Higher From Here? An Updated 2024 Market Outlook with Matt Palazzolo

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Stacie Jacobsen: Thanks for joining us today on The Pulse by Bernstein, where we bring you insights on the economy, global markets, and all the complexities of wealth management. I'm your host, Stacie Jacobsen.

With the first quarter of 2024 behind us and the second quarter now underway, it's a good time to review what's happening in the markets and the economy. For stocks, it's been a good start to the year. Global equities posted mid-single digit returns in the first quarter, led by U. S. large caps. And unlike 2023, when the Magnificent Seven dominated returns, we've seen a broader range of stocks hitting highs.

Then there's the U. S. economy. Over the past year, expectations have shifted from a possible recession to now a more optimistic economic outlook, and the data continues to show surprising resilience. Looking ahead, what can we expect from the markets and economy for the balance of the year? That's what we're about to hear from Matt Palazzolo, Bernstein's National Director of Investment Insights, who's here with us today.

Matt, welcome back to The Pulse.

Matt Palazzolo: Oh, thanks a lot, Stacie.

Stacie Jacobsen: All right, Matt, I know our listeners want to hear your outlook for the rest of the year, both on the macro perspective and your take on the markets. But first, let's have a quick recap as to what's happened so far in 2024, and then move into that outlook.

Matt Palazzolo: Yeah, look, 2024 has been a lot like 2023 in that the economy ended up coming in better than many people had expected, ourselves included.

Um, with the labor market not weakening all that much, and in fact, in some months, strengthening that together with by extension, the consumer continuing to spend many metrics that we look at very closely have shown that the economy in 2nd quarter has been coming at a pace of about 2 percent or so, GDP growth year over year, and that's better than we had thought for the full year of 2024.

Now it might very well slow down from that pace, but at least over the last 15 months or so, the economy has been growing at a pace better than many economists had expected.

Stacie Jacobsen: At the beginning of the year, markets had priced in several possible rate cuts by the Fed in 2024, and now the consensus expectation is for fewer cuts.

Can you give us some more detail on that?

Matt Palazzolo: Yeah, this number certainly has moved around a lot, depending on any individual economic data point that has come out. You know, the market had been pricing in at 1, 6 or 7 cuts in 2024 down to about three cuts in 2024. So again, it really had depended on the month and the economic data point that had just been released.

We've been fairly consistent around three or four cuts as our main expectation for the year, starting right around the summer, and we're still there. We now think there's three cuts that will occur, first one occurring in June, and a lot of that just comes down to the point that the Fed has communicated again and again that the inflation data is running at a pace that is consistent with the levels that they're comfortable starting that process because they do admit as the market, too, recognizes fully that the restrictive stance that they have on at this moment with the Fed funds rate north of 5 percent is not where it needs to be given where the inflation data is.

So given that we've got several data points and months of data points that, that show that inflation has come down towards target, not at the 2 percent target, but towards target, and they believe they're comfortable reducing that level of restrictiveness down to a level that's lower than where it is today.

Stacie Jacobsen: Okay. So, with that, I do want to ask another question on inflation, and we can even define what normal might be, but will it get back to what we presume to be normal at some point in the relatively near future?

Matt Palazzolo: I think it's fair to say that we will, or at least pretty darn close to it. The Fed defines their target as 2 percent year-over-year core inflation, so core being excluding food and energy.

Depending on the month over the last few months, we've been running at a rate of about 3 percent or so. And recall, that's down, as you know, Stacie, from like 8 percent or 9 percent year-over-year. So, we've made a lot of headway. As we and others have said for quite some time, that last mile to go from 3 to 2 is going to be the hardest 1 percent that you're going to get out of this decline.

But I think we'll get there, probably not in 2024. We might land by the end of the year on a year-over-year rate or an annualized rate, something closer to 2. 5 or 2. 75, so not quite down to target. But I think by 2025-year end, we'll be at or very close to what the Fed wants us to be running at by the end of that year.

Stacie Jacobsen: So, sticking with the Fed rate cuts, how are the cuts and the shifting expectations of those affecting the bond markets?

