Beyond Inflation in 2024: The Real Growth Concerns for Investors

 

The talk around economist locker rooms centers almost exclusively on is inflation accelerating and running too hot for the Fed?  And when and how many rate cuts will the Fed move on in 2024?  To me, these are the wrong questions now.

That was the question to ask 3-4 months ago before inflation started its normal seasonal upturn in the 1stquarter. To me, this is not the right question one should be asking oneself now.  The question one should be asking as an investor is how much the economic slowdown in the 2nd and 3rd quarters will be based on the Fed’s prior actions.  If something is ailing the market, it isn’t inflation, it’s the depth and magnitude of the coming summer slowdown.

Central banks aim for a soft landings in the economy when they raise interest rates to curb inflation. However, our Federal Reserve has a pretty bad track record in accomplishing soft landings during past rate hiking cycles and the current data supporting a smooth landing is mixed at best and unfortunately won’t be known until late the 3rd or 4th quarter this year.

We’ve discussed prior soft-landing cycles, that is the “Goldilocks outcome” in prior videos.  The last successfully executed one was the monetary tightening conducted under Alan Greenspan in the mid-1990s.  In 1994, the Fed raised rates seven times, doubling the federal funds rate from 3% to 6%. In 1995, they cut the federal funds rate three times when it saw the economy softening more than required to keep inflation from rising. The stock market as measured by the S&P 500 never pulled back to its 50 day mva until late August in 1995.  Will that happen in 2024?  I do not know.  As of right now it is possible, however the economic set-up also says it could be late 1q2000 near the peak of the tech bubble.  Here’s a look at the US economic surprise index, which we’ve talked about before. Here it is.

Chart 1: US economic surprise index

As you can see, this data series exhibits a normal seasonal upturn in the first quarter as those cautious or dower economist forecasts have been bettered more often than not.  However, note the recent peak in the data series is both earlier and lower than previous first quarter peaks. That’s a bit of a warning sign behind the scenes for second and third quarter economic growth. Dire? No, just probably not as rosy of an outlook for summer as those talking on TV are trying to imply.

While inflation is the boogieman that the Fed has been trying to slay for the last 12-15 months, I want to focus on the other side of the coin.  Real economic growth as measured by real-time “real” interest rates, also known as TIPs. Remember investors this is the component of Treasury yields that goes a long way in determining the PE ratio of stocks and the overall equity risk premium. A lower trending real rate is initially good for PE’s and the market and particularly for higher growth stocks. Those stocks were the darling in 4q23 and early 2024 however, YTD, behind the scenes things have been changing in sector selection in the market.  Here’s a chart of 10 year real interest rates.

Chart 2: 10 year real interest rates

It’s not a coincidence that growth stocks like semiconductors, bitcoin, and AI stocks bottomed again in late 2023 and rocketed higher as the real rate broke its 15-month uptrend and headed lower.

However, we behind the scenes, the market is flashing warning signs that this trend might have gone too far and the Fed is too tight with its economic policies.  Here’s the chart of the 1-year real rate.

Chart 3: 1-year real rates

It’s heading down and to the right as well, which was initially good for growth stocks. However, one can see the one-year real rate has fallen from 4% back in late 3q23 to under 1% currently.  In fact, it’s nearing only 90bps. To me that says that the market sees a dramatic slowdown in real economic growth coming in mid-2024.  To me that says the long and variable lags that economists talk about all the time, are finally upon us in the USA and that the Federal Reserve is not to lose with monetary policy, but rather too tight.  To me that is what ails the market right now.  The market is beginning to struggle with the Fed staying too tight for too long and causing a hard landing ike 2001 or worse 2008.

Investors, we are currently in a soft landing and have been for over a year now.  That’s exactly why stocks have rallied to make new ATH’s as our team has expected.  The $65 trillion question is how long will this soft landing last and are there early, predictive signs behind the scenes that we can see as investors that we are closer to an economic top and rollover which will inevitably lead us to a recession?

Right now, we are sticking with picking stocks for our clients in single stock accounts. The markets in 2024 are NOT the same ones we had in 2023.  Behind the scenes many boring stocks and sectors are beginning to work.  Investors are beginning to hedge against the Fed making a mistake by lowering their risk profile into what is normally a seasonal slowdown in the economy during summer.

The math I see behind the scenes, the same math that said 5150-5200 on cash S&P500 optimistically into mid-March 2024 over a year ago, says that should the Fed glide the plane to gentle landing late this year, that S&P 500 over 6000 is possible in the 1h2025.  At the same time, that math also says that a hard landing in late 2024 or 2025 puts the S&P 500 back at 3500, or lower.  I know that’s not comforting or a great look, but as Tom Cruise says in his movie Maverick, “It’s the only look I got”.

For investors or retirees uncomfortable with this wide range of possible outcomes, the Oak Harvest team has launched a new strategy that retains the ability to go long stocks, short stocks, as well as buy partial hedges for a stock portfolio.  Information on this exciting new strategy of ours can be found at OakHarvestFunds.com.  From the whole team here, thank you and have a great weekend.