Summary, Last Quarter:

At the end of 2023, the expectation was that the economy would slow down in either the first or second quarter of 2024, followed by a strong second half of the year. In Q1 2024, U.S. gross domestic product (GDP) looks like it will be stronger than expected, according to the Atlanta Federal Reserve’s “GDP Now” forecast. Also, real GDP for Q4 2023 has been revised upward to 3.4% from 3.2%, according to the U.S. Bureau of Economic Analysis. Meanwhile, inflation has been stubborn—decreasing in some areas while increasing in others—but overall has held relatively steady. Thus, the U.S. Federal Reserve kept rates where they were rather than risk cutting them too early, which is a real concern because a premature rate cut could cause inflation to spiral out of control.  

Our Commentary:

There was no recession in 2022 or 2023, nor was there a hard landing. That doesn’t mean we can’t have a hard landing in 2024, but the current economic situation looks like a triumph for the bulls and optimists, and the economy may be better described as “flying” rather than “landing.” Consumer spending remained strong through the end of last year and early 2024, confounding some forecasts that excess consumer savings would run out and cause the economy to falter. With unemployment under 4% and strong wage growth, worrying about excess consumer spending seems to miss the point. If employment, productivity, and wage growth are strong—which they are—then workers’ real income is also strong. With robust income and employment, the U.S. consumer will continue to do what it does best—consume—representing the “demand” side of the economy well.

Underneath this healthy income and employment lie strong productivity, manufacturing, services, and corporate profits. These represent the proverbial “supply side” of the economy, and these factors drive demand as they provide healthy employment and wage growth to consumers. Thus, the strong employment situation doesn’t appear to be an abberation. Our expectation is that the economy will not fall into a recession, but there may be slowdown. Inflation still hasn’t been tamed yet, and the Fed is now playing a game of “chicken” with inflation. The current major risk in Federal Reserve policy is potentially lowering rates too early, which could reignite inflation. That would amount to a policy failure, something the Fed must be keenly aware of. Thus, we expect the Fed to keep rates at elevated levels until inflation is tamed substantially. This dynamic eventually could lead to a slowing economy.  

For equity markets, strong productivity, employment, and corporate profits are positives. Although they haven’t been spectacular, corporate earnings have been strong and better than expected. The inflation problem still exists, and sometimes—like now—taming inflation can help to calm potentially runaway equity markets. As investors, we want sustainable growth, not out-of-control growth. So, for now, this means more of the same: elevated short term interest rates, unattractive long-term interest rates, and a relatively known monetary policy. This last item—a known monetary policy—is generally good for equity and bond markets. Market participants like certainty because it helps them determine where and how to invest.

The engine that drives the economy and the markets is productivity through entrepreneurship and innovation. We are currently in a tight monetary policy regime, but the market continues to reach new highs. Artificial intelligence (AI) and the onshoring of production are expected to increase productivity and therefore corporate profits and employment. However, the economy and the markets will likely continue to experience fits and starts until we get past the tight monetary policy and the uncertainty that tends to accompany a U.S. election year.

Until next quarter,

Leelyn Smith Investment Committee

Bond Disclosure:

Fixed income securities carry interest rate risk.  Fixed income securities also carry inflation risk and credit and default risks.  Any fixed income security sold or redeemed prior to maturity may be subject to a substantial gain or loss.

Forward-Looking Statements:

Certain statements contained within are forward-looking statements including, but not limited to, statements that are predictions of or indicate future events, trends, plans or objectives.  Undue reliance should not be placed on such statements because, by their nature, they are subject to known and unknown risks and uncertainties.

Indices are unmanaged measures of market conditions. It is not possible to invest directly into an index. Past performance is not a guarantee of future results.

International investing entails special risk considerations, including currency fluctuations, lower liquidity, economic and political risks, and differences in accounting methods. Past performance cannot guarantee future results.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

Investing involves risk including loss of principal. No strategy assures success or protects against loss.

The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.