially representing a more compelling opportunity than they have in years, how should investors position fixed income portfolios? It might be tempting to gravitate towards CDs and cash like investments which yield more than 5% with little or no price risk.
However, bonds with longer maturities and higher interest rate sensitivity can offer the opportunity to lock in the historically high yields for a longer period. They may also appreciate in price if growth softens, and the Fed starts cutting rates possibly in the second half of 2024. We recommend investors build a bond ladder with an appropriate exposure to intermediate and long-term bonds, which can complement their cash positions.
We think the bond allocation of the US Aggregate Index provides a good starting point for diversification. If CDs represent an oversized part of your fixed income portfolio, consider reducing your allocation to cash or reinvesting the maturing principal into longer-duration bonds.
To sum up, while this is hard to pinpoint within yields might have already reached a cyclical peak. As economic growth slows, the Fed pivots to rate cuts in 2024. And inflation gets closer to the Fed's 2% target.
Volatility in bonds will probably stay elevated for a while longer. But we expect a rebound in prices, especially for those bonds with longer maturities that have been hit the worst. With that, thank you for joining us. We hope to see you again next month for another Market Compass.
Thanks for joining us on the October Market Compass video. Halloween is upon us, which means we're coming down the home stretch for 2023.
It's been an eventful year to say the least, including four distinct phases through which the markets have navigated. First, stocks rose to start the year continuing the rebound that started last October as inflation finally peaked. Then markets pulled back in February and March amid the banking crisis and worries that inflation wouldn't come down as quickly as hoped.
That then gave way to a powerful summer rally in which equities rallied nearly 20% on the growing view that the economy would avoid recession. And then most recently we've re-entered a phase of rising rates driven by the prospects of the Fed keeping rates high for longer, which has prompted a dip in stock prices. This point in October also means the stock market rebound has turned one.
The last 12 months have clearly been more favorable than the preceding year when stocks fell into a bear market under the weight of spiking inflation and Fed interest rate hikes. Given the path I just described so far in 2023 and the list of risks that presently occupy the headlines, it may not feel like we're in the midst of a sustainable recovery. The coast is far from clear. It rarely is, but we think there are reasons to be optimistic.
Here's our take on three key questions as we head into year end and into year two of the recovery. First, interest rates have moved sharply higher. Are they going to keep rising? Our short answer to that would be we believe rates are actually quite close to peaking. 10 year rates, a common benchmark for yields and for borrowing costs, have seen a renewed surge recently rising in early October to levels that we haven't seen since 2007.
It's this recent jump in rates that, interestingly, gives us some confidence that we may be near an exhaustion point. In fact, we've seen some evidence of this in mid-October as yields have retrenched from those highs. In 2022, if we reflect back for a second, long-term yields surged among the powerful and sustained push from four decade high inflation and historically aggressive Fed policy rate hikes. It's not as if those influences are completely gone, but the backdrop is much different now.
Today, inflation is declining, and the Fed is at the tail end of its rate hiking cycle. Yet interest rates have lagged higher. Why? Well, there's a few forces at play. One, the combination of the Fed's high policy rates for longer message that it emphasized at its last policy meeting and, two, the market's recognition that a significant amount of treasury bond supply is likely needed to fund the bloated federal budget deficit.
While we think these factors are behind the latest move higher in rates, we think there's a case to be made that this may be a bit of an overshoot. Moreover, the rise in yields may actually prove to be a catalyst for lower rates, insofar, that high rates exacerbate restrictive financial conditions curbing economic activity, which would actually warrant lower rates. In other words, the cure for rising rates may be the rise in rates.
There's certainly the potential for bond yields to continue their uptrend for a bit longer, but we think that falling inflation, slower economic growth, and the end of the Fed's rate hiking campaign will ultimately prove to be more powerful influence. Over the last 50 years, there have been several instances when core inflation rose above 10 year rates. This was the case most recently.
The inflation rate as measured by the core consumer price index peaked on average a bit more than a year before the peak in interest rates. So if we apply that to the current phase, core inflation peaked in September of 2022, which suggests to us that the peak in rates might not be that far off. Of note in those previous experiences, when rates peaked the 10 year yield declined by an average of 1.9% over the following 12 months.
OK, question number two, between skyrocketing government debt and war in the Middle East, are these risks threatening a renewed sell off in the markets? Well, as we noted before, the investment landscape is rarely devoid of risks. That said, we recognize that political and geopolitical risks are credible and can impact near-term moves in the market.
