1Q:2024 Capital Markets Outlook Video

Hello everyone and a Happy belated New Year. After entering 2023 with many expecting a hard landing, markets, despite the ride, ultimately were strong and punctuated by a historic two-month performance to end the year. How historic? A 60/40 portfolio had its best two-month run since the early 1980s, as did the US Agg., and the S&P 500 logged its 12th-best two-month return in about 75 years. The driver, of course, rapidly falling yields, but it's largely been about rates for the last couple of years. At the intersection of growth and inflation expectations, rates’ reaction to both was ultimately what pushed markets higher and lower throughout the span of time, so where does that leave us now? Well, 2023 certainly reinforced the soft-landing narrative, and things worked out far better than many, including the Fed, thought would be the case. Inflation fell further, and growth and labor were stronger than forecast a year ago.

That, in turn, helped drive the late gains with the Fed blinking their way to rate cut expectations in 2024 and markets seeing and raising those expectations. But as I alluded to a moment ago, who's correct in the rates wager will come down to growth and inflation. Let's get to those. A big driver of growth has been the ongoing strength of the consumer, but we do expect that to wane somewhat this year, in part because the cushion of financial policy support that consumers have had has largely fallen away. At the same time though, consumer-debt-to-income levels are historically healthy, the labor market remains resilient, and the all-important-for-us household paycheck proxy, which here measures the inflation-adjusted consumptive power of the country, remains at solid levels. Inflation came down strongly but appeared to stall out more recently. However, that's been largely from base effects as weaker months from a year ago drop out of the 12-month series.

But if I zoom in on the more recent months and annualize it, you see a more encouraging picture as near-term numbers have continued their descent. Putting it all together, we expect inflation to make its way toward 2.5% in 2024, and that would go along growth moderating to a level of about 0.8%, and in our estimation would lead to something between the market and the Fed's estimates for rate cuts in 2024 and Treasury yields falling further. As investors, where does this leave us? Well, as you know, when we talk about equities, we always talk about the P and the E. The P multiples finished the year at high levels relative to history. No getting away from that. From an earnings perspective, if we expect economic normalization, then we're also going to expect for top-line sales to normalize. But one of the things that we know is as sales come down, there are certain parts of the market that tend to react well, and one of those is quality.

That brings me to an important point. Look, there's been a great deal of focus on the Magnificent Seven and for good reason, but I would suggest there are magnificent others to consider in 2024 and 2025. Among those would be things like value. Likewise, high-dividend yields. We've talked a lot about bonds, but don't lose sight of high-dividend-paying equities in a falling-yield environment. Lastly, low volatility. As we've reached high levels of valuations, being able to defend into a moderating economic environment will likely be an important part of portfolio construction. What about the rate side of the equation? Look at this visual. It's unreal. The decline that happened in rates simply in one quarter, nearly 100 basis points.

Now, why does that matter to you? Well, as I've said before, we've urged investors to take duration because of the capital gains that it could generate. Generate them, it did. The biggest question we're getting now is, is it over? No, there's still room to go and you can see it here. If our estimates are correct, there are meaningful total returns available to us in 2024. Beyond treasuries, it's also credit, where we've continued to talk about benefits for investors specifically within high yield, which also had a very strong 2023 as yields fell, but those yields remain compelling. As we've also talked about before, the level of yield is highly predictive of returns in the forward five years.

As we move toward normalization, we believe high yield represents a compelling risk-adjusted opportunity inside of equity portfolios. Look, for me, 2024 and 2025 represent the last links in a chain toward normalization, aka a pre-COVID world. I believe there are still meaningful returns to be had, but normalization, to me, also means asset price rebalancing. Translation: as we move beyond the sledgehammer phase of markets to the scalpel, thoughtful portfolio construction will be key. Thanks as always for joining, and we'll see you next quarter.