February 2024
US Economy: Strength in numbers.
The U.S. economy surprised to the upside in 4th quarter 2023, with a consumption-driven 3.3% rate of growth. Meanwhile, unemployment (3.7%) has held steady in January, with new jobs created (353,000) offsetting an increase in labor force participation. Robust or improving data on growth, new hiring and forecasting surveys such as US ISM manufacturing (49.1 in Jan.) has investors questioning the forward path for rates and inflation.
US Stocks: Too fast forward?
U.S. large-cap stocks ended January with gains, despite sobering comments by Fed Chair Powell that interest rates may not come down as far or as fast as expected in 2024. As has been the trend, a handful of large tech stocks dominated returns. It is telling that after substantial stock market gains since Q4 of last year, small-cap U.S. equities continue to lag given their higher sensitivity to interest rates and slowing economic growth.
Foreign Stocks: China woes continue.
With U.S. interest rates possibly staying elevated for longer than hoped, the U.S. dollar rallied and cut roughly 2% from foreign developed market stocks and 1% from emerging market (EM) returns. China (-10.6%) was again a significant factor in weaker EM results, with investors seemingly uninspired by central bank stimulus to combat a severe downturn in the Chinese real estate market, high youth unemployment and deteriorating consumer confidence.
Fixed Income: Higher yields on longer maturities.
Longer-term interest rates rose modestly, as Fed Chair Powell walked back expectations for interest rate cuts early in 2024 amid some measures of inflation rising (U.S. CPI ticked up to 3.4% from 3.1% in Jan.). Shorter-maturity U.S. fixed income held its value and posted positive returns in most cases. Riskier emerging markets debt was another relatively strong performer with higher yields offering a cushion against falling bond prices.
Real Assets: Soft commodities soar.
Commodities rebounded (+0.4%) and were one of the only bright spots in the real assets category early in 2024. Anticipation of higher for longer U.S. interest rates and geopolitical tensions each provided broad headwinds. While slowing production boosted the price of oil, it was the soft commodities such as frozen concentrated orange juice (+14.2%) and raw sugar (+17.3%) that stood out as prices soared on weather-driven supply shortages.
Alternatives: Red flags in real estate.
While private market investments have seen relative success over the last few years, real estate has lagged and faces ongoing challenges. Per Goldman Sachs, roughly $1.2 trillion in commercial real estate loans will mature in the next two years, almost 25% of all loans. The potential for dislocation could mean opportunity for patient investors as investment-grade CMBS (commercial mortgage-backed securities) are yielding more than lower quality junk bonds.
Source of data: Bloomberg
Equities Total Return
| JAN | 3 MOS | YTD | |
|---|---|---|---|
| U.S. Large Cap | 1.7% | 16.0% | 20.8% |
| U.S. Small Cap | (3.9%) | 17.6% | 2.4% |
| U.S. Growth | 2.2% | 18.7% | 33.1% |
| U.S. Value | (0.2%) | 13.8% | 5.7% |
| Int’l Developed | 0.6% | 15.8% | 10.0% |
| Emerging Markets | (4.6%) | 7.0% | (2.9%) |
Fixed Income Total Return
| JAN | 3 MOS | YTD | |
|---|---|---|---|
| Taxable | |||
| U.S. Agg. Bond | (0.3%) | 8.2% | 2.1% |
| TIPS | 0.2% | 5.7% | 2.2% |
| U.S. High Yield | 0.0% | 8.4% | 9.2% |
| Int’l Developed | (0.8%) | 4.5% | 1.8% |
| Emerging Markets | 0.7% | 4.1% | 6.9% |
| Tax-Exempt | |||
| Intermediate Munis | (0.3%) | 5.3% | 1.9% |
| Munis Broad Mkt | (0.2%) | 8.7% | 3.1% |
Non-Traditional Assets Total Return
| JAN | 3 MOS | YTD | |
|---|---|---|---|
| Commodities | 0.4% | (4.5%) | (7.1%) |
| REITs | (4.9%) | 15.9% | (3.7%) |
| Infrastructure | (3.1%) | 10.8% | (1.5%) |
| Hedge Funds | |||
| Absolute Return | 0.6% | 2.3% | 3.5% |
| Overall HF Market | 0.4% | 2.9% | 1.8% |
| Managed Futures | 1.3% | (2.4%) | (1.7%) |
Economic Indicators
| JAN-24 | OCT-23 | JAN-23 | |
|---|---|---|---|
| Equity Volatility | 14.4 | 18.1 | 19.4 |
| Implied Inflation | 2.2% | 2.4% | 2.2% |
| Gold Spot $/OZ | $2040 | $1984 | $1928 |
| Oil ($/BBL) | $82 | $87 | $84 |
| U.S. Dollar Index | 121.0 | 123.8 | 119.8 |
Our Take
As we start February, the fundamental backdrop is similar to what we have seen over the last several months, underscored by surprisingly brisk GDP growth in Q4 2023. Most of the underlying data — tight labor market, higher real wages, steady increases in consumer spending and business investment — support a mounting consensus that the U.S. economy is likely to face a mild recession or perhaps the rarely executed soft landing.
