2024 Outlook: A Turning Point

Jeff Buchbinder (00:00):

 

<Silence> Hello everyone, and welcome to the latest LPL Market Signals podcast. Jeff Buchbinder here, your regular host for today. Pleased to be joined by my friend and colleague, Jeffrey Roach. Jeff, thanks for joining. We got a little bit of a different setup today. We are not going to do our regular sort of market recap and week ahead look, we'll give you a little bit on that. But we are going to spend the next 30 minutes or so talking about our recently released 2024 LPL Outlook. So, let's get right into it. It's Monday, December 11, as we're recording this. But the Outlook will be released on well, you'll see it by the time you listen to this on Tuesday morning, December 12. So, here's the disclosures that we usually share, and here is the cover page for Outlook 2024.

 

Jeff Buchbinder (00:57):

 

So, this is always a fun process for me, Jeff. I know you've done a few of these now. First, I love the work that the designers do. It's just, they're amazingly talented, Scott Wells being the lead designer. And then I also like the fact that it gives us a chance to all get together as a team and craft one story, you know, collaborating together. It's just a lot of fun. I've done, you know, a couple dozen of these now, and I've enjoyed each and every one. Jeff, thoughts on the Outlook here.

 

Jeff Roach (01:29):

 

I'm glad to participate in this Outlook edition of Market Signals. So, this will be a lot of fun. And you're exactly right, Jeff, that we craft the words, or at least the beginning stages and then the graphs and then the marketing experts help craft the narrative with, you know, the phrase and the title and the graphics. It's a lot of fun.

 

Jeff Buchbinder (01:53):

 

It is, it is. We, end up, we think, telling a story. And you know, that's always kind of a neat part of this, coming up with a theme, telling a story, matching the images to the content. And certainly, we think a lot of this will be of great interest to the general public, not just industry folks. So, let's get to it. Economy. We're starting with your section, Jeff. So what do we have to look forward to for the global economy in 2024?

 

Jeff Roach (02:25):

 

Right. So, as we we're playing off this theme of the turning point, you think about you know, where we are a few years outside the pandemic or the onset of the pandemic, and what is happening as we go into 2024. And that theme of "Turning Point" really is trying to capture a, a number of things. And we try to highlight the fact that the turning point is not necessarily turning to the downside, right? It's not necessarily a negative thing. It depends on what sector you're thinking about, but there could be a turning in inflation. We're going to talk about this with the chart that's showing right here, or a turning that's really interesting in this new year within residential sectors, or thinking about services, thinking about central banking, thinking about yields. So, the turning point in this rotation, if you will, starts out, I think in this big macro theme.

 

Jeff Roach (03:25):

 

And the first theme, as I just hinted to, is this chart that I'm showing you here is, you know, we're past the worst of the inflation period. You can see the spike particularly in the CPI durable. So that's your used vehicles. That was the big story, right? Back in the day when supply chains were constrained, and we had a lot of shortages, particularly in the semiconductor space, used car prices skyrocketed, but there was a little bit of a lag time when we saw the peak show up in the services component. So that's your darker line there that's dotted, but either way you slice and dice it, we are past the peak. And that's kind of this, this turning point that we're playing into. And that certainly has ramifications for bonds, for estimating the equity risk premium. The way in which investors think about the decision allocating to equities, allocating to bonds, what's the premium that they need to get in order to find equities attractive.

 

Jeff Roach (04:31):

 

A lot of this does boil down to the experience of the inflation metric. So, I wanted to highlight that right off the bat. Because again, this has, it's kind of influences in the rest of the section. So, that's the one big turning point from the inflation story. I think by the end of 2024, we're going to see inflation a lot closer to the Fed's, 2% target. It'll take a little bit of time to get to that last, you know, 2% number. But you're starting to see, even now, as we head into the holidays here, and then into 2024, we're starting to see inflation past its peak getting into a comfortable level. Market's certainly responding that to that point. So, that's very important for investors to think about as we go into 2024. Now, what's funny, Jeff, is here, we are recording thinking about our mid-year, and we talk about the end of the year.

