The forecast is not without risk, but the performance of the U.S. economy is strong and promising thus far for 2024.

This was the overall theme of a recent PNC Investment & Economic Principles Webinar Presentation. PNC Chief Economist Gus Faucher and Chief Investment Officer Amanda Agati provided their perspectives on the factors that are influencing the current economic environment and recent financial market performance, as well as what the outlook for investors is likely to be in the coming months.

The Macroeconomic Backdrop

According to Chief Economist Gus Faucher, even though positive indicators abound, there are some reasons to temper expectations regarding economic performance in the coming months. The risk of a global recession is one, but the main factor continues to be inflation, as the Federal Reserve continues its battle to reach its 2% objective.

However, even if the Fed does keep rates high in the near term to contend with inflation, the economy is still likely to continue to expand in 2024, according to Faucher, for three reasons:

  • Consumer balance sheets are in good shape. Personal saving rates, which soared during the COVID-19 pandemic, remain solid. Estimates indicate that households have $500 billion extra in consumer savings relative to pre-pandemic levels. Also, the financial obligations ratio, which measures consumer spending on things like mortgage payments, rents, auto loans, and similar expenditures relative to after-tax incomes, is much lower than pre-pandemic levels. Consumers used pandemic stimulus payments to pay down debt, took advantage of loan and rent deferments, and refinanced mortgages in a low-rate environment. Debt payments relative to incomes are low, which means that even in a rising rate environment, consumers can continue to increase their spending as the job market remains strong and wage growth continues.
  • In a tight labor market, businesses need to hold onto employees. The labor force participation rate (the share of adults who are working or looking for work) fell sharply during the pandemic, and these levels have not fully recovered, remaining 0.5 percentage points lower than prepandemic levels. Many people close to retirement age who left the labor force are not likely to return, and businesses will continue to have difficulty finding workers going forward.
  • The housing market will not be a drag on growth in 2024 (although it won’t contribute significantly to growth either). With mortgage rates starting to decline, housing affordability is improving. Although there has been some recovery in single-family homebuilding in recent months, the housing market has been undersupplied over the last 15 years, and excessive inventory will not be a factor. The housing market has held up well even with high mortgage rates, which should be a slight positive for economic growth in 2024.

There is one concern top of mind related to economic growth in 2024: the inverted yield curve. When an inverted yield curve occurs, which happens when short-term interest rates exceed long-term rates, recession tends to follow. However, the inverted curve has been in place now for more than a year, and the U.S. economy has thus far avoided tipping into recession. Although the curve is an indication that recession risks are above average, PNC does not expect one to occur in 2024.

With inflation moving closer to the Fed’s 2% objective, PNC expects the Fed will cut interest rates a few times this year, starting sometime in the second quarter of 2024. This will provide a boost to economic growth in late 2024 and going into 2025, which could lead to a slight acceleration in growth in 2025.

Insights for Investors

With these economic observations as a backdrop, Chief Investment Officer Amanda Agati provided insight into some potential market impacts for investors.

  • Market performance – Despite positive headlines about stock market returns, most stocks did not have a strong performance in 2023. The Nasdaq and S&P 500® were both up for the year, but performance was disproportionately driven by the returns of the so-called “Magnificent Seven” (a group of high-performing U.S. tech companies). Combined, these seven stocks were up more than 90%, while more than 150 of the stocks in the S&P 500 posted negative returns last year. This narrow market leadership is notable in terms of what it means for the path forward, as broader market leadership is needed to fuel a sustainable rally. Furthermore, given the high valuation environment, stocks have less room to increase without an improvement in fundamentals.
  • The Federal Reserve – Market expectations for Fed rate cuts have shifted dramatically since the start of the year. In December 2023, when the Fed indicated it expected three rate cuts over the course of 2024, the market immediately priced in more than double that number, demonstrating a clear disconnect and contributing to volatility in the forecast. Since the Fed has officially eliminated the possibility of a rate cut occurring in March, the market has tempered its expectations and now expects a potential rate cut in May. As market expectations align more closely with Fed forecasts, it may help tamp down the potential for major volatility.
  • Bond Market – Throughout 2023, the bond market has shown indications of marching toward recession, due to the inverted yield curve. However, the yield curve is starting to recalibrate and become less steeply inverted on its own – without the Fed taking any material action – a reflection of the improving economic backdrop as the U.S. economy approaches a so-called “soft landing” scenario. From a market perspective, longer duration yields will be naturally pressured higher throughout 2024 based on continued economic growth, adjusted inflation expectations, and help from the Fed in the form of rate cuts in the second half of the year. Agati expects to see some volatility in the bond market but notes it could lead to some normalization of the yield curve, which is a healthy outlook for the bond market and bond investors. 

Agati noted that credit tends to be an important signal of the health of the bond market. When a recession is near, there is often volatile movement and widening in credit spreads, but this has not been the case thus far in the current economic cycle – a positive sign that the soft landing is starting to take hold. There also has not been significant activity in terms of credit defaults, which so far have been confined to lower-rated issuers. 

  • Earnings – Earnings growth acceleration and participation are likely to resolve many of the underlying issues for the investment outlook. However, the final quarter of 2023 was a significant period of negative earnings revisions. When excluding the “Magnificent Seven,” the growth rate for the S&P 500 fell into negative territory. For investors to achieve a positive path forward in 2024, the stock market needs to see a broadening of leadership from an earnings and underlying fundamentals perspective, on a systematic and progressive basis.

The overall outlook for investors, according to Agati, is that the market is likely to eke out positive returns by the end of 2024, but it won’t be a linear progression. Her best advice: stay invested, but also buckle up.

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PNC economists provide analyses and forecasts of national, regional, and global economic and financial trends. For more economic data and reports, visit www.pnc.com/economicrelease.

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