First, let me note the human element and tragedy of the conflict overseas shouldn't be dismissed or downplayed. But if for the sake of this discussion we evaluate the implications for the investment landscape, history shows that geopolitical uncertainties and events tend not to have a lasting influence on market performance.
In the near run, the most acute impacts are likely to be seen in oil prices as we've witnessed so far here in October. And we could see a slightly more cautious stance in the broader financial markets. Interestingly, to the extent that a flight to safety response plays out in the financial markets as it has in the initial response to the conflict, this would, in our view, actually push treasury yields down, which could serve as a catalyst to support equity markets.
There are additional uncertainties we're watching as well, including the federal debt. So US federal debt is near $33 trillion, and it's growing. Rising rates have put additional pressure on the growing budget deficit with annual interest payments now approaching the $1 trillion mark. The near-term impact may show up in a temporary government shutdown if a budget agreement can't be reached by mid-November.
While high government debt is not an overarching threat to the near-term performance of the economy or markets, we do view this as a longer term risk that will eventually require tough budget choices, including potentially adjustments to taxes, spending, and even entitlement programs like Medicare, Medicaid, and Social Security. Fortunately, the US economy is flexible, it's dynamic, and it's resilient, which provides an important advantage in addressing government debt. But higher interest rates are shining a brighter light on the budget issues for now.
OK so third question, the stock market has lost some steam lately. Where does it head from here? Well, the stock market definitely hit a soft patch coming out of the summer with the S&P 500 pulling back more than 8% between that late July high and early October. We don't importantly, however, think that this marks the beginning of a new broader downtrend in equities. Though it does serve as a reminder that spates of volatility are normal.
This is the second such pullback just this year. The other one was in February and March, and we view this as a breather for the markets after the summer's steady sprint higher. Importantly, we think there are a few fundamental factors that can serve as a positive catalyst from here.
Most notably, we think a peak in interest rates can serve as a spark for stock prices. There were episodes of surging 10 year yields in the spring and fall of 2022, as well as the earlier in 2023-- all of which weighed on the equity markets. As the rise in yields abated, stocks found some footing, including an average return for the S&P 500 of better than 6% just in the three months following those instances.
More broadly, as we mentioned earlier, over the last 50 years, there have been several instances when inflation peaked followed by a peak in the 10 year interest rate. As rates fell from those peaks, the S&P 500 rose by an average of 20% over the following 12 months.
Now there are no guarantees that those returns are going to be mirrored this time around, but we do think this serves as a good guide. Rates have been governing equity markets lately. So some relief on the rising rate front should in our opinion be supportive of market returns. In addition, we think the broader term guide will be the path for the economy ahead.
GDP and corporate profit growth have been incredibly resilient this year, and we expect the economy to soften as we round out the year and head into 2024. But our view is that much of that outcome was already priced into the bear market decline. Evidence of slower economic growth will probably drive some episodes of caution in the markets, but we believe corporate profit growth over the course of 2024 will really be a positive influence on financial markets.
Also we may have time and the calendar on our side. In terms of the former, stock market was down in the third quarter-- the first such quarterly decline in a year. And if history is any guide, then the market story gets better from here as weak third quarters have often been followed by a strong encore.
Since 1990 in the 11 years when the stock market fell in the third quarter, the S&P 500 rebounded with a gain in the subsequent fourth quarter nine of those times averaging an impressive 10.6% return in those final three months of the year. Now, if you're curious, the two years that we missed were 2000 and in 2008, where stocks fell on both the third and the fourth quarters.
While Q4 returns have been notably healthy following third quarter declines, the fourth quarter just in general is traditionally a solid period for stocks with an overall average quarterly gain of 5% going all the way back to 1990. Since 2019, so more recently, the average Q4 gain was 9.5% in the stock market.
And as we mentioned before, stocks just passed the one year anniversary of the 2022 bear market bottom. We've maintained our view that we held coming into 2023 that last October's low would ultimately prove to be the starting point of a new bull market. There's no guarantee that a market recovery in motion continues in motion uninterrupted, but we do think some of that momentum can be sustained.