 

Jeff Roach (05:26):

 

You know, what's nice about all this LPL Research does a midyear outlook as well, <laugh>. So we can update these as things progress.

 

Jeff Buchbinder (05:36):

 

We can only be wrong for six months, Jeff, that's good, <laugh>

 

Jeff Roach (05:40):

 

Well, we continue to evolve as more data comes in, right? That the way we want to do it. We want to let the data speak for itself. We craft the narrative. But certainly, as more information comes in, we hone the story, the market story. So, inflation certainly a kind of a fundamental tenant of thinking through how markets both equities, fixed income, currencies for that matter, central banks, how they react to that dynamic. So, inflation's been quite interesting to track on a on month basis. The job market has also been really quite something to track post pandemic. So with the implications of hybrid work, there's been such an incredible flexibility for people looking for, I guess you could say, the dream job.

 

Jeff Roach (06:37):

 

And so you saw coming out of the pandemic firms were hiring pretty aggressively, and firms were saying, hey, we don't care where you are, <laugh> for a while, right? It's the, you know, wherever you are, you can be great from anywhere, as LPL says, well, that's had really interesting repercussions in the labor market, and that is, workers have never found a better environment for them as workers. So you can see this graph, I'm just showing you two lines here of wage growth, kind of income growth for those that are in a job over a period of time, they're not switching around. And then you say, okay, well, what is happening with people that are hopping from place to place? Or saying, hey, I think I can find a better job given the fact that I'm not required to move, or at least maybe move as far as I would otherwise have to.

 

Jeff Roach (07:37):

 

We've never seen the premium you could say, or the gap between these two lines as wide as we had just in the last year or so. Meaning the ability for workers to really get a sizable bump in pay has just been incredible. So this is year on year growth between the two categories. Again, this has ramifications. Talked about inflation, now labor market and it's all about the idea of saying, okay, we know the labor market's shrinking. We know there's a greater percentage of folks that are in the retiree category. So what's going to help an economy grow and reach that maximum potential with a shorter or smaller labor force? Well, technology, artificial intelligence certainly is one thing, but a flexible workforce, I think, is something that could actually be quite a positive influence in 2024, despite the headwinds.

 

Jeff Roach (08:41):

 

So this, again, going back to what I said earlier about the turning point, this theme of the Outlook, it's not necessarily a negative theme. It's not necessarily a positive theme. It depends on what you're talking about, what categories you're talking about. So let's go to the next slide, just a kind of a double click into the interaction between firms and workers. So, we do know there's these spikes. You can see this for the last several decades. So, this chart shows in that gray vertical shaded area, the recessions over the last several decades, right? We had a recession in the late 70s, early 80s. Of course, you know, around 90-91, of course '01, the Great Financial Crisis. That's the widest gap there, you see in 08-09. And the point is that during periods of uncertainty like this, you do see firms shifting from full-time to part-time work.

 

Jeff Roach (09:38):

 

I think it was worth highlighting as we think about how to continue to kind of get into the mindset of the firm. What does it mean for productivity? What does it mean for the ability for firms to handle a slowdown if we have one, we think we are going to have a slowdown. How do firms prepare for that? We're starting to see a little bit of this uptick already in firms hiring part-time workers as it relates to this category, part-time as a percentage to full-time workers. This is something to watch. Again, there's an opportunity, in essence, you could say, firms have spent a lot of time preparing for the slowdown. So a recession if it hits in 2024, is certainly not going to be much of a surprise, right? Everybody was forecasting one last year as the data started to get a little more positive less and less we're saying, hey, that's our baseline anymore.

 

Jeff Roach (10:34):

 

But watch this, this is a leading indicator. It's helpful to kind of get a little bit under the headlines here into the details of how firms are responding to business conditions. So let's go to this last slide here that I have and just kind of set the stage for the big picture. You know, you think about investors, there's always this, I think this love hate relationship with the international space, right? There's always some intrigue with emerging markets thinking about, can I get a little greater alpha in the portfolio if I allocate toward, you know, the internationals, whether it's developed internationals or emerging internationals. I think the point that we want to make here in this turning point really for the globe is we think even though the U.S. will probably get most of its growth the latter half of 2024, U.S. will probably grow a little bit better, a little bit stronger than the Eurozone.