Matt Palazzolo: Yeah, so as we have changes in what the market is expecting in terms of what the Fed will ultimately do in 2024, we have seen, as you rightly note, movements in the 10-year treasury just as a proxy for longer term interest rates.

And it's those longer-term interest rates that are impacting bond total returns so far this year as the market priced out. More cuts as we got some incoming data that was a little bit hotter on the inflation front, then interest rates moved higher and bond prices moved down somewhat. Not anywhere close to what we saw during the period of time where interest rates moved meaningfully higher, but somewhat higher.

The 10-year treasury today, as we're recording, is right around four and a quarter percent, and that's higher than it was at the end of 2023. So, it certainly has had an impact as inflation data is hotter or higher than expected, interest rates move higher. And Fed cut expectations move down and bond prices take it on the chin a little bit as well.

Stacie Jacobsen: Okay. Shifting into the expected return for equities, you and I had a conversation in the beginning of 2024, where at that point, the thought was the return for the entire year would be somewhere in that mid-single digit range. And now we've already seen that level of return in just the first quarter.

Now we know that markets can certainly give that back, but for now, how should we think about the expected return for the rest of the year?

Matt Palazzolo: Stacie, you're right. We had expected the beginning of the year something like a mid-single digit return on the S&P 500, just as a proxy for stocks. And as of recording today, we're up around 10%.

Look, we were wrong so far. You know, we're only three months in, we still have nine months more to go. But as I mentioned earlier on the show, the economic pace and economic activity has been better than expected. And by extension, corporate earnings have been better than expected and probably should be and likely will be for the balance of the year.

And so, with that, that flows through our model. And so, we now apply a higher earnings growth pace on the same PE multiple that the market has today. And we're looking at a return that is higher from here. Now, as you rightly mentioned, there can be some volatility who knows over a nine-month period of time.

It's very hard to forecast over such a short period, but our expectation now is that the market could be up 12, 13, 14 percent by the end of the year. Now it might be choppy as we get incremental data points on inflation and other parts of the economy. We might see some larger movements from here to there, but we're gaining greater confidence.

And it's priced into the market already. We're getting greater confidence than we had at the beginning of the year that the economy is going to hold up. And then inflation still is going to come down towards target. And the Fed is going to be able to cut interest rates, not as much as we had originally anticipated, but still three or four cuts by the end of the year.

Stacie Jacobsen: Well, Matt, if you're ever going to be wrong, directionally you underestimated the return of the market. I agree. One thing we do keep returning to is cash and the amount of cash that's in money markets is at an all-time high. What would you say to those investors who are staying on the sidelines?

Matt Palazzolo: It really depends on the reason why that investor has so much cash on the sidelines.

If they've got it there because it's earmarked for something that they're going to spend it on in the next year or two, then great, they're in the right place and you're getting a very nice return sitting in a money market fund or very short duration, a fixed income portfolio. But if that money is really earmarked and should be in their long-term strategic allocation, then I think it's right time to get that money into the market.

Many investors that we talk to are really waiting for something to happen, a pullback to occur, a sell off, and at that point that they'll jump into the market. But I've just been doing this so long, you know, we recognize that when you're waiting for a pullback, it often doesn't occur. And when it does occur, it's 15 or 20 percent higher than where you are today.

And so that pullback, you know, you were better off investing at an earlier point. So, our advice really is to, to think about the reason why you're in cash. And if it's nothing that is earmarked for a purchase or usage in the near term, and it's long-term money. Then get it in. Now, if you'd be kicking yourself, if the market did all of a sudden sell off after the market went down, then dollar cost averaging, take three months, take four months to put that money into the market or put it into something that is just a little bit more return, a little bit more risky than what you have today, which could very well be it.

High quality bonds that are paying a very nice yield now, but you don't have the risk that you would if you were to put it into your balanced account 60 40 or otherwise. So, I think there's a lot of reasons to move now and think about it if you're sitting in cash.

Stacie Jacobsen: I know your team has conducted research on understanding the impact of having too much cash in the portfolio for too long.

Will you share some of that data with us now?