When prior bear market recoveries reach that one year mark from those cyclical lows, stocks did not in any of those instances since 1974 go back and revisit those prior lows. Now inertia alone is not a saving grace. But we believe investors should find some comfort in the fact that as the pendulum of market sentiment has swum firmly back into pessimistic territory more recently, the response from equities has been rather orderly and a normal pullback has transpired from the summer highs, not a severe sell off.
There's no assurance that the current market mood will turn immediately, but we think this spate of volatility is creating a compelling buying opportunity both in stocks and bonds. And it's the combination of the economy, corporate earnings, and interest rates, not the calendar, that will be the determining driver of market performance ahead.
For what it's worth, I'll point out that October has a knack for putting in a floor in market bottoms. Looking back to the last eight bear market bottoms over the last 50 years, half of them-- so that'd be 1974, 1990, 2002, and 2022 all came in October. So to us, here's the bottom line. While the path has been far from smooth, the stock market is holding on to a double digit gain so far for 2023 highlighting the importance of a disciplined investment strategy and a well-diversified portfolio.
While the recent rise in rates has weighed on both the stock and bond markets and the list of headline risks may have you feeling like hiding out in CDs is a more attractive approach, we think there are several reasons to be optimistic about the path ahead. As we head into year end, use the calendar and market volatility as an opportunity to pursue proactive rebalancing in your portfolio where appropriate, as well as review your plan with your financial advisor to take advantage of timely planning and tax strategies.
This in combination with disciplined and opportunistic portfolio decisions can help keep you on track as we round out the year and turn the calendar to 2024. So for more information on those timely planning strategies, Here's Scott Thoma who leads our planning strategies team.
Thank you, Craig. Well, the signs of fall are all around us. And while some of you type A's may have already finished your holiday shopping, which may strike fear in the rest of us, we know the end of the year will be here before you know it. Importantly, there are a number of planning opportunities that should be on your shopping list, so to speak, that we recommend discussing with your financial advisor.
First, I want to highlight actions some people have to do before the end of the year. Anyone age 73 or older must take the required minimum distribution or RMD from their IRA before 2023 ends to avoid a 25% penalty. In addition, if you have a flex spending account, these are use it or lose it funds. So be sure to use them before the year ends.
So there are your half to do items. But there are also a number of actions you can consider this year to make progress towards your goals. First, we know investors hold a lot of money in CDs given the rise in interest rates. While holding cash is important, cash is not the solution for money that's intended for long term goals like retirement.
So consider maximizing contributions to accounts, such as your IRA or health savings account or contribute to a 529 plan, all of which can help put you in better position to reach your important goals. In addition, if you're charitably inclined, you could consider bunching two or three years worth of charitable donations, which could enable you to itemize your deductions and maximize your tax benefit. And for those of you who must take an RMD but don't need to spend it, there are strategies to help you donate that money directly to charity, which is called a qualified charitable distribution or QCD.
Now since we're on the subject of taxes, depending on your tax situation, there are other actions you could consider. For example, with all the volatility in the markets, it could be a good opportunity to consider tax loss harvesting strategies to help offset any gains you might have or even consider a Roth IRA conversion if you have room in your tax bracket this year.
Now I'll stop there since I've covered a lot. And if your hand is tired from trying to write all this down, I have a solution for you. We have a new report called year-end moves for your financial strategy that you can get from your financial advisor, which covers all of these items and more. And by talking with your financial advisor, together you can determine which moves might make the most sense for your situation, as well as ensure you meet any deadlines to better position yourself to achieve what matters most to you.
Hello, everyone, and welcome to the September Market Compass. You know, it's hard to believe we're at the fourth quarter of 2023, but I guess time does fly when you're having fun in this market. Now what I thought I'd do today is highlight four themes for the fourth quarter. Probably the most pressing questions we've been getting from investors. These themes include the Fed, inflation, the US consumer, and finally, where are the opportunities for investors in this backdrop, especially given that yields remain elevated, cash like instruments can still offer over 5%?
Now let's dive right in. First on the Federal Reserve and its path going forward. We in fact heard from Jerome Powell and the Fed on September 20th. Overall, the message did seem to be rates will be higher for longer. Inflation is still above the Fed's 2% target. And notably, headline inflation has been driven higher recently with the rise in oil and gasoline prices. Issues like the recent United Auto Workers strike could impact inflation as well.
