What Should Investors Expect for the Economy, Stock Market, Bonds and Crypto in 2024?

If 2023 was the year when rising interest rates threatened to bring a recession that never arrived and derail a stock market rally that appears to still have legs, investors are hoping that 2024 will bring stabilization and normalization. However, what is considered stable and normal has changed dramatically over the past few years, and investors’ expectations need to change with it. Here’s a look at the key issues to keep an eye on.

Economic Expectations

Don’t get used to the blistering 5.2% pace of GDP growth set by the U.S. economy in the third quarter of 2023. That was fueled by debt-driven consumer spending. It may have been the last licks from households that have all but exhausted the government stimulus they received from mid 2020 to late 2021.

According to a survey of private forecasters compiled by the Federal Reserve Bank of Philadelphia, U.S. GDP growth will likely weaken to 1.3% in 2024, as the Federal Reserve’s inflation-fighting rate-hiking campaign that began in March of last year and geopolitical uncertainties weigh on the outlook.

Still, most economists believe that the U.S. will avoid a recession and could very well achieve that so-called “soft-landing” the Federal Reserve has been hoping for. Innes McFee, Chief Global Economist of Oxford Economics, says it will be more like a “soft-ish” landing. “Inflation will continue to fall but at a much more gradual pace than in 2023 driven by a gradual loosening of labor market conditions,” McFee said, noting that it will prompt the Fed to start trimming rates late in the year.

Interest Rates: Higher for Longer? Really?

The Fed acknowledged this week that it expects to start cutting its benchmark Fed Funds rate next year, the first time during the current tightening cycle that the Fed has indicated a willingness to pump the brakes on its inflation-fighting efforts. The news gave stocks a boost, sending the Dow to a new high, and reinforced the notion among market participants that the Fed will cut rates soon and frequently in 2024.

Fed fund futures are currently indicating a75% probability that the Fed will lower the fed funds rate by at least a quarter percentage point from its current range of 5.25-5.50% when the central bank meets on March 20, according to the CME’s FedWatch Tool. The market is pricing in nearly a 99% chance that the benchmark rate will be at least a full percentage point lower by the end of next year, with a 70% likelihood it will be a full 150 basis points lower.

The market may be getting ahead of itself, as Fed officials themselves are only projecting a 75 basis-point reduction, according to the Summary of Economic Projections that was released this week along with the announcement that the Fed had held rates steady at a 22-year high.

For investors hoping that rate cuts come soon, Charles Schwab warns in its 2024 U.S. Outlook that they should be careful what they wish for.

“It may be the case that if the Fed is cutting rates by mid-2024, it’s because of further deterioration in the economy—specifically the labor market,” Chief Investment Strategist Liz Ann Sonders and Senior Investment Strategist Kevin Gordon wrote in the report. “In fact, one of our key expectations for the year to come is that the Fed will begin to shift its focus from the inflation side of its dual mandate to the employment side of its dual mandate.” 

A spike in unemployment, if it should come to pass, could be the final straw to break the proverbial back of consumer spending, which drives two-thirds of U.S. GDP.

The Stock Market: Can the Bull Keep Running?

The stock market’s recovery in 2023 was the rally few investors wanted to believe. The rally off the bear market lows of 2022 actually began in October of that year, and stocks started off this year with gusto, even as inflation remained stubbornly high. While the rally was carried in large part on the backs of the Magnificent Seven—Apple (APPL), Amazon (AMZN), Alphabet (GOOGL), Meta (META), Microsoft (MSFT), Nvidia (NVDA) and Tesla (TSLA)—investors were finally able to exhale after the brutal losses of 2022. 

Given the 23% rise for the S&P 500 so far this year, and the 42% rise for the Nasdaq 100, investors are likely wondering if that trend will continue until it becomes subject to Newton’s first law of motion. If it does, just what will derail the rally? There are many possibilities:

• A ‘hard landing’ for the economy wherein unemployment jumps and consumer spending dries up, leading to a recession.
• Weaker-than-expected corporate earnings. If companies find that their sales are slowing and their profit margins are compressing, they could lower their profit forecasts, reduce their share repurchases, trim their dividends and lay off more workers. That said, analysts are currently expecting the aggregate earnings of S&P 500 companies to hit a record high in 2024, according to data compiled by FactSet. That puts a target for the S&P 500 at 5,059, up from about 4,700 now.
• Stretched valuations in the face of any economic sluggishness could also derail the rally. The trailing price-to-earnings ratio for the S&P 500 is 22x, and the forward P/E ratio is 20X, according to Jurien Timmer, Director of Global Macro at Fidelity. That’s not cheap, and it puts the current equity risk premium at 3.9% – a level that will make cautious investors think twice about diving headlong into stocks.