Matt Palazzolo: So, look, if you were to invest in the stock market on an average annual basis, going all the way back to World War Two, just to pick a point in time, the average annual return from then was roughly 11 percent per year. Very good return. Now, let's say you were a terrible investor, right?

And you didn't just put the money in at the beginning and sit there. Let's say you only put money in. At market tops. So, the market at the top, and then there's a sell off right after it. You're just a terrible investor. Your average annual return is not that far off. It's only 10%. So, 10 versus 11. So, the point is, you know, if you're worried about getting in at the wrong time, right before a big sell off and you've got a long time period to make up and heal those wounds, you're not going to give up all that much return.

It's fretting about something that really, we shouldn't be fretting about. If we're all long-term investors and we really are now you compare that to sitting in bonds or sitting in cash where that average annual return is much, much lower. You're talking three or 4 percent versus 10 or 11. So all of this is, you know, really to reanchor our clients and investors more broadly on what matters and what doesn't, particularly if you're going to be in it for decades.

Stacie Jacobsen: So, one of the reasons that I hear from investors where they might be keeping more cash on the sidelines is the fact that it's an election year. It's an unknown outcome. Markets don't like uncertainty. So, let's put this into perspective. We did talk to Cherri about it a few episodes back, but Matt, what does history tell us about the potential impact of the election on the markets?

And is there anything different about this year's election that would lead you to believe that impact could be different?

Matt Palazzolo: Looking historically at election years doesn't really tell you all that much. There's not a big correlation between the returns in an election year versus nonelection years, depending on the period of time that you're looking at, the average annual return is still going to be around nine or 10%.

I guess the only thing that strikes me as interesting, two things that from our analysis, one would be that on average during election years, now it's not the case this year, but on average markets don't really move all that much for the first 10 months. And then after, you know, once they know who the president is.

Or at least for the last two months, not necessarily because the market knows who the president is, but at least over the last two months, there starts to be a rally that looks to be a trend. Not always, as you can tell from this year, we're up already 10%. We'll see what happens over the last couple of months or from here until November.

The other thing that I thought was interesting from our analysis was that if you look at the returns during all administrations again, it's 10 percent return or so over that period of time, but for all the anxiety complaint, whatever adjective you want to use that describes the last three administrations, because I would think that those, you know, I think we can all agree.

Those are the most polarized periods of time that we've been in quite some time, okay. Those three administrations have seen an average annual return closer to 15%. So much better, even if you don't like the person who's in the Oval Office over these last three administrations, if you're invested in the stock market, you made a lot of money per year over this period of time.

So that's at least some background. Now, does that hold water with many of the clients that we're talking to about the election and their anxieties? Not that much. So, we have to take into consideration. the two candidates and what that would ultimately mean. Look, at the end of the day, what matters to markets is profitability and policies that would impact profitability.

Now, most of the policies for right or for wrong that presidents and Congress pushed through don't ultimately impact the profitability of your average S&P 500 company. They just don't tax policy does regulation does some other things do, but for the most part on a broad scale in aggregate presidential and congressional policies don't matter all that much.

So, you know, we have to be careful not to conflate our euphoria or optimism or pessimism about whomever is going to be president to what that will mean for our finances. Because in most cases, again, even if you've got a president, you don't like or don't agree with their policies, but the most part, their policies won't matter all that much.

Now, as we get closer, you know, you should have Shri or myself or any of our other colleagues back on to talk more specifically about the platform that both of these presidential candidates are running on. And then we can get into a little bit more of the weeds, but at this point, we're still too far away.

Markets aren't paying attention yet. And nothing has really been ironed out as closely as we'd like it to be.

Stacie Jacobsen: All right, Matt. Well, I think you just invited yourself back for some time before the election, and we're happy to have you. With that, thank you so much for joining us once again to give a wrap on the first quarter and the outlook for the rest of the year.

I really appreciate having you here.

Matt Palazzolo: My pleasure. Good to see you again.

Stacie Jacobsen: Thanks to everyone for tuning in. Don't forget to like, share, and subscribe to The Pulse by Bernstein wherever you get your podcasts. I'm your host, Stacie Jacobsen, wishing you a great rest of the week.