The economy is still growing. Real GDP rose at a solid 3.3% annual rate in the fourth quarter, and consumer spending was strong in December meaning the first quarter is off to a good start. New home sales came in above expectations and initial jobless claims remain low. What’s not to like!
All eyes are now on this Friday’s jobs report, the Fed meeting on Wednesday and most specifically all the big technology companies announcing their earnings beginning this week. If we exclude job gains in government, health & education (which are largely funded by government), job growth looks exceptionally weak. In the last seven months of 2023, payrolls excluding these categories rose only 3,000 per month, the kind of weakness we might expect before a recession. In other words, much of recent growth is fueled by government deficits. What is tough to measure is the strength to the economy of our technology and the lack of additional hiring needed when this new, strong technology is implemented. Meanwhile the stock market continues to rally, with the S&P 500 closing at a new record high last Thursday.
Election Cycle Expectations
We are of course paying attention to earnings, the overall economy, and the words out of the Federal Reserve this week, but there are structural and calendar types of issues to pay attention to as well. As you read in my normal weekly comments, history tends to repeat itself till it doesn’t! We are now in the thick of a difficult period in an election year. I narrow this down even more to analyze the action of the markets historically during election years when the incumbent is running again. As can be seen below, February till tends to be a digestive period. I have made it clear in my 2024 notes that I expected the first few months of this year to be challenging. This further supports the probability of this.
After Market Hits New Highs Expectations
If the economy remains healthy and keeps growing, it’s very hard to imagine the Federal Reserve cutting short-term interest rates by the 125-150 basis points the markets appear to expect. In turn, less rate cutting than the market expects could increase the probability of the “feared” recession to finally present itself. Should the recession not present itself this presents quite a conundrum for the interest rate actions from the Fed. Of course we won’t know what is happening with the economy moving forward until we get more data, but what I think is relevant is to analyze what the stock market does after it makes an all-time high if the economy then does one of three things: new all-time high followed by recession, new all-time high followed by no recession, new all-time high without a recession being a consideration in an economic cycle. As you can see in the graphic below, if there isn’t a recession, this could be a barn-burner year in 2024. If the economy just does its normal thing and trudges along, the returns have historically been decent. But, if the economy does go into a recession, the following year has not been particularly friendly. I’ve taken the liberty to circle the three different periods in yellow as this chart- showing every year, is particularly busy:
What would get the Fed to cut rates by 125-150 bps? Either a sharp drop in inflation or a decline in economic growth. While lower inflation is good, can a sharp drop happen without a weak economy? Either way, we don’t think the stock market would like that outcome because they would likely signal lower corporate profits. This is one of the most difficult unknowns on my mind in the current year.
Where Is The Money To Come From To Fuel Continued New Highs
One of the issues I keep focusing on is the amount of money still sitting on the sidelines and the amount that was taken out of stocks in the last year. If the S&P 500 continues to show resiliency, then investors sitting in short-term instruments could lose their patience waiting for an opportunity to invest in a pullback and instead simply put money to work either in one fell swoop or bit by bit over a short period of time. I believe that the earnings reports we get from the market leaders for the fourth quarter could give us a clue as to how this plays out. But all the same, here is what money did in 2023. Clearly huge amounts went into the risk-free interest rates of money market funds and CDs, and a sizable amount came out of stocks in general:
The cycle work I showed last week along with the first chart I have shown in this note lend themselves to this first part of the year being a bit challenging. But at the same time, the year should end up leaning towards the bulls, particularly if we don’t end up in a recession. In closing, I would like to once again give the chart that shows going all the way back to the 1950’s, if the market is coming off of a digestive period (as we have experienced since late 2021 until this last month) and then goes to a new high, what does the market do following this new all-time high? As can be seen, the probability is not just for the market to put in an attractive, continuing advance, but 13 out of the 14 cases, it has been up and been up quite nicely:
Of course, nobody knows for sure how anything is going to turn out. Things are heating up quite a bit in the Middle East and 3 US troops were killed. This surely does not settle well with anyone, and the US tends not to sit idle when something like this occurs. This seems to also be happening right when the equity markets are appearing a bit tired and entering what is normally a tough time. We will most certainly keep you abreast of what is going on under the hood in the markets.
As always, should you wish to discuss your individual situation or ask any personal questions, we are always here to answer them in a timely fashion.
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