However, when we look at the Fed's own updated set of projections, we can highlight a few quick takeaways. Firstly, the Fed still does see the terminal Fed funds rate at 5.6%. Now that does imply potentially one more rate hike ahead. And they still expect to cut rates in 2024. But these estimates now indicate two potential cuts instead of the four that were penciled in June.
They also see inflation gradually moderating but not reaching the 2% goal until 2026. And the unemployment rate doesn't rise as much in these new projections, peaking at 4.1% versus the 4.5% in the June forecast. Now notably they have upgraded their outlook for economic growth this year given the resilient consumer and jobs market, but they do see it cooling somewhat in 2024.
Now in our view, the Fed will likely remain on this extended pause until 2024. We don't believe they'll signal any rate cuts until inflation. And especially, core inflation is more meaningfully towards that 2% target. But the outlook on growth and unemployment could be downgraded if we see a more meaningful slowdown in consumption ahead.
So this brings us to theme two, the inflation outlook. Speaking of inflation, what is our outlook going forward? Well, inflation really has been a tale of two price indexes. Headline inflation, which has come down as low as 3% on CPI inflation, has in the last couple of months ticked higher to 3.7%. This has been driven by higher oil and commodity prices, as well as the easier comparisons after June of last year.
Now while oil prices could stay elevated, it's known to be a volatile series, over time, prices could moderate as demand cools and offsets the recent decreases in supply. Now on the other hand, core inflation has continued to ease. We see here that core CPI inflation has gone from 6.6% to 4.3% in August, very gradually and steadily moving in the right direction.
The Fed has historically preferred to look at core inflation as it does take out some of the more volatile components of food and energy prices. So this trend lower is certainly welcome news for the Fed. And we believe core inflation should continue to moderate. Why is that? Well, we see the shelter and rent components of inflation, which have come down in real time, starting to impact that CPI basket on a live basis.
We also see wage gains, which have kept core services inflation elevated, continuing to ease as well, especially after the job market has shown some early signs of cooling. And so that brings us to our third theme for the fourth quarter, which is consumer, and specifically, consumer fatigue. Now the consumer, which as we know, is the backbone of the economy, has remained quite resilient this year thus far. And consumers have been enjoying support by a strong jobs market and higher levels of excess savings coming out of the pandemic.
But as I noted earlier, we're seeing early signs that the job market may be cooling, including lower job openings and lower voluntary quits rates, as well as some workers returning to the workforce after a hiatus. Now in addition to a cooling job market, we know consumers have worked down the excess savings that were built during the pandemic, and credit card debt has also climbed higher.
Now as this summer travel season ends, the US consumer is faced with still elevated interest rates, a slightly softer jobs market, lower savings, and higher debt levels overall. Now consumption has remained quite resilient already. We wouldn't expect it to fall dramatically, but we do think a period of slower consumption growth could be a credible scenario ahead.
And finally, our fourth theme. Where are the opportunities in this backdrop? Overall, markets have performed fairly well this year. The S&P 500 is up nearly 16%, and bond markets, while returns are flat, have offered better yields. Short duration CDs and money market funds are offering 5% in many cases, and investors may be wondering if they should park their money here, particularly if consumption and growth are set to slow.
Now while having some cash-like exposure, depending on your profile, is appropriate, we would caution against being too overweight these cash-like instruments. And there are three main reasons for this. First, the opportunity cost is certainly there in holding cash. As we've seen this year with the S&P 500 up 16%, the tech-heavy NASDAQ up about 30%, being too weighted in cash means investors may miss better potential returns elsewhere.
Secondly, there is some reinvestment risk. As we noted, the Fed may pivot to rate cuts in the months ahead. And interest rates overall may trend lower. So investors that are looking to reinvest their CD money may have to do it at lower rates in the future.
And finally, and probably most importantly, there are interesting opportunities forming in both stocks and bonds. In the stock market over time, especially as we re-emerge from any slowdown in the economy, we may see a broadening of market participation. This could include areas like cyclical sectors, small cap stocks, in addition to technology and AI.
And in bonds, we have seen an attractive opportunity now forming in longer duration bonds in particular, especially those that are investment grade. This comes as the Fed not only holds interest rates steady but over time, moves them lower. Now with that, I thank you for joining me to discuss the four themes for the fourth quarter, and we certainly hope to see you back here next month for another Market Compass.
