Will We Get a "Goldilocks Economy” in 2024?

The past few years have been anything but normal for the economy and capital markets. The U.S. experienced a pandemic-induced recession, trillions of dollars of fiscal stimulus, and near-zero interest rates…followed by soaring inflation, a greatly imbalanced labor market, and rapidly rising interest rates. The market response was also quite wild, with a sharp bear market in 2020, an equity market boom in 2021, a 10-month-long bear market in 2022, followed by yet another strong recovery for stocks in 2023.(1)

After this dizzying stretch, investors are hoping for a return to normalcy in 2024.

Investors’ wish list is pretty long. We’d like to see inflation numbers continue on a downtrend and settle below 3% levels. We’re hoping for an interest rate policy that pulls the benchmark Fed funds rate back in the direction of its neutral rate (2.5% or so), not away from it. And we’d certainly like to see modestly positive quarterly GDP growth accompanied by an earnings rebound in the realm of 10+% year-over-year.(2)

Ticking all of these boxes would be the equivalent of the U.S. economy settling into a ‘goldilocks’ state, with modest inflation, modest growth, and ‘normalizing’ interest rates – conditions we haven’t experienced in years. This goldilocks outcome would also bode very well for stocks, in my view, and deliver a nicely positive second year of the bull market.

The upshot is that given what we see today, there are early signs investors could get everything they want. The Fed’s preferred measure of inflation, the personal consumption expenditures (PCE) price index, is already hovering just above 2% when viewed on a six-month annualized basis. The Federal Reserve, while generally striking a cautious tone, has signaled 75 basis points of rate cuts on the table for this year. On the earnings front, Zacks Investment Research is forecasting earnings growth of 11.6% for the year. And finally, trends in the labor market suggest the economy is holding up just fine, with employers anticipating 4% wage growth in the new year – enough to keep consumers spending.

In short, the U.S. economy is fundamentally strong. But I also think that’s the precise reason investors should be extra vigilant in 2024.

To understand my thinking, consider the example of 2023. At the outset of the year, nearly every economist and pundit on TV was calling for an economic recession sometime during the year, and for good reason. All of the traditional recession indicators, like the inverted yield curve and declining leading economic indicators, were screaming recession. But it never happened. Any investor clinging to that recession narrative, who then also allocated away from stocks as a result, felt some pain last year.

In 2024, many of those same experts are more sanguine about the economy, and the expectation for a ‘soft economic landing’ with single-digit stock market returns has become a crowded trade. A December survey conducted by Bank of America Securities found that fund managers were more optimistic than in any month since January 2022, which, ironically, coincided with the beginning of that year’s bear market. The latest addition came this week, with the World Bank calling an economic soft landing “increasingly possible.”

This growing consensus by itself makes me think we should expect a different outcome. And in my view, that means 2024 will either be a big up year or a slightly down year.

Bottom Line for Investors

As I’ve written many times before, it all comes down to reality versus expectations. Inflation could come in hotter or cooler; interest rates could fall more or less than expected, or even go up; earnings growth could disappoint to the downside or surprise to the upside; the U.S. economy and labor market could perform better or worse than many expect; and/or, geopolitical issues globally could make the world more or less investor friendly. Not to mention the swirling uncertainty surrounding the U.S. presidential election.

I continue to be in the camp of seeing the U.S. economy as under-appreciated, which makes me inclined to believe the year will turn out better than most expect. But I also plan to be hyper-sensitive to risk in the new year, precisely because most are expecting a soft landing. Consensus was wrong in 2023, and I wouldn’t be surprised if most get it wrong in 2024 too.

1 Wall Street Journal. January 2, 2024. https://www.wsj.com/articles/investors-hope-for-2024-a-return-to-long-lost-normalcy-4029df63?mod=djemMoneyBeat_us

2 Wall Street Journal. January 1, 2024. https://www.wsj.com/finance/optimism-abounds-wall-street-this-new-year-a0ec5cc0?mod=djemMoneyBeat_us

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