Gain insights on 2024’s investment landscape from Bernstein’s Matt Palazzolo.
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Stacie Jacobsen: [00:00:00] 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 [00:00:15] management. I'm your host, Stacie Jacobson. The goal of The Pulse is to bring you valuable insights driven by Bernstein's award-winning research with views from experts around the industry.
With that in mind, we wanted to kick off the new year, giving you our recap of 2023 [00:00:30] and take a look at what 2024 may hold. To do that, we're here with Bernstein's National Director of Investment Insights. Matt Palazzolo. Matt, welcome back to The Pulse and welcome to 2024.
Matt Palazzolo: Oh, thanks a lot, Stacie. Happy to be here.
Stacie Jacobsen: All right, let's start [00:00:45] by looking back at 2023. How would you characterize the year in the markets and the economy?
Matt Palazzolo: I guess the first thing I would say is we were pleasantly surprised to be wrong on the economy and on the markets for 2023. Twelve months [00:01:00] ago, when we were making our initial forecast for the year, we thought economic activity was going to slow relative to the pace we were on in 2022.
And that the markets were going to respond with a flat range bound level [00:01:15] of returns. We were wrong on both economic activity in the United States ended up coming in right around two and a half percent. That's on GDP. And the stock market was very strong, particularly in the last quarter of the year. And so were fixed [00:01:30] income returns.
So a lot of that came down to the news that we got out of the federal reserve in the last meeting, uh, that sparked. Fairly significant rally in both equities and fixed income. All right.
Stacie Jacobsen: So now let's [00:01:45] turn our focus into 2024 and I'm interested in your outlook. So first let's start with the macro perspective and then move into your expectations for both the equity and bond markets.
Matt Palazzolo: Yeah, well, so to a certain degree, what we expected in 2023, we're now [00:02:00] expecting in 2024. It's just kind of a 12-month delay on that economic slowdown. Again, GDP in the United States was right around 2. 5 percent for 2023. We think it slows to right around a half of a percent for [00:02:15] 2024. Why? Much of that is because of the actions that the Federal Reserve has taken over the last couple of years, raising interest rates up to the level that they did.
And the purpose of that was to bring down inflation towards their 2 percent [00:02:30] target. You didn't get All the way there at the end of 2023. And they probably won't get all the way there at the end of 2024, but the economy will slow fairly significantly, whether or not you want to call that a recession. And I [00:02:45] don't think that matters all that much, but, but the slowdown in economic activity will have an impact on corporate profitability, certainly on the unemployment rate and the labor market here in the U S so that I think is the backdrop upon which [00:03:00]we and others are beginning to think about asset allocation and market returns. Second part of your question, Stacie, obviously was on what do we expect from stocks and bonds? And given that economic outlook I just laid out, if we assume that earnings growth [00:03:15] for corporations grows mid-single digits and that P evaluations don't go anywhere, they are somewhat expensive or at the upper end of their historical range, but I think justified, uh, at least where they were at the end of [00:03:30] 2023.
And so with that, putting those two pieces together, stock market returns should also be up mid-single digits, call it 6 percent, something in that range I think is fair. And bond returns should be right around where their yield [00:03:45] levels are. So if yields today on municipal fixed income in the intermediate range is 4, 4.5 percent, I think that's a safe place to start assuming the return that you'll get. Maybe we get a little bit of capital appreciation if interest rates fall, but I think it's a more of a [00:04:00] mid-single digit year than it is another strong year like 2023.
Stacie Jacobsen: You know, throughout the year in 2023, a word that we used a lot on the show was soft landing.
When we were talking about the potential for recession, uh, is that still a phrase that you would lean into for [00:04:15] 2024 or do you have another one that we should, uh, focus on?
Matt Palazzolo: You know, hard landing, soft landing. I think it's just landing. Okay, the Fed is on pace and the United States economy is on pace for this immaculate disinflation.
[00:04:30] Remember back, uh, eight, nine, ten months ago, inflation was comping at six or seven percent. We're now in the range of about three percent. And the economy has not collapsed, so it's been a wonderful outcome. So far, we [00:04:45] need to see it continue into 2000 and 24. But I think there's a possibility that we have a soft landing that the Federal Reserve lands this plane without a lot of bumps.
I wouldn't say it's 100 percent degree of certainty, [00:05:00] but it certainly is possible. But. Again, I go back to what I said before, hard landing, soft landing, some kind of landing is what we're going to get. And then as we look into 2025 in the back half of this year, I think it will be an improved outlook, [00:05:15] just like today is an improved outlook relative to where we were at 12 months ago.
Stacie Jacobsen: Okay, got it. That's helpful. Um, with that as a backdrop, many investors have been holding excess cash. Do you think that's a good idea going into 2024? [00:05:30]
Matt Palazzolo: I don't think it's a good idea to have excess cash going into 2024, just like I didn't think it was a good idea to have excess cash going into 2023. In fact, if you now with the year done, if you look back on the returns for holding [00:05:45] cash in 2023 compared to what a long term investors strategic allocation returned, they ended up underperforming holding money markets or cash returns in some form or fashion.