Hello, everyone, and welcome to the August edition of Market Compass. We are more than halfway through the year. And the one word that seems to capture the economic and market activity is resilience. Despite strong headwinds of high borrowing costs, still elevated inflation, and geopolitical uncertainty, the US economy has fared much better than expected. The same goes for corporate profits and equity markets, which we're not going to complain about.
Even though major indices have been more volatile recently, large cap stocks are up more than 20% from last year's lows and are not far from their all-time highs. So what justifies the move higher in stocks? We think the improvement in inflation, a strong labor market, and expectations for an end to the Federal Reserve's rate hiking cycle have moved us away from any worst case scenarios. But hefty gains taken together with flat earnings growth for the S&P 500 this year mean that valuations have increased, and investors need to be more selective going forward.
Historically, August and September have been less favorable for stocks, with volatility tending to pick up. However, this shouldn't be a reason to stop working towards your long-term goals. With that in mind, here are three opportunities we see in today's markets based on the macroeconomic conditions we expect for the rest of the year. The first, diversify into lagging segments of the equity market that carry lower valuations.
Until recently, market leadership has been very narrow, with just a handful of mega-cap technology stocks accounting for the majority of this year's gains. Beyond the largest seven S&P 500 companies by market cap, gains have been more modest not only within the S&P 500 itself, but across other indices and asset classes. These include value-style investments, small caps, and international equities, which trade at a larger than average discount.
From a sector perspective, so far this year, only 3 of the 11 sectors have been able to outperform the S&P 500 index, while some defensive sectors have posted losses year to date. We think participation could broaden, and therefore recommend investors rebalance as appropriate. The second opportunity we see is the dollar cost average to take advantage of the potential for higher volatility. We think the path has widened for the economy to avoid a recession, but some downside risks to growth remain.
Historically, a strong first half of the year has been associated with further gains for the remainder of the year, but with deeper pullbacks. To avoid trying to time the market and also take advantage of the potential for volatility, we recommend investors dollar cost average by investing systematically at regular intervals. Dollar cost averaging can spread out your purchases and help you buy more shares when prices pull back.
The third opportunity is to complement, in our view, CDs and other cash-like investments with longer term bonds. Yields are historically attractive across the curve, providing great opportunities for investors to generate income in certificates of deposit, as well as longer term bonds. We think this is a good time for investors to complement their CDs and short-term bonds with longer duration bonds that have higher interest rate sensitivity.
These bonds offer the opportunity to lock in historically high yields for a longer period. They also may appreciate if yields start to move lower as economic growth softens and the Fed starts cutting rates possibly in 2024.
To highlight this exact point, let's look at some historical data going back to 1980. Over the past seven rate hiking cycles, 10-year yields have declined by 1% on average six months after the Fed's last rate hike. This highlights that the end of tightening can be a positive catalyst for government bonds, which experienced a historic decline last year.
To sum up, we think that the evolution of growth and inflation provides a solid foundation for stocks to remain in a sustainable uptrend, but with higher volatility in the months ahead. Yet, market gains over the past several months should not be a reason to stay on the sidelines as we still see opportunities in parts of the equity market, including the defensive sectors. And within fixed income, we see an opportunity to position for potentially lower yields next year. With that, thank you for joining us. We hope to see you again next month.
There's an old saying that markets climb a wall of worry, which would be an appropriate characterization a performance so far this year. Those worries have been centered on a potential recession, and that climb has taken the form of an 18% year-to-date rally in the S&P 500.
So we came into 2023 expecting a mild brief recession to emerge, and the good news is that hasn't happened. As the strength of the consumer has kept a contraction at bay that does not however mean a recession is canceled. As our evaluation of underlying economic trends and signals suggest to us that a slowdown is still a likely outcome.
With the economy setting the foundation upon which market performance is built and with markets likely to remain focused on the recession or no recession debate, here's our take on four key questions. First question, given the calls for recession, why isn't one materialized?
Second, is the timetable simply pushed back, or can we avoid a recession altogether? Third, what would a recession look like if one were to materialize? And four, what are the implications for the financial markets and investors?
So let's circle back. Question one. Given the calls for recession, why hasn't one materialized so far this year? Well, it really starts with consumer spending. Consumer spending accounts for 70% of GDP in the US, and that area has been particularly resilient. In fact, in the first quarter of this year while the economy was growing at a little bit better than 2%, consumer spending was growing at better than 4%.