 

Jeff Roach (11:33):

 

And I think that's important to think about. And you might say, well, wait a second, what about this the risk of emerging markets? And you have these really hot numbers for emerging market growth. Well, remember these emerging market economies are growing from a lower base, meaning it's a lot easier to get a, you know, a higher percentage number because the base is so much lower. Hence, you can see kind of this difference between developed economies, emerging economies, but again, want to kind of leave our audience thinking about the idea that despite our baseline thinking slowdowns coming, that does not necessarily mean there aren't going to be opportunities. It's going to be an opportunity to be a savvy investor, if you will. And also the fact that even though you get a slowdown, that does not necessarily mean for the whole year you'll see something negative. You could actually see positive growth for the year, even though we might see us a little stronger headwinds for the first half of the year. So that's the very big macro picture. We can have a little more dialogue, Jeff, but that's enough of me talking. Let's get onto the rest of the categories within our Outlook.

 

Jeff Buchbinder (12:50):

 

Thanks, Jeff. Before we go on so you know, we had two consecutive quarters of negative GDP in 2022, right? And, you know, that's not the official definition of recession, but could, the question is, could we see something similar? Maybe it's just one quarter. Could we actually still see a negative quarter of GDP in 2024 and have the market, you know, hold up better than it did certainly in 2022?

 

Jeff Roach (13:19):

 

Yeah. And the ability to move on. So,, you think about where the economy has been coming out of this unusual shutdown period, and then this massive, you know, reopening and then stimulus excess savings, a lot of uncertainty with consumers still growing, but a real challenge with inventory management and trade because of supply constraints. So we had two consecutive quarters of negative growth in 2022. Consumer is still hot, but we had contraction overall. I think that's a great way to anticipate and think about, well, what could 2024 look like? Could it repeat some of that? The answer is yes, once the consumer kind of slows down, maybe businesses don't slow down as much, and you have a market that responds saying, hey, we've anticipated a recession for the last year and a half, now we're finally getting it. In some ways, I think the markets could say, alright, we're at this period, now we can move on to the next chapter.

 

Jeff Roach (14:18):

 

Markets are always forward-looking, right? They're always going to say, well, alright, here we are. Now let's think about those, building out those expectations for the next six to nine, 12 months. Just one last little quick reminder. And our listeners know this. You know, typically recessions are periods when you have two negative quarters, not necessarily all the time. So for example, in 2001, we only had one quarter of negative growth, then it was positive again, then negative. So there was no two consecutive quarters there, but you had a recession. You have to go all the way back to 1947, right out of the World War II, where you had two consecutive quarters of negative growth but no recession, as the economy was retooling and reallocating labor and capital. So a lot of interesting ways to say maybe history will rhyme with 2024, probably not repeat, but certainly rhyming. So, that's you know, there are always opportunities. That's how I like to leave it from the macro standpoint. There's always opportunities whether an economy is slowing or growing or expanding, always opportunities for investors.

 

Jeff Buchbinder (15:29):

 

Wonderful. So, thanks for that, Jeff. Let's move on to the stock section. So here, I did add a chart just to the S&P 500 to acknowledge the breakout that we just had over 4,600. So we are now at a new 2023 high on that index. That index has been up six straight weeks. Same with the Nasdaq. So just a really nice run. We're right around 12% off the lows. Really strong run. So a lot of people are talking about how we're overbought, but we actually think that momentum, you know, coupled with a pretty good fundamental foundation you know, pretty good earnings season. And then you've got positive seasonality working for us for the rest of the year. So, we think we could make a run at 4,800 in the next, call it two, three months.

 

Jeff Buchbinder (16:19):

 

However, we got to get through this 4,700 to 4,725 range where there's a little bit of technical resistance first. Also want to point out as we do on the bottom of this chart, that the breadth has been pretty good lately. So that's another reason to be encouraged and think that maybe this momentum can carry us higher. And as you'll see here shortly, our forecast for the S&P at year end 2024 allows for further gains, even above the previous all-time high from the start of last year. So let's keep moving here. We've got several equity charts from the Outlook to walk through. First, this is a really simple one, but I think it's a good reminder that you know, equities move in cycles, right? And so after you've gone through the first year of a bull market, which we did in October, year two following that first year is almost always positive.