And I think that probably ends up being the case in [00:06:00] 2024 as well, given that in our expectation, the Federal Reserve will start to cut interest rates in the middle of the year. And with that, the return on cash will go from just above 5 percent to maybe [00:06:15] by the end of the year, just above 4 percent or even below 4%.
And so with that, you're looking at a return that You know, probably underperforms again, even if we're right and stocks and bonds return mid-single [00:06:30] digits. Uh, so I think that certainly is a consideration for investors. You know, we've been advocating for some time to move excess cash. That's not earmarked for something in the next 12 to 18 months out of money market funds into investments because of exactly what you [00:06:45] saw at the end of 2023 markets can generate returns in bursts.
And you've got a burst in the fourth quarter, and it's not forecastable. It was a surprise at the end of the year that the Fed was as dovish as they are. And that's what [00:07:00] generally and over time historically has generated much of where the bulk of returns are those bursts in months or quarters. And that's something to consider for long term investors.
Stacie Jacobsen: We can't ignore the fact that 2024 is a presidential election [00:07:15] year, and that's certainly going to drive a lot of the news cycle. How might that impact the markets?
Matt Palazzolo: Yes, we go back and we look at over history, the amount of influence that election years have on returns [00:07:30] isn't so meaningful. The data is inconclusive.
Let's just say that there's not a lot of correlation between election years and and whether or not you do well or poorly relative to what you would have done in non election years. And I think that probably ends up being [00:07:45] the case. Certainly election years garner a lot of headlines and we'll be reading about it in the paper and watching it on television.
But at the end of the day, U. S. election cycles, non-U. S. election cycles, and even geopolitics in general, [00:08:00] for the most part, not always, but for the most part doesn't end up having a longstanding tangible impact on equity and fixed income returns.
Stacie Jacobsen: Yeah, that's certainly helpful as we brace ourself for that new cycle coming.
Now also, you know, [00:08:15] every year there is something that comes as a surprise. You mentioned the Fed's actions towards the end of 2023. As you look into 2024, are there any surprises that you may not be all that surprised to see.
Matt Palazzolo: I guess one of them would be, I really wouldn't be surprised or I would, I [00:08:30] should say I'm becoming less and less surprised if the Fed ends up landing this plane without a lot of bumps, you know, that we bring inflation down to their 2 percent target, that nothing breaks in the economy. You look back at [00:08:45] other periods of time where the Federal Reserve has raised rates as significantly or as quickly as they have, what ends up usually happening is that something cracks, that uncovers some issue in our economy.
And that's what ends up [00:09:00] bringing us or pushing us into a recession. I don't want to be too Pollyannish or optimistic, but that would be a surprise that, that the fed is able to manufacture this immaculate disinflation where they bring inflation to heal [00:09:15] without anything breaking possible. And to a certain degree that was getting priced in at the end of 2023.
So that's something certainly to watch out for.
Stacie Jacobsen: Okay, so that's helpful with the surprises for 2024. Where might we be [00:09:30] wrong? What is it that keeps you up at night?
Matt Palazzolo: Yeah, I guess what keeps us up at night is when you have an economy that is only growing in line with what our expectation is, something like 0.5 percent GDP, it's like stall speed. You're [00:09:45] more susceptible to some exogenous shock, something occurring that you hadn't forecast, wasn't forecastable even, and that tips you over. And that is a greater risk in 2024 than it was for [00:10:00] prior years because we're going to slow at a level that I think is consistent with stall speed.
So that's something that we have to certainly be on the lookout for, but keeps us up at night.
Stacie Jacobsen: All right. Now I can't really let you leave on a negative note. So let's give our listeners something positive to think about. [00:10:15] What do you have for us?
Matt Palazzolo: Well, I guess the positive is assuming we're right, the economy slows and that it's not anything too terrible.
When we start to look out to 2025 at the back half of this year, 2025 might very well be, I know it's a long way away, but [00:10:30] might very well be a pretty good year. Economic growth should be recovering your early cycle at that point in time. Uh, earnings growth. We'll be on the upturn, maybe back up to high single digits, and that'll be a much better [00:10:45] landscape to invest in than we were in, in the beginning part of 2024.
So I think that's the, the optimism and that's, isn't it? What investors always have to do is to look further and further out to, to ride out the bumps. Um, [00:11:00] because again, as we said earlier in the show, you get these bursts and as long as you can deal with the downturns and that's the cost of long term investing, you get the growth over time.
And I think we'll start to see a clearer, more conducive picture by the back half of this year.
Stacie Jacobsen: [00:11:15] All right, Matt, thank you so much for joining us and thanks to everyone for tuning in. Please join us again in two weeks for our next episode. And in the meantime, don't forget to like, share and subscribe to “The Pulse by Bernstein” wherever you get your podcasts.
I'm your host, Stacie [00:11:30] Jacobsen, wishing you a happy and prosperous 2024.