Q4 2024 Market & Economic Outlook

 

Current Economic Views

The U.S. economy continued to grow at a solid pace as inflation cooled, job growth held steady, and the Federal Reserve lowered interest rates for the first time since 2020.

 

Inflation levels (Consumer Price Index) have continued to fall from the June 2022 peak of 9.1%, most recently reported at 2.5% in August. With inflation trending lower, the Fed cut interest rates by 0.50% in September and signaled further cuts in 2024 and 2025.

 

Unemployment remains low at 4.1%. Job growth has continued, albeit at a slower pace. In 2023, the economy averaged 251,000 new jobs each month; in 2024, job growth continued at 200,000 per month and remained solid at 186,000 in the third quarter.

 

At the September meeting, the Fed announced its projection for growth (Gross Domestic Product) of 2% for 2024 and 2025. The Fed’s Summary of Economic Projections signaled two additional rate cuts this year, with more in 2025. The Fed’s preferred measure of inflation, core PCE, dipped to 2.7% annually in August; while there is progress, it remains above the Fed’s 2% target.

 

Major overseas economies such as Europe and China have underperformed relative to the U.S. However, with global inflation falling, central banks in Europe have lowered interest rates to boost future consumer and business spending.

 

China lowered interest rates and took further steps by announcing additional measures to stimulate the economy, including lowering down payments for housing and efforts to boost corporate spending and investment, including stock buybacks.

Looking ahead

We still expect a “soft landing” as ongoing job gains and lower interest rates can maintain U.S. consumer spending levels. Job growth has slowed, and consumer confidence measures are weak, but household balance sheets remain solid.

 

At the beginning of October, Bloomberg pegged the chance of a recession in the coming 12 months at 30%. Additional rate cuts should happen this year, lowering interest expenses even further for businesses, credit cards, auto loans, and student loans. Mortgage rates should trend lower, too.

 

Looking ahead to 2025, estimates for global growth appear steady at 3.1%, with the U.S. at 1.7%. Global growth estimates for 2026 are also 3.1%, and additional rate cuts should be a tailwind for global growth in the coming months.

 

Given the uncertain U.S. election, we expect business and consumer surveys to remain weaker in the near term. The results can impact future tax, trade, and regulatory policy, which in turn can impact business profits.

 

Other areas of concern include rising government debt, an ongoing labor shortage, and a potential escalation of the ongoing wars. Overall, heading into 2025, we expect the U.S. economy to grind ahead but at a slower pace.

Current Investment Views: Equities

Equities continued upward, producing a 5.89% total return for the third quarter. The increase is the fourth consecutive quarter of index price appreciation.

 

Inflation continued to cool in the third quarter, providing the Federal Reserve coverage to cut rates. Meanwhile, the employment picture began to deteriorate – which caused many investors to worry the Fed was behind the curve – and the labor market replaced price stability as the biggest unease in investors’ minds. Recession fears began to reassert themselves, with negative economic surprises and lower long-term interest rates no longer supportive of equity price multiples. Instead of quelling overheating and higher-for-longer rate regime concerns, weaker data triggered distress that the economy had already entered a negative feedback loop between employment and activity.

 

In response, the Fed cut rates by 50 basis points in September, which surprised many.

 

As a result of the mid-quarter risk-off sentiment and September dovish monetary policy surprise, market internals skewed towards defensive and rate-sensitive areas of the market. The best two performing sectors were utilities (up 19.4%) and real estate (up 17.2%), which benefit from traditionally defensive characteristics and lower interest rate dynamics.

 

Policy normalization also contributed to an improvement in market breadth. While large-cap growth stocks – and more specifically, “Magnificent 7” stocks – led first-half 2024 returns higher, small caps and value regained market leadership in the third quarter, while large growth was the worst-performing style box.

 

The Equal Weighted S&P 500 returned 9.6%, surpassing its cap-weighted counterpart.

Looking ahead

Our outlook remains unchanged from previous quarters.

 

We anticipate inflation will continue moderating towards the Fed’s 2% target. Activity should remain buoyed by a still historically strong labor market, elevated consumer net worth, tech-driven capital spending, and lower consumer/enterprise interest rate sensitivity than previous times – supporting real GDP growth around 3%.

 

In other words, our base case remains a soft landing scenario.

 

Forecasts call for S&P 500 sales to increase 4.7% year over year in the third quarter, consistent with our nominal GDP expectations outlined above. Consensus third-quarter earnings per share estimates stand at $60.50, down from $62.73 coming into the quarter. This represents a 4.3% year-over-year growth rate – a deceleration from the previous four quarters.

 

We think the lower forecasted earnings per share growth reflected uncertainty and resulted in conservatism expressed by management teams when providing third-quarter guidance on previous calls.

 

A lower bar into earnings could produce a more favorable backdrop for companies to beat expectations.