So this has been supported by a very tight, very healthy labor market that's remained significantly stronger than we had anticipated in the first half of 2023. And this includes a half century low in the unemployment rate, as well as elevated wage growth. Of note, services spending has been the standout as consumers have returned to more normal spending habits following the pandemic. Keep in mind after the pandemic, a lot of the spending was oriented on goods we're now seeing that shift back to more normal spending on services.
So the second question, is the timetable simply push back, or can we avoid a recession altogether? The resiliency of the economy is most certainly welcome, nobody's going to complain about a recession not emerging. But a look under the economic hood, signals to us that a slowdown is still a likely outcome. The strength in consumer spending has to a degree masked weakness in other areas of the economy, most notably manufacturing, business spending, and housing.
We think the economy will slow as we move through the back half of the year driven principally by slower consumer spending. Key employment indicators, like initial jobless claims have shown some deterioration, monthly payroll growth has also slowed, and wage gains are moderating. In addition to that, accumulated household savings, so the amount of savings we have on top of our income, which topped more than $2 trillion following the pandemic has been drawn down more recently. A little less dry powder for consumers to spend.
We don't think consumers will have to go into full hibernation. But as the labor market conditions soften, we think the source of strength for the economy so far in 2023 will lose a bit of steam. We're mindful that the Fed has embarked on historically aggressive tightening campaign in the last year raising its policy rate by more than 5% in an effort to quell high inflation.
Monetary policy tightening traditionally acts with a lag taking some time to fully filter its way through the economy. And we think the full effects of the Fed's rate hikes are still working their way through the system and will ultimately result in a slower economy ahead.
So to be clear, a recession is not inevitable. And the path toward a soft landing for the economy, in which the Fed brings inflation down without clobbering the economy completely is still a very viable path. But we're careful not to dismiss underlying signals that have traditionally heralded a slowdown.
So then three, what would a recession look like? Well, this is where the news gets much better. Our view coming into the year was that any recession that did emerge was going to be mild and short based in part on our view that the health of the labor market, and the consumer heading into this phase would be helpful. In part because there were no major economic bubbles or systemic imbalances that would produce a more severe outcome.
Good examples of these two would be 2008-2009 where the housing bubble popped caused a lot of consumer deleveraging that drove a more severe downturn. Whereas in 2000-2001, consumers were a bit more resilient through that phase and we saw a more shallow downturn in the economy.
So in our view, the slowdown will take the form of what we would call a rolling recession. Meaning that various areas of the economy will slow and recover at different times. We've already seen a meaningful downturn in manufacturing, and housing market activity, and in business investment. And in fact, we're seeing early signs that production is stabilizing, and the latest reads on the housing market are indicating a bit of a rebound.
As input and labor costs moderate, we expect to see some resiliency in business spending as well. This could transpire at a time that consumer spending is softening. Meaning that the overall GDP levels may not fall dramatically, even though underlying components of the economy are experiencing recessionary conditions.
Question four then. So what are the implications for financial markets and for investors? There are reasons for investors to be optimistic about the markets even as the economy is slowing. It's critical to remember that markets are forward looking, historically stocks on average have declined around 30% during recessionary bear markets.
We think last year's 26% decline between January and October already anticipated some of this mild recession that we think could take shape. Looking back at Bear Markets since 1948, each started before a recession occurred. And markets began their recovery before the economy rebounded.
To be clear, we don't think markets will ignore emerging evidence of a slowdown, but we don't believe that will drive a return back to the lows and the stock market of last October. We think greater volatility and a mild pullback could emerge as we progress through the back half of this year. But we think that should be viewed as an opportunity by investors, not a warning sign of a more prolonged or severe sell off.
Interestingly, we think the slowdown in the economy can actually have a silver lining for the markets. As consumer spending softens, that should help the downward path for inflation, and in turn, allow the Fed to back away from restrictive interest rate policy. Thus, we think a market pullback spurred by signs of economic weakness can be mitigated by the prospects of less aggressive Fed tightening and potentially lower interest rates next year.
Looking at the comparison between earnings yield on stocks and the yield on bonds or higher interest rates, we've seen that relationship has trended toward levels very similar to prior stock market recoveries that began in 2009 and in 2018. This there's no guarantee that the coast is clear, but we believe that despite the risks of recession, investors can have confidence that a durable bull market will ultimately take shape.