Economists give the odds of a U.S. recession of any variety in the next 12 months a 45% probability (in a recent Bloomberg survey), the most optimistic level since the summer of 2022. In the face of the most dramatic U.S. interest rate hikes in over 40 years, the ongoing economic strength and resulting optimism are quite remarkable.
Threading the Needle
January has a reputation for being a good month for investing, but not so much the 2024 edition. U.S. large-cap equities again stood out, as has often been the case over the past several years. But most other publicly traded assets gave back gains from the fierce rally that ended last year. Why? The most likely answer is that good news for the economy often means bad news for upcoming Fed policy.
With interest rates up a steep 4.25 percentage points over a 15-month period, investors have been hopeful that economic activity would thread the needle: The U.S economy would stay strong enough to avoid a major recession while being weak enough that the Fed would see its way to reducing interest rates over the course of 2024.
As we have called out before, historically the full impact of each bump up in interest rates isn’t experienced until 16-18 months after it occurs. That means six of the Fed’s 11 rate increases are due to be felt in 2024. In some ways, investors have been hoping that the Fed can run out the clock, cutting interest rates before the consequences of the previous hikes are brought to bear. Unfortunately, that optimism has been weakening as Fed Chair Jerome Powell has said a rate cut shouldn’t be expected in the next few months. As a result, we saw longer-term interest rates and the U.S. dollar rise while most risk assets fell.
The Road Ahead
We see evolution toward a multi-polar geopolitical landscape driven by a deterioration in global cooperation continuing to play out and marked by higher-than-what-we’ve-been-used-to inflation, interest rates and volatility. In 2024, we expect Fed policy and its ramifications for lending rates and inflation to be a major influence on financial markets along with heightened geopolitical risk.
With nearly 4 billion global voters casting ballots in national elections, 2024 is likely to feature market volatility into and out of those elections as the consequences of the results are weighed, particularly here in the U.S. and provide signals as how the transition to a multi-polar world will unfold.
Much has been made of the “Magnificent 7,” the giant, mostly tech stocks whose rapid ascent has driven the S&P 500 to all-time highs. A contrarian perspective is that these stocks are now overvalued, and it would be savvy to trim them in favor of equities that might be undervalued.
Our philosophy in U.S. large-cap equities — arguably the most transparent, monitored and analyzed asset class — is to match the benchmark as it is very difficult to outfox the market in that space. A strong case can be made that these companies are expensive for good reason: they have an advantage in the burgeoning market for artificial intelligence.
Instead of predicting market direction, our process is designed to capture rotating market leadership via proper rebalancing, with an eye currently on bringing non-U.S. equities (which happen to be less tech-heavy) back to target, as a way to reduce outsized risk. And we continue to focus our energy on other asset classes that are not as efficiently priced by the market and offer greater idiosyncratic opportunities for outsized returns.