Current Investment Views: Fixed Income

Yields across the curve declined significantly during the third quarter. The 10-Year U.S. Treasury dropped 61 basis points, ending at 3.78%, and the 2-Year U.S. Treasury declined by 111 basis points to 3.64%, meaning the 2-Year/10-Year spread ended the quarter positive for the first time since 2022’s second quarter. Although volatility remained high, there was a clear downward trend in yields throughout the quarter. Reasons for this downward momentum include:

 

• Investors welcomed a full quarter of inflation reports essentially in line with the Federal Reserve’s target. Core PCE inflation, the Fed’s preferred inflation gauge, showed an annualized 2.1% increase in the June-August timeline.
• The labor market continued to cool to levels more consistent with pre-pandemic times. Weaker job growth and further rises in the unemployment rate suggested that it was time for the Fed to begin loosening restrictive monetary policy. Market fears of an impending recession resurfaced.
• Fed officials showcased their commitment to staying ahead of the curve by opting for a half-point cut at the September meeting and forecasted several more cuts to come.

 

Credit spreads (the excess yield investors demand for holding a corporate bond instead of a similar Treasury) were largely unchanged despite heightened volatility. The average U.S. Investment Grade spread finished the quarter down four basis points to 92 basis points, although it reached 112 basis points in early August. The average U.S. High Yield spread tightened 18 basis points to 303, down from its early August high of 393 basis points.

 

Overall, the fixed-income market welcomed the first rate cut since March 2020, but investors are still waiting for more guidance on future monetary easing.

Looking ahead

In the Fed’s latest economic projections, the median unemployment projection increased from 4% to 4.4% at year-end to reflect the recent softening in labor market conditions. The Fed’s median core PCE inflation projection for the end of the year decreased to 2.6% from 2.8%.

 

Given that the Fed now sees inflation and unemployment risks in balance, the median projection for one quarter-point rate cut in 2024 increased to four cuts. The 2025 and 2026 median projections moved lower in conjunction with forecasts for greater easing in the near term. Fed members generally expect a slow and steady easing cycle.

 

The path of rate cuts is uncertain because of the recent economic data and diverse projections from Fed members. Despite improvements, inflation is still above target, but the labor market has weakened. The growing national debt, international conflicts, and the uncertainty around the elections also create more unknowns. The Fed is balancing both sides of its dual mandate for an economic soft landing.

 

We still think a soft landing is in the cards, but the odds of an economic slowdown have increased. Monetary policy acts with a lag, and downturns in the labor market can happen quickly.

Asset Spotlight: Oil

Oil is one of the world’s most important assets. Oil prices impact the economy, consumer sentiment, inflation, foreign relations, and elections.

 

The U.S. oil and gas industry makes up about 8% of the nation’s GDP and roughly 10 million related jobs.

 

Oil prices are notoriously volatile. Past geopolitical shocks that led to higher oil prices (e.g., the Russia/Ukraine war) led to higher prices at the pump. Frequently, when oil prices dip back towards equilibrium, gasoline prices will follow but with a substantial lag.

 

Recently, oil prices hit a three-year low, and some pump prices are under $3 a gallon. China’s economy (one of the world’s largest oil importers) has been sluggish. Also, the U.S. and other American producers have increased production.

 

Russia is China’s largest supplier of oil, and the relationship strengthened after the U.S. imposed sanctions on Russia after it invaded Ukraine. While Russian oil exports have increased recently, oil prices were declining in part because China’s economy was stagnant. Oil consumption is down on a year-over-year basis. China is also buying EVs. Roughly half of the country’s new car sales are electric¹. Lastly, the high-speed rail network is reducing air travel.

 

The outlook for oil demand can also impact prices. OPEC+ recently revised its forecast lower for this year and 2025. Additional curbs may be forthcoming with non-OPEC+ supply rising faster than demand.

 

Dropping oil prices helps on the inflation front. Oil is a large contributor to the energy portion of CPI, and energy makes up about 8% of the overall inflation metric. Also, it is hard to have a recession if gas prices are falling. Lower pump prices leave more household income for other spending and lift consumer sentiment.

Looking ahead

Crude oil has been trading around $75 a barrel and is up about $5 since the start of the year due to China’s stimulus measures and the Israel/Iran conflict. Outside of another short-term supply shock, the near-term path of least resistance appears to be flat or slightly declining.

 

Recently, OPEC said 2024 oil demand would rise by 2.03 million barrels per day, down from 2.11 million barrels per day in a previous estimate. OPEC downwardly revised China alone by 50,000 barrels.

 

Longer-term forecasts are murkier. In addition to the Middle East conflicts several issues are worth watching.

 

One emerging trend is oil transactions in currencies other than the U.S. dollar. Russia and Iran have stepped up oil sales in alternative currencies, and other oil exporters are exploring this option, too.

 

According to estimates, about 20% of oil sales now occur in currencies other than the dollar. U.S. sanctions could lose some impact if countries move away from the dollar. The U.S. is the world’s reserve currency, which comes with great global economic influence.

 

Also, the shift to green energy is rising in the U.S. and Europe. Vehicle fleets and transport modes are moving away from fossil fuels, and government entities are funding clean energy.

 

¹ NPR