Balancing an Improving Outlook with 2024 Q1 Headwinds

Market Update
Written By Jonathan M. Elliott, CPWA®, CRPC®, CDFA®, ChSNC®, CPFA™, RMA®

Photo Credit: Jasmin Ne, Unsplash

Analyzing Market Expectations for 2024

Stocks and bonds rallied in Q4 as the headwinds from Q3 dissipated. The rally started in early November when the Treasury’s Quarterly Refunding Announcement (QRA) favored issuing Treasury bills over Treasury bonds. The QRA provided relief to bonds, particularly long-duration bonds, as Treasury yields declined and erased most of their Q3 rise. In December, the Fed’s FOMC meeting triggered another rally as the Fed’s dovishness and updated Summary of Economic Projections surprised the market. Treasury yields took another leg lower as the Fed endorsed the prospect of 2024 interest rate cuts, with stocks and bonds once again trading higher.

Market Fed Funds Rate Forecast vs Actual

Market Fed Funds Rate Forecast vs Actual

Number of Months Between Final Rate Hike and First Rate Cut

Number of Months Between Final Rate Hike and First Rate Cut

Are Markets Priced for Perfection in the Near Term?

The following is a list of the expectations we currently see priced into financial markets.

  1. Investors expect the Fed to cut rates by more than -1.25% in 2024, starting in March.

  2. The US economy is forecast to grow below-trend as higher interest rates slow activity, and inflation is expected to settle around the Fed's 2% target.

  3. The pairing indicates that the market expects a soft landing.

  4. S&P 500 earnings are forecast to grow over 10% in 2024 as sales growth drives profit margin expansion.

  5. The high-yield credit spread is tight compared to history, indicating investors are not worried about credit risk.


Is the Consensus Wrong?

The above expectations are already priced into stocks and bonds. We believe the number of forecasted interest rate cuts is too aggressive given current labor market dynamics and underlying economic resilience. While we expect rate cuts in 2024, the Fed will take a more measured approach, like the -0.75% of proactive cuts in 1995 and 2019. Current credit spread levels leave little margin for error despite the historical lag of monetary policy and banks tightening lending standards. While we do not expect credit spreads to blow out, the high-yield credit spread is tight compared to history. The corporate earnings are too optimistic considering that falling inflation, which historically leads to slower sales growth, suggests profit margins could come under pressure. However, our S&P 500 Earnings Indicator is trending higher, indicating that the earnings outlook is improving.


Potential Headwinds for 2024

The year-end rally may extend into early January, but potential headwinds loom in 2024 Q1. Seasonality, a tailwind in Q4, is historically a headwind early in presidential election years. The Treasury QRA, scheduled for January 31st, could cause Treasury yields to reverse higher, with Secretary Yellen likely to increase Treasury bond issuance due to internal Treasury guidelines that specify the ratio of bonds to bills. The Q1 headwinds stem from the market's optimistic rate-cut forecast and exuberance rather than an economic slowdown.

US Election Year Seasonality

Putting It All Together

At the same time, today's easing financial conditions lay the groundwork for a potential economic rebound in 2Q24 and beyond—a trend evident across our indicators. As the calendar turns, the financial markets' twists and turns look set to continue in early 2024.

 

Important Disclosures
This material is provided for general and educational purposes only and is not investment advice. Your investments should correspond to your financial needs, goals, and risk tolerance. Please consult an investment professional before making any investment or financial decisions or purchasing any financial, securities, or investment-related service or product, including any investment product or service described in these materials.

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Jonathan M. Elliott, CPWA®, CRPC®, CDFA®, ChSNC®, CPFA™, RMA®

I am currently the Managing Partner for our independent investment advisory firm, Optima Capital Management. Together with my business partners, Todd Bendell CFP® and Clinton Steinhoff, we founded Optima Capital in 2019 as a forward-thinking wealth management firm that serves as an investment fiduciary and family office for high-net-worth individuals and families. In addition to being the Chief Compliance Officer, my role at Optima Capital is portfolio management. I have over 18 years of experience in managing investment strategies and portfolios. I specialize in using fundamental and technical analysis to build custom portfolios that utilize individual equities, bonds, and exchange-traded funds (ETFs). I began my financial services career with Merrill Lynch in 2003. At Merrill, I served in the leadership roles of Market Sales Manager and Senior Resident Director for the Scottsdale West Valley Market in Arizona. On Wall Street Magazine recognized me as one of the Top 100 Branch Managers in 2017. I am originally from Saginaw, Michigan, and a marketing graduate from the W.P. Carey School of Business at Arizona State University. I am a Certified Private Wealth Advisor® professional. The CPWA® certification program is an advanced credential created specifically for wealth managers who work with high net worth clients, focusing on the life cycle of wealth: accumulation, preservation, and distribution. In addition, I hold the following designations - Chartered Retirement Planning Counselor (CRPC®), Certified Divorce Financial Analyst (CDFA®), Certified Plan Fiduciary Advisor (CPFA), and Retirement Management Advisor (RMA®). In the community, I am a member of the Central Arizona Estate Planning Council (CAEPC) and serve as an alumni advisor and mentor to student organizations at Arizona State University. My interests include traveling, outdoors, fitness, leadership, entrepreneurship, minimalism, and computer science.

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