Now that we’re full steam ahead into 2024, should investors have reasons for optimism about the overall economy and the financial markets? I believe the answer is yes, with some important caveats.
Based on recent economic data, I believe the worst of inflation is well behind us, both here in the U.S. and globally. The financial markets are now anticipating when the Fed will start its (at least) three forecasted quarter-point rate cuts this year. Does that mean we’ll return to the ultra-low-rate environment we enjoyed for so long prior to 2020? I don’t think so — a moderate level of inflation will be with us for the foreseeable future.
Why? Because there are certain structural forces at play in our economy that will keep prices elevated. For example, the “green premium.” In short, the major players in our economy (e.g., governments, large corporations and consumers) are pushing hard toward environmental sustainability and demanding innovative products and solutions to help get them there. But production of these solutions is not yet able to meet growing demand.
If I remember my freshman econ class, this supply/demand imbalance is going to keep energy prices high. In my view, that will help put U.S. inflation levels about midway between 2% and 3% halfway through 2024, if not sooner.
That said, I’m optimistic about where we’re headed for the rest of 2024 — with some key provisos. One being my prediction that the overall U.S. economy will decelerate in the first half of the year to roughly 1.5% GDP growth, before accelerating in the second half of 2024.
I believe we’re going to avoid a hard landing or a recession. And as we head deeper into 2024, we’ll see companies ramp up capital expenditures and consumers grow in confidence. It’s also important to note that we should see a boost late in the year after the general election, as the economy and financial markets tend to react positively once we’re past the uncertainty of who will win at the ballot box.
Market moves: Covered calls and sectors to watch
For many equity investors, this presents an opportunity to move ahead with a process of “re-risking” by adding U.S. stocks to their portfolio. However, timing is going to be key.
As the economy slows in the first half of 2024, we can expect some volatility in equities, with the markets moving more sideways than upward. As the equity-risk premium compresses, it’s important to consider income as a larger portion of total return. For example, look for strong, reliable dividend payers among value stocks.
Another way to increase income in your portfolio is to sell covered calls during periods of heightened stock market volatility. Using a covered call, an equities seller offers buyers the option to purchase a stock at a certain price within a certain time frame. The buyer pays a cash fee for the right to purchase the stock, generating income for the seller. This can be a smart strategy for a seller who does not expect a stock to appreciate significantly, i.e., during periods of market volatility.
And as the equities markets price in the effects of our weakening economy in the first half of 2024, this could create some potential buying opportunities. In this vein, I’m sanguine about particular sectors among large-cap public companies. One is financial institutions (more on this in a bit), and another is the defense subsector of industrials (full transparency: I work for a large-cap financial institution). You can also add to this list subsectors of health care that are driven by demographics (e.g., our aging population), such as pharmaceuticals and medical technology.
Big tech stocks benefit from AI
Last, but certainly not least, is big tech. Notwithstanding the very high valuations, I believe certain of these companies will continue to hold on to their global leadership positions as AI implementation expands.
Meanwhile, my firm recently moved to overweight on small-cap stocks, but keep in mind you may need to exercise a bit of patience; they tend to perform better once the economy enters its next growth cycle. Given that, smaller regional banks comprise about 20% of the Russell 2000 small-cap stock index — and I believe many of these institutions are poised for recovery as their borrowing costs decrease, and they see some relief from their deposit pressures. I’m also confident most regional banks will be safe from loan losses as the economy makes its soft landing.
Final thoughts
While no one can predict exactly which way the economy will turn as 2024 progresses, the key indicators I’m watching make me believe that economic growth will be tepid in the near term. But I’m also hopeful that we’ll avoid a hard landing or recession. In this scenario, smart investors should consider adding more risk assets to their portfolios in advance of the bounce back that I expect to come in the latter part of the year and beyond.
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