 

Jeff Buchbinder (17:22):

 

Certainly, it's always been positive in this look back to 1949 and we expect that to repeat again. We expect stocks to be higher from October 12, 2023 to October 12, 2024. Of course, the bull market doesn't line up exactly with the calendar year, but close enough. So the year two average for the S&P 500 is about 13%. Our forecast is not quite for that strong of a gain but still you know, mid to high single digit gain nonetheless. So you know, Jeff, you set up the turning point theme here. You know, with regards to inflation, well, it's also going to be, we think, a turning point for yields. We've already seen that here just in recent weeks with the 10-year yield moving down sharply. Stock market's been very sensitive to moves in yields, that relationship has flipped.

 

Jeff Buchbinder (18:19):

 

Because when yields get high and people start worrying that they're going to get higher, stocks go down when yields rise. However, the opposite is true at lower yields, where the market actually likes yields rising. Like, for example, coming out of an economic slowdown. We're in a period where the market, the stock market wants lower yields. And so you can see that on the far right, that's the correlation. That just means yields up, stocks down. So this is an opportunity for stocks, we think as yields move lower, and our forecast for yields is for them to move lower, not dramatically so, but to move lower as the Fed you know, pauses and then eventually cuts maybe by mid-year. And economic growth slows. So this is a positive story. If yields cooperate, we think stocks will respond positively.

 

Jeff Buchbinder (19:13):

 

I mentioned you know, that this is a period where you've got some fundamental support, right? It's not just you know, positive momentum or falling inflation in the Fed helping stocks. It's also earnings. So we're going through a turning point in earnings in that we're coming out of an earnings recession. You see you just see the annual earnings numbers here for the S&P 500. Actually $217 is probably too low for 2023. We'll see. We got one more quarter to go. Consensus is 219, and then we think we can go to 235 in 2024. So that's about 8%, an 8% increase roughly off of that 217 number. So maybe the growth rate's a little bit smaller depending on where 2023 shakes out. But this is a really solid earnings story. We're moving into a new environment for earnings where they can do some of the heavy lifting to push stocks higher and won't be so reliant on the macro picture, even though the macro picture's getting better.

 

Jeff Buchbinder (20:21):

 

So Jeff, you stole a little bit of my thunder here on this chart. The equity risk premium, this just compares how much earnings a stock index is producing, compares that to how much in income a bond index or a bond is producing. So we use the S&P 500 earnings yield here, which is just the inverse of the P/E. Okay? So that's earnings yield. Compare that to the 10-year treasury yield. So when I ran this a couple of weeks ago, it was about, it was about even, so the earnings yield and the 10-year Treasury yield, and the, I think it was about, I don't know, 4.4 at this point, we're equal. So, what does that mean? Why does this matter? It means that on a valuation basis, investors should be indifferent between stocks and bonds, but because stocks are more risky, right?

 

Jeff Buchbinder (21:18):

 

In theory, at least, you should be compensated for taking that extra risk. So, what this says is risk reward on equities isn't quite as attractive as bonds. So we're coming into 2024, kind of almost indifferent between stocks and bonds. But we do think it makes sense to have maybe a little bit less cash than your target and throw that into the bond market. Have a little bit of overweight to fixed income. So here's my last equity slide, and then I'll have Jeff, you weigh in on this. Anything jumps out at you. So when we ran this couple weeks ago, we were around 4,560. We're obviously higher than that. So, we'll call it a 19 P/E if we carry that P/E forward a year and maybe increase it just a bit to 19.5, and then we take that 235 S&P 500 earnings number that I mentioned and grow that about 6%, you get to a preliminary target of $250 in S&P earnings for 2025.

