When it comes to making accurate economic and stock market prognostications, professionals on Wall Street do not necessarily have the best track record. This could be clearly seen in predictions that were proffered at the end of 2022. I would venture to say that the vast majority of economists and market strategists predicted a recession arriving at some point during 2023. The main reason cited was the Federal Reserve’s aggressive war against inflation. Moreover, many equity market strategists predicted stock market returns to be only modestly positive at best.
To be sure, hindsight is 20/20, and both predictions turned out to be wrong. Although the financial markets faced both economic and geopolitical headwinds, the economy successfully avoided recession. And the stock market recorded strong double-digit returns, led by the superior performance of a handful of leading technology companies. Thus, one wonders why investment professionals even bother attempting to offer predictions in such an uncertain world.
To answer that question, I recall my years working on Wall Street when a colleague of mine at Morgan Stanley, Byron Wien, would actually go out on a limb with his predictions. At the close of every year he would pen a list of “10 Surprises” for the coming year.” Many of these surprises ostensibly had a low probability of occurring. But many investors and business news media outlets eagerly anticipated and paid careful attention to Byron’s list.
My interest in this list had nothing to do with whether I thought Mr. Wien was the best at making predictions. Despite the fact that many of those predictions seemed outlandish, reading the narratives on this list helped me develop a better understanding of the potential fault lines in consensus forecasts. Imagining the possibility of various “Black Swan” events occurring helped me better position client portfolios that I manage. I weighed the risks of those events coming to pass and positioned portfolios to withstand those possible events in a way that reduces overall portfolio risk.
Mr. Wien passed away this past year at the age of 90 and there does not appear to be any heir apparent to his annual list. Thus, to help fill a void, I will attempt to mimic Mr. Wein in the hope of helping investors think about some of the risks and opportunities for 2024. For the sake of brevity, I will limit my predictions to three. So here goes:
- Interest Rates Will Remain Stubbornly High
The consensus estimate is for the Federal Reserve to cut interest rates as many as six times this year from the current 5.25%-5.5% range. While the Federal Reserve’s tight interest rate policy is showing signs of success in reducing the rate of inflation, I believe there is a chance that the progress will stall. In fact, I believe that the rate of inflation could perhaps even creep higher in the second half of the year. While commodity prices have declined substantially from the peak, there are other factors that could cause rising inflationary pressure. To mention just a few, housing prices are still increasing as the shortage of available housing stock is limiting available supply. The settlements of union strikes, particularly in the airline and auto manufacturing industries, include substantial pay raises well into the future. Finally, the labor market continues to be historically tight, putting upward pressure on wages. Those cost pressures will need to be passed along to consumers in the form of price increases. These factors could make the Federal Reserve much less likely to substantially lower interest rates anytime soon.
- The US Economy Enters A Recession in 2024
If the Federal Reserve is done raising interest rates, why would the economy fall into recession? There are two main reasons in my opinion: First, there is historically a meaningful lag effect on the economy when interest rates rise. Thus, we may have seen only some of the economic effects of the rise in interest rates in 2022-2023. Heavily indebted companies, particularly in the commercial real estate sector, could be pressured. Office property managers are at risk of seeing declining operating income due to stubbornly high vacancy rates. Those that have near term debt maturities will likely encounter added stress as they refinance at significantly higher rates. From the consumer standpoint, many lower-end consumers have been economically walloped by the effects of inflation in recent years. They are seeing their strong liquidity positions from the pandemic stimulus checks deteriorate rapidly. While potential interest rate cuts may be coming, it may not be enough to forestall a credit crunch that may send the economy into recession.
- Goodbye AI – Hello Value
While we believe the stock market could have modest positive returns in 2024, some of the high-flying technology stocks may begin to struggle.
Expectations for strong growth in large technology companies over the next few years, driven by AI innovation, could already be reflected in the prices of those stocks. Any disappointment in the rate of growth could be met with a wave of selling.
More generally, the market valuation premium of growth stocks over the more pedestrian sectors of the market such as banking, energy and health care, is at an historically wide gap. In fact, because of this yawning gap, investors may want to consider 2024 as the beginning of a potential multi-year cycle of value stocks outperforming growth stocks.
Takeaways
As a play on Vice Presidential candidate Lloyd Bentsen’s stunning rejoinder to former Vice President Dan Quayle: I knew Byron Wein, I worked with Byron Wein – Mr. Caplan – you are no Byron Wein! But I think it is quite prudent for investors to try to think outside the box when assessing the risks and opportunities in investing. I believe that based on the three predictions above, one should ask:
- Is my portfolio structured to withstand a continued high interest rate environment?
- How would a recession affect the earnings of the stocks that I own?
- Are the securities that I own positioned to perform if optimistic expectations, particularly for large technology companies, do not pan out?
Here’s wishing you a terrific and successful 2024!
Investment Advisory Services are offered through Mariner Independent Advisor Network (MIAN), an SEC Registered Investment Adviser. Caplan Capital and MIAN are not affiliated entities. Some information provided herein has been obtained from third party sources deemed to be reliable as of the date of original publication, and rules, laws and legislation are subject to change without notice. This article should not be considered personalized advice, and it is important that your unique circumstances be taken into consideration prior to making any financial decisions.