Lessons from History

Outside of the fundamentals, investors can look to history for some clues about how the stock market may perform in 2024. For example, according to Ben Carlson of Ritholtz Wealth, after a year of gains of 20% or more for the S&P 500, the index added more gains 65% of the time, or 22 out of the 34 years that has happened. The average return following a 20% or higher year was 8.9%.

It is also a presidential election year, and while that usually brings headline volatility to the capital markets, the stock market has been higher 19 out of the last 23 election years, or 83% of the time, according to First Trust. Furthermore, the results are pretty close no matter which party wins the Oval Office. When a Democrat was in office and a new Democrat was elected, the total return for the year averaged 11.0%, First Trust said. When a Democrat was in office and a Republican was elected, the total return for the year averaged 12.9%.

Bonds Look to Bounce Back

After a three-year bear market that brought long-term U.S. Treasurys down 25%, a pause in interest rate hikes may have finally stabilized the Treasury market. But that doesn’t mean bond yields, which move inversely to bond prices, are going to come tumbling back down to 2021 levels. The U.S. 10-year treasury yield topped 5% in late October of 2023 as doubts about the Fed’s ability to engineer a soft landing increased. But as those doubts have mostly dissipated, sending the 10-year yield to around 4%, the U.S. balance sheet is still a mess, with a deficit of $33 Trillion. 

Mark Cabana of BofA Securities says the U.S. fiscal stance has deteriorated, as has its net international investment position. The traditional foreign buyers Treasurys—The Bank of Japan and the People’s Bank of China—have curtailed their purchases of U.S. bonds and the appetite for owning what was one considered the safest, most widely held asset on the planet, has diminished.

While the appetite for Treasurys may have waned, they still dominate the capital markets, with $20.8 trillion in issuance so far this year, up 34% from a year ago, according to the latest figures from SIFMA. As the U.S. economy stabilizes and interest rates come down, the outlook for government bonds has improved dramatically, according to Vanguard. The index fund giant now expects U.S. bonds to return a nominal annualized 4.8% – 5.8% over the next decade, according to its 2024 outlook. That’s a big turnaround for fixed income investors who have experienced nominal returns of 1.5%-2.5% for the past several years.

Crypto Goes Main Street

You might think that the collapse of crypto brokers such as FTX and enforcement actions against Binance and Coinbase (COIN) would’ve destroyed the price of popular tokens like bitcoin and ether (ETH). Think again. The price of bitcoin (BTC) is up 150% so far this year as some investors may believe the crypto market is actually safer than it’s ever been. They may be right. Crypto is about to hit Main Street in 2024 and there are a lot more eyes on it now, as bitcoin ETFs are set to be approved for retail investors.

Several ETF issuers, including Grayscale, Valkyrie, and VanEck, have had their applications for spot bitcoin ETFs under review by the SEC for over a year, but crypto watchers are convinced that the regulator will finally approve them in the first quarter. That’s because biggest traditional asset managers in the world, such as Blackrock (BLK) and Fidelity, stepped in with their plans for spot bitcoin ETFs, which opens the door for more retail investors to gain exposure to these digital currencies. 

In addition, bitcoin, the most widely-held crypto asset, is nearing another halving event this Spring. Bitcoins are created, or mined, and only 21 million coins will ever be created. Miners who verify bitcoin transactions and successfully add the next block to the blockchain receive bitcoin as reward. Halving cuts the miner’s reward in half.

Since 19 million bitcoins have already been mined, the halving process means even tighter supply for a scarce asset that is already in demand. Scarcity plus wider acceptance via ETFs will likely lead to even higher prices, according to Ric Edelman, the founder of the Digital Assets Council of Financial Professionals.

Trends in Motion

While nothing about next year is certain, investors can expect many of the trends that are in motion at the end of 2023 to stay in motion absent a Black Swan event.

Inflation will continue to cool, bringing bond yields and interest-rate sensitive products like mortgages with them. As yields stabilize, albeit at higher levels than the past ten years, investors will continue to have alternatives to equities, which could be under pressure given rich valuations.

But so much depends on when the Federal Reserve plans to cut interest rates, and by how much. Given the outperformance of the equity and crypto markets in 2023 based on the assumption that the Fed will turn more dovish early next year, 2024 could bring either a rude awakening to investors, or a soft landing and a continuation of recent trends.