 

Jeff Buchbinder (22:25):

 

So at the end of 2024, market looks forward, we'll be looking at that 2025 earnings number at 250. You do the math there, you get 4,875. So, we have put our range, here is our target, a range of 4,850 to 4,950 for year-end 2024. Given the recent rally, it's actually not quite as far away as we've put on this slide. It is more like 6% away, but then you add the yield, you get to eight. Now we think this actually could be a little bit conservative because there's probably a little bit of upside if companies can produce some margin expansion. And then the revenue side, I think is conservative because you just have to get inflation of maybe, you know, 3% on top of GDP of one for the year. That's 4% revenue growth. That relationship doesn't hold exactly, but it's usually pretty close. So you just hold margins and you grow revenue somewhere around 4%. You get some share buybacks, interest rate stability can help. We think it's pretty easy to get to you know, call it six, 7% earnings growth, at least for the next couple of years. So you know, hopefully we're too conservative. Hopefully we end up doing better. That's our forecast for fair value on the S&P. So any thoughts there, Jeff? What jumps out at you?

 

Jeff Roach (23:50):

 

Well, I think it's helpful, you know, for our listeners, just to, again, kind of focus on why it is so important to show that graph you did earlier, Jeff. Not that we need to go back to it, but with the equity risk premium, that decision between allocating to stocks and bonds, and you say, well, wait a second. There's actually another question out there that's implied in that, and that is the cash allocation. And you actually referenced it, Jeff, I just wanted to underscore it for the listeners to think, all right, well, it's been an unusual period in the last little bit because cash has been so attractive, you know, the volatility of the market, and, you know, the fact that, you know, a lot of fixed income investors were really changing their expectations almost from, you know, month to month on central bank policy. And so, you know, with high fed funds rate, high rates, cash was so attractive. We don't think 2024 is going to be quite that attractive for cash. Hence, I think that's a really great thought to think about as you prepare for the coming year. Putting that cash to work, I think is going to be a really interesting thought experiment and important investment thesis as we go through the coming year. So, put the cash to work.

 

Jeff Buchbinder (25:09):

 

You are providing a perfect segue for the bond market. So back to normal. We've got a slide in here that we've shown some of you before. The fact that sort of 3-5% on bond yields is normal, right? Certainly, zero is not normal. <Laugh>, we did enough of that. Let's move on to something normal. So our forecast for year end 2024 is 3.75 to 4.25 on the 10-year yield. And you can see here we're right around the high end of that range. So this is the 10-year Treasury yield you know, last click 4.28. So a touch above our range. We had been at a 4.25-4.75 range. So we're down, you know, about a half a percent off of that.

 

Jeff Buchbinder (26:00):

 

This, it all ties together, you know, Jeff, you alluded to it, we get lower inflation, helps yields come down, slower growth of course, helps yields come down, that supports both stocks and bonds. So the other piece of why we think, you know, bonds look as good as stocks is because you have the potential for falling yields to give you a kicker on top of pretty attractive income levels. So, like bonds and stocks frankly, but both offer maybe a little bit of upside beyond our forecasts. So, Lawrence Gillum, our chief fixed income strategist, you know, put together these scenarios. If we have a recession that sort of looks like a normal recession you'll do even better off your bond investments because we're probably going to have much lower yields than where we are now.

 

Jeff Buchbinder (26:49):

 

Mm-Hmm, <affirmative> that is not our expectation. Probability of that we think, is fairly low, the middle scenario, much more likely, kind of our base case. Maybe you get a mile recession, maybe you don't, it probably doesn't bring yields down that much. But that's kind of where you get to our 3.75 to 4.25. Maybe we don't get four rate cuts next year, like the market's saying now, but you know, maybe you get two, maybe you get three. And that can certainly support bond investments. And then the last scenario, which we also think is unlikely, where you get a re-acceleration of economic growth, a re-acceleration of inflation pushing yields much higher. And then you could see some losses in bonds again. Again, low probability, not our base case, but certainly you know, something to keep in the back of your mind.

