Economic Outlook Second Quarter 2024

As we embark on the second quarter of 2024, U.S. large-cap equity investors started the quarter from elevated levels. The S&P 500 Index traded at a forward price earnings ratio of 21 times as of the end of March, well above the historical average of 16 times and a good distance away from the rest of the world, which trades at just under 14 times.

While it is true that equity performance has broadened out thus far in 2024, for example, Japanese equities are enjoying a strong rally and the Magnificent 7 seem to be ending their run and perhaps investors shift their focus in favor of the Fab 4, still quite a bit of good news remains priced into the U.S. market. Starting from here the bar has been set high for earnings to outperform expectations and drive prices higher. Multiples can still, however, expand from these heights particularly if they are helped along by interest rate cuts from the Federal Reserve.

Speaking of the Fed, the second quarter of 2024 will most likely see the start of new interest rate cycles from global central banks. A recession in the core of Europe and the close call in the UK are clear reasons to consider rate cuts while Japan has finally pivoted in the opposite direction, lifting rates for the first time in 17 years as inflation and economic growth remain relatively strong. Regarding the U.S., policymakers will most likely join Europe and the UK in pivoting to rate cuts at some point in 2024 despite solid growth, historically low unemployment and stubbornly above target inflation. The Federal Reserve seems convinced that the current economic backdrop is a perfect starting point for additional monetary stimulus. From our perspective, we remain unconvinced that pro cyclical rate cuts are needed in 2024.

Debt markets also deserve attention as well, particularly in the United States as fiscal spending continues unabated. U.S. Government debt has reached $36 trillion, as of December 2023, more than 120% of GDP with annual interest cost reaching the $1 trillion mark to the already bloated debt pile every year just in interest alone. One would think that this would be a good starting point for discussing some fiscal discipline although the pending election makes that highly unlikely. What is certain is that there will be no shortage of supply in government debt so the question is: “Will there be enough demand?”

It is also worth noting that multiple rate cuts remain priced into equity markets across the globe therefore any disappointment in these stimulus measures could prove challenging; however, equities have been resilient thus far this year as rate cut expectations in the U.S. have already been reduced by over half. We hold the belief that the level of interest rates will be more important than the number of cuts. In other words, if the U.S. 10-year Treasury yield revisits a level of 5% or greater, equities may struggle. On that point, in the United States specifically, we see stubborn inflation (stickier services inflation), firming growth and low unemployment along with a deluge of supply continuing to put upward pressure on bond yields.

Moving forward, our preference is for Developed Market Equities continuing to favor U.S. over foreign and emerging market stocks.  Despite valuations we regard as extremely attractive, we continue to retain a more cautious stance on Developed and Emerging Market equities but would consider becoming more constructive later this year. From an asset allocation perspective, we continue to favor a globally diversified portfolio of Developed Market Equities (prefer U.S. over foreign and emerging market stocks) over fixed income for 2024.