Soft Landing Conditions Improve
We have been making the case for an economic “soft landing” for most of this year. This stance was not a consensus view in the Spring. Several big names like Berkshire Hathaway’s Warren Buffett and JP Morgan’s Jamie Dimon agree with the Fed and see current banking woes leading the economy into a mild recession later. Yet, the economy has been amazingly resilient and is just as likely to slow down, but power its way through these headwinds, short of recession.
It is hard to argue that the US economy isn’t amid a meaningful slowdown right now. The Atlanta Fed’s now forecasts the 4th Quarter annualized GDP to be 2.1% more than three percent slower than the 3rd Quarter. We have seen estimates for 2024 growth of around 1.5%. If these projections hold and growth moves closer to trend but doesn’t contract, our base case for soft landing will prevail. That would be good for stock and bond investors over the short-and intermediate-term, and it’s the fundamental reason our models are positioned as aggressively as they are.
It's a bit too early to celebrate. Is there a potential for a growth scare in 2024? The answer is yes, as the effects of 11 interest rate hikes by the Fed have not been fully felt. Again, slower is OK for stocks, but economic contraction is not. We will, of course, be keeping a close eye on consumer spending as we move into the new year. It will be interesting to see if Black Friday and Cyber Monday enthusiasm has followed through the rest of the holiday shopping season.
Since inflation was the main reason the Fed embarked on its rate-hiking campaign, let’s look at the results so far. It was easily understood that the decline from 9% mid-2022 to, say 4% would be relatively easy. It would be getting from 4% to the Fed’s target of 2% that would be the big challenge. Now into December, disinflation(which is a decline in the inflation rate, not a decline in prices) is continuing, but at a predictably slower pace. The headline CPI number, most popular in the financial press and shown in the table above, was 3.2% for October. The Fed’s preferred gauge, the core PCE Index, declined to 3.5% from 3.75% in September.
The improvement in these numbers decrease pressure on the Fed to have to continue to raise interest rates. For equity investors, history is on your side after the Fed stops hiking interest rates. According to an analysis by FactSet, S&P and Alger stocks have returned 15% and 20% in the six and 12 months, respectively, following the final rate hike. This includes five cycles dating back to 1989. The numbers are even more attractive if the economy avoids a lagging recession (soft landing). The las fed funds hike was July 26, 2023.