Hello, everyone, and welcome to the June Market Compass. It's hard to believe we're now squarely in the middle of 2023, looking out to the second half of the year. Now what I thought I'd do first is recap some of the themes that have played out in markets so far. And then I'll talk about three themes for the back half of the year, including, number one, a cooling in economic growth and inflation, number two, the Federal Reserve potentially stepping to the sidelines on rate hikes, and number three, the opportunities we see forming in both equities and bonds.
So first, two trends to highlight in equity and bond markets this year. Number one, while equity markets have moved higher, leadership has been narrow. As you can see from this chart, while the S&P 500 overall is up over 13% this year, only three sectors-- technology, communication services, and consumer discretionary-- have outperformed the broader index.
Now, these three sectors are up over 25% year to date, while the remaining eight sectors are up modestly, flat, or even down for the year. Now while it's certainly welcome to see positive returns this year, in our view, broader leadership is a healthier sign for markets. And we would actually expect this to occur as we head into the back half of 2023.
Now second, unlike stock market returns, bond market returns have been somewhat more muted thus far. Rates continue to move higher, pushing bond prices lower.
In fact, the Barclays us Aggregate Bond index is up just about 2% this year. As you can see from this chart, two year and 10 year US Treasury yields have moved higher in the past few months, as expectations for Federal Reserve rate hikes continue to climb as well.
Now this has put some pressure on bond returns near term. But we would expect yields to be peaking in the months ahead. We'll discuss this more in our themes for the second half.
So given this backdrop in equity and bond markets, what are the key themes we see for the back half of 2023? We'll highlight three.
First, we continue to see signs that the US economy may continue to soften, and potentially a mild recession may emerge in the back half of the year. However, we still do not expect any downturn to be deep or prolonged. And in fact, we may ultimately see this downturn manifest as a slowing in growth to below trend levels of about 1 and 1/2% here in the US.
Now we also believe that inflation will continue to moderate as the year progresses. Keep in mind, both the consumer price index and producer price index inflation metrics for the month of May have come in lower than expectations, especially on a headline basis. And we've seen now the 11th consecutive lower reading since inflation peaked back in June of 2022.
Now our view is that inflation should continue to moderate, likely heading towards about 3% on a headline basis by year end. And what factors do we look at that support this view?
Well, here are a few forward looking indicators to highlight. First, ISM prices paid indexes for both manufacturing and services have moved lower. Next, global supply chain pressure indexes have eased and actually are now back to pre-pandemic levels. Home and rental price appreciation has moderated, which tends to show up with a lag in the inflation metrics.
And finally, labor markets have been solid. But some early signs of cooling have emerged, including rising jobless claims and a lower total number of job openings.
Now the second theme for the back half of this year is that the Federal Reserve will likely pause its interest rate hiking cycle. As you can see from this chart, the Fed's estimate of its terminal or peak Fed funds rate has climbed higher since early March of 2022.
The latest set of estimates by the Fed indicate that the peak Fed funds rate may now be close to 5.6%, which implies about two more rate hikes from here. However, we believe the Fed will be data dependent. They will pay close attention to the incoming economic and inflation data.
And if those data don't warrant two additional rate hikes, they may not implement these. But more broadly, we do believe that overall the Fed is nearing the end of its tightening campaign.
Now while rate cuts are not likely this year, a pause in rate hikes will be welcomed by markets, especially if this is because inflation has moved closer to that 2% target range.
Finally, the third theme for the second half of 2023, the opportunities we see forming in both stocks and bonds. Now in equities, we would look for broader participation in leadership, particularly as investors look towards 2024.
We think that could bring lower inflation, lower interest rates, and better earning trends overall. Leadership could include small cap stocks, cyclical sectors, such as industrials, materials, consumer discretionary, alongside the AI and technology themes.
Now in bonds, we see an opportunity to complement some of the short duration bonds and cash like instruments with longer duration bonds, particularly in the investment grade space. Now keep in mind that the peak in treasury yields typically occurs one to two months prior to the peak in the Fed funds rate.
This could imply that peak yields are likely, perhaps in the weeks ahead. This would present an opportunity for longer duration assets, as investors can not only capture better yields, but also have the potential for price appreciation as the Fed pauses and ultimately pivots lower.
So with that, hopefully, we've given you some good food for thought on the themes and opportunities for the second half of 2023. And we'll see you back here for the July market compass.