 

Jeff Buchbinder (27:39):

 

So, here's the chart I alluded to, what's normal, right? Three to 5% on the 10-year yield is normal. It's pretty cool that this chart goes back to 1880. I've even seen yield charts that go back hundreds of years more than that, which is amazing. But the point here on this chart is just to share that we are in the normal range, right? Yields in general should be about in line with nominal GDP, which is real GDP, what's reported. And we all watch every quarter plus inflation. So you know, when we just hit five not too long ago, that was kind of the high end of normal. We think we'll be in the normal range in 2024. We're already in that range now, and we think we're going to stay there. So credit, you know, we're not, still not big fans of going too far out on the risk spectrum in terms of credit, like, for example, high yield bonds or bank loans or things like that.

 

Jeff Buchbinder (28:38):

 

And here's one of the reasons why you see, you know, S&P, the bond rating agency is actually downgrading more companies than they are upgrading right now. Plus, spreads are so tight, you know, the earnings or the yield that you get from higher risk bonds compared to lower risk bonds, like the treasuries, that spread is just, we don't think is wide enough to really justify taking on too much risk. So still pretty conservative outlook in the bond market. So, I also threw one of the geo-politics slides in here, increasingly complicated landscape. By the way, we didn't get into the election in here, the presidential election. We're going to cover a lot of that in the Mid-year Outlook. Frankly, we think geopolitics globally matters much more, certainly in the first half of the year. So more to come on the election later, but in geopolitics, we think currencies is important.

 

Jeff Buchbinder (29:39):

 

The, you know, the dollar has been very strong recent years, but you know, that's taken it, we think, to a place where it's a little bit expensive. So, you know, it's really hard to predict currencies, but we think we're probably going to see some dollar weakness over the next year or two, especially as the Fed cuts rates. And if we're right in our interest rates fall. This is a purchasing power parody look, I want to get your thoughts on this, Jeff. Essentially, what's the purchasing power of the yen versus the dollar? What's the purchasing power of the euro versus the dollar? And are they equivalent or not? Right? And I think what we're seeing here, Jeff, is that they're not, the dollar goes much further which maybe suggests that these international currencies are too cheap.

 

Jeff Roach (30:30):

 

I think part of it too ties into the growth outlook on the international scale. You know, thinking about if the U.S. can have a little more stability as we've seen really coming out of the, the pandemic the value in essence, the purchasing power, the stability of the dollar will be attractive. But I think you're right, Jeff, to think about what central bank activity will do, how synchronous will the ECB, the Bank of Japan, other major central banks around the globe, will be with the Fed. And it's very possible. Yeah, the Fed starts moving first, and then you know, that could ease some of the strength of the dollar. I think the other one that clearly should get your attention when you're looking at a graph like this is you look at the incredible you know, downside power of the yen.

 

Jeff Roach (31:28):

 

And of course that has been quite an interesting experiment, I think in the last several years, thinking about in more recent days, of course, think, okay, inflation is running hot now in Japan. So a lot of investors are starting to think, okay, well, will the Bank of Japan finally move beyond its aggressive easing in accommodative stance? So I think, I think one of the turning point themes, as we're calling it here in the Outlook, I think would, is going to be really, really important as we think about yen, particularly yen as it relates to dollars. So, that's kind of the big picture. One of the reasons why we care about the dollar is certainly it has ramifications for those that want to maybe dip their toe into the emerging market waters. So, you know, typically you'll want to see a little bit of the easing of the strength of the dollar, maybe find some of the internationals a little more attractive. But this clearly is I think setting up for a turning point particularly when you look at what's happening in Japan.

 

Jeff Buchbinder (32:38):

 

Yeah, the BOJ kind of slowing the markets roll over the weekend, in fact, <laugh>, right? Saying that it's not quite time to take off that accommodation and start tightening rates. So we'll see what happens in the coming months with the yen. But that'll be real interesting to see. It's very cheap. It's probably too cheap and you know, could be on the verge of making a move higher sustained, move higher. So thanks for that, Jeff. We'll go ahead and wrap up there. Again, we're really excited to bring you the Outlook for 2024. It's a lot deeper than what we just went through <laugh>, we just went through it real fast. So hopefully you like it. And we'll be back certainly with more content from the 2024 Outlook in the next couple of weeks as we continue to do Market Signals and finish up the year. So, with that thanks Jeff for joining. Thanks everybody for listening to another edition of LPL Market Signals. We will be back with you next week. Take care everybody. Thanks so much.