Stocks were mixed Friday after a solid December employment report. But the Dow ended up falling for the first time in 10 weeks. 10-year Treasury bond yields rose back over 4%.
One of the indicators that has modest statistical validity is the January barometer. It says, as goes the first day, week and month, so will go the year. Markets fell on both the first day and first week. The strongest statistical validity relates to the whole month as a forecasting tool, but January is off to a weak start. Economic data last week was mixed. Retail sales held up rather well through Christmas and even into the days after. Car sales continued to rise but at a slower pace. And, Friday’s employment report showed a net gain of over 200,00 jobs in December, consistent with a forecast of a soft landing. With that said, and given data is still decelerating amid a continued tight money environment, it’s still a 50-50 bet whether the economy falls into recession in 2024 or not.
The fall last week was led by profit taking among the leaders of 2023, notably the Magnificent 7. The issues that surfaced, however, weren’t just technical and profit taking. One leading brokerage downgraded Apple as iPhone sales appear tepid at best. Tesla had a reasonably solid fourth quarter, but ceded its leadership EV position to BYD, a Chinese manufacturer. Tesla’s only new vehicle for 2024 and well into 2025 is its Cybertruck, unlikely to continue the accelerated growth trend by itself. For Tesla to enjoy strong double digit revenue growth in 2024, it will have to cut prices further. Doing that and maintaining margins will be a difficult task. In 2024, the company is likely to introduce its successor low-cost models. Tesla’s history of hype suggests meeting original pricing targets will be tough. It’s stock price still reflects auto manufacturing margins in the future far above industry averages. We will see in time whether reality meets the hype. But it serves as a warning that coming anywhere near 2023 performance for the Magnificent 7 will be a tall order.
The performance of the Magnificent 7 alone is not the only issue or even the major issue facing investors as 2024 begins. Most believe that the Fed’s last Fed Funds rate increase was last July. Markets still believe that a cut is more likely than not at the March FOMC meeting and as many as 7 are possible in 2024 (assuming each cut is 25 basis points). Virtually no one expects a cut at the January meeting, suggesting every subsequent meeting this year is a live one with a rate cut each time more than likely. Whether there is a recession or not, that seems to be a tall order. Thursday the government will issue the December CPI report. For a first cut to come in March, that reading has to be very benign and be followed by continued signs that inflation is receding in both January and February. Last Friday’s employment report showed wages continue to rise about 4% annualized, a number that is consistent with 2% inflation only if productivity can improve at or near a 2% annualized pace.
But if interest rates have peaked, and most, including myself, believe they have at the short end of the curve, that leads to several key considerations. First, the yield curve is still inverted. At the short end, yields on Treasury bills and money market funds are still close to 5.4% versus a 10-year Treasury yield a shade over 4%. From 5-years on out, the yields are centered around 4%. The inversion is all at the short end. As the Fed cuts rates, whatever the pace may be, the curve should uninvert. 200 basis points of rate cuts, a minimal expectation if the economy normalizes near a 2% growth rate and inflation stabilizes around 2%, will do the job. Markets think that can happen sooner than Fed officials think. But it should happen.
That means lower rates, perhaps all along the curve should the economy slip into recession in 2024. If that proves to be true, bonds are likely to be an attractive investment. Lower yields equate to higher bond prices. If yields along the curve are at 4-5% or better, and prices rise to reflect a trend toward lower rates, the combination will make bonds an attractive investment in 2024. Just using risk-free Treasuries as a proxy, returns could average mid-high single digits depending on one’s chosen duration. Using corporates or munis could increase the return commensurate with the added risk. That makes bonds a lot more competitive with stocks putting pressure on equity valuations, at least in the short run. A counter balance, however, is that lower yields in time could raise equity valuations by justifying a higher price-earnings ratio. But that will only happen if longer term rates (10-year or longer maturities) experience a sustainable decline. That remains an open question dependent on economic performance during the year.
There are other headlines that gain attention. There is an ongoing climate change debate. The one near certainty in 2024 is that Congress is unlikely to enter that fray. But, whatever the cause of a warmer planet, the facts are unassailable. Earth is getting warmer and the economic consequences are rising. Nowhere is that more evident than in the insurance marketplace where the costs of fires, hurricanes, etc., are forcing insurance companies to jack up rates and even withdraw from markets where risks are highest. Combine the costs to protect property with the costs to provide needed medical care and it’s clear that insurance is going to become an increasing focus in the years ahead. As the problem becomes national and increasingly in focus, you can guarantee that government officials will have their say. Since getting to a consensus is increasingly difficult these days, the rhetoric will be high. Actual reactions will vary by state. For consumers, getting proper coverage at a reasonable cost will become a challenge. The likely outcome is that more and more will effectively self-insure a greater part of the risk by accepting larger deductibles or by not buying insurance at all.
2024 is also campaign season. Biden and Trump will be trying to stake ground for a differentiated agenda beginning in 2025. For Biden, that means doubling down on his progressive ideas like free community college, forgiving student loans, and increasing taxes on the wealthy to pay for everything. Nothing will happen in 2024. It will only happen in 2025 and beyond if Democrats control Congress. Keeping control of the Senate will be especially difficult given that most of the toss-up seats in November are currently held by Democrats. As for Trump, he will push again for his America first agenda and lower taxes. And, of course, completing the wall along the Southern border. Being more a populist than a conservative, he won’t attack entitlement spending. His campaign is almost certain to center around his own persona rather than major issues. He may have a better chance of moving forward an economic agenda in 2025 but Republicans are unlikely to get anywhere near 60 votes in the Senate, limiting what he will do. The bottom line is that political bluster in 2024 is going to be much greater than the economic impact, assuming Biden and Trump are the nominees. That still appears likely, but in politics, changes happen rapidly. So, don’t write anything in ink quite yet.
Earning season starts later this week and will accelerate rapidly over the following two weeks. There are few reasons to expect Q4 to offer bad news. GDP growth appears to have been solid as was the Christmas retail season. But the reaction to earnings will be all about the future outlooks company managements present as they report results. Except for hot sectors least dependent on the overall economy, managements are likely to be very cautious. All want to offer guidance that is achievable and none are likely to be excessively optimistic. Whether a recession or soft landing lies in front of us, the skies are far from blue. High credit card costs pressure consumers. The impact of rapid inflation over the past two years continues to hit our collective pocketbooks. Short-term, it’s hard to be an aggressive investor in front of these reports, especially knowing that corporations that report earnings over the next three weeks are unable to buy back stock until after results are reported. Thus, even if one believes markets overreacted to the downside last week, it might be wise to wait a little longer to dive in.
A good old-fashion correction of 5-10% would be healthy for markets. A larger correction is possible if a recession becomes reality. But that’s skipping ahead. So far, no data supports that conclusion. As always in earnings season, have a shopping list and take advantage of overreactions. At the same time, listen to managements. If your expectations and those of management are out of alignment, it may be time to move on elsewhere.
Today, North Korean leader Kim Jong-Un turns 40. Veteran CBS broadcaster Charles Osgood turns 91. I’d rather listen to him.
James M. Meyer, CFA 610-260-2220