Transamerica Asset Management, Inc. 2024 Market Outlook

Source: GDP Bureau of Economic Analysis, as of 9/30/23, second estimate released 11/29/23; Forecast - Federal Reserve Bank of Atlanta, as of 11/30/23

Despite recent economic strength, as exemplified by 3Q gross domestic product (GDP) growth of 5.2%, it is our assessment that leading economic indicators point to a slowdown during the early months of 2024. At the forefront of these factors is the lagging effects of 5.25% of Federal Reserve rate hikes that have occurred since March 2022. In our judgment, it could take 12–18 months for each rate hike to fully filter through the economy, meaning there could be approximately 375 basis points of previous Fed rate hikes yet to have their impact completely felt.  

Source: Federal Reserve Board of Governors, Transamerica Asset Management. As of 11/30/23

In addition, escalated longer-term rates, as seen in the U.S. Treasury 10-year yield, have recently reached multiyear highs and are spilling over into the credit and mortgage markets. This is also likely to create economic impact in 2024.

As of 11/30/23 Source, 10-Year US Treasury Yield: Bloomberg; Source, 30-Year Average Fixed Mortgage Rate: BankRate.com

Other leading indicators include depleting levels of consumer savings, mounting credit card debt, and the resumption of student loan payments. These factors could soon begin negatively impacting consumer spending that has been a key driver of recent economic strength seen over the past year.  

Household Savings Rate as of 10/31/23, Source: Bureau of Economic Analysis; Revolving Consumer Credit Outstanding as of 9/30/23, Source: Federal Reserve 

Further signifying risk of slowing and potentially negative economic growth in 1H 2024 is the ongoing decline in the Conference Board’s Leading Economic Index (LEI), which is a series of 10 economic, market, and consumer metrics with an established history of turning negative prior to broad-based downturns. This index has been in decline since March 2022 — for 18 consecutive months — and over that time has displayed a cumulative decline of more than -11%. In the past 40 years, the LEI has never fallen by such magnitude without a recession following in the year ahead.  

Source: Conference Board, as of 10/31/23

All considered, we expect an upcoming 1H 2024 economic downturn to be relatively mild and more along the lines of recessions incurred in 1990 and 2001, lasting a couple of quarters and with peak-to-trough GDP declines in the 1–2% range, as opposed to more severe recessions that occurred in 1981 and 2007. We expect the economy, driven by potential rate cuts coming from the Fed in 2H 2024 and the widely anticipated nature by which the pending slowdown has allowed corporations to prepare, will rebound by year-end and finish 2024 at about flat annualized GDP growth.

We continue to be encouraged by recent inflation trends as seen in consumer price index and personal consumption expenditures (PCE) core inflation year-over-year readings now at their lowest levels in more than two years. We believe these core rates of inflation will likely head toward 3% during 1H 2024.

In our view, there is a high likelihood the most recent Fed tightening cycle has concluded, and no further rate hikes are forthcoming. A major reason for this perspective is the widening increase in the level of real interest rates as measured by the upper bound federal funds rate minus the year-over-year rate on core inflation. Now at a differential of 2% (5.5% upper bound federal funds rate minus 3.5% October PCE core inflation), this represents not only the highest real rate since the Fed began tightening in March 2022 but also a level we view as being sufficiently restrictive in regard to constraining inflation.

Source: Federal Reserve Board of Governors, as of 10/31/23

Given the Fed’s dramatic pace of rate hikes since March 2022, pending economic weakness, and mitigating levels of inflation, we believe there is a strong probability of federal funds rate cuts in 2H 2024. Odds remain challenged, in our view, that the Fed does much before about mid-year. However, after that point, the Fed could begin an easing cycle consisting of perhaps four quarter-point rate reductions in 2H 2024, taking the federal funds rate down to a target range of 4.25%–4.50%.

As of 11/30/23. Source - Fed Funds Target Rate: Federal Reserve Board of Governor. Forecast: Transamerica Asset Management

A major focus for fixed income investors during 2024 will be the changing slope of the Treasury bond yield curve and where to be positioned on it. Here, we see a material flattening of the 3-month to 10-year yield curve throughout the year. This would be consistent with history dating back to 1969 in which yield curves have inverted prior to recession and normalized back toward an upward slope just before or during recession. Given the magnitude of the Fed’s rate hikes since March 2022 and the likelihood of rate cuts not occurring until about mid-year, we expect the 3-month to 10-year Treasury yield curve to fully flatten in the year but not resume an upward slope until perhaps CY 2025. We therefore expect the longer end of the curve to see yields little changed in CY 2024, with the 10-year U.S. Treasury rate concluding the year at approximately 4.25%.

As of 11/30/23. Source - Data: Bloomberg. Forecast: Transamerica Asset Management

Given this prospective drop in short-term rates and stabilization in longer-term rates to facilitate a flattening yield curve in 2024, we believe the intermediate portion of the curve, in the maturity range of six to nine years, is optimal for fixed income investors. We say this because this area of the curve allows bond investors to lock in yields at or near multiyear highs while mitigating reinvestment rollover risk at the short end of the curve as well as duration-based price risk at the longer end (10 years or greater). We also view the overall credit environment as more benign than prior to most previous economic slowdowns due to the widely anticipated nature of an upcoming recession and stronger corporate balance sheet management in preparation of a downturn. 

We are more drawn to investment-grade bonds than high yield in large part due to the ability of investment grade to best weather an economic downturn during 1H 2024. Therefore, as we begin the new year, we view investment-grade bonds as the preferable risk-reward profile, though we do see high yield still generating positive total returns and warranting a smaller portion of fixed income investors portfolios. 

A Rated Bond Yields represented by the Yield to Worst on the US Aggregate Bond: A Index, BBB Rated Bond Yields represented by the Yield to Worst on the US Aggregate Bond: BBB Index, Source: Bloomberg, as of 11/30/23

Given the widely anticipated nature of a recession in 1H 2024, we believe U.S. equities are likely to handle a modest economic downturn well based on our expectations of lower interest rates, corresponding earnings acceleration in 2H 2024, and the steep declines equity markets incurred in 2022 and have yet to fully recover. 

Source: Bloomberg. As of: 11/30/23
Indexes are unmanaged and an investor can not invest directly in an index. Past performance does not guarantee future results. 

We view 5,000 as a reasonable year-end 2024 price target on the S&P 500, driven by potentially improving corporate earnings growth, declining rates of core inflation, and the end of the Fed’s tightening cycle combined with potential rate cuts in 2H 2024. These factors should act as meaningful catalysts for stock prices in the year ahead.   

Following close to a flat year for earnings growth in CY 2023, S&P 500 net operating income should increase during the year ahead, even in the event of a mild recession in 1H 2024. We believe S&P 500 net earnings can achieve double-digit growth in CY 2024, however it will likely be back weighted with corporate profits increasing more in the second half of the year during recovery from a potential economic slowdown in the first two quarters. 

Source: FactSet Earnings Insight November 17, 2023

We view overall stock valuations as reasonable given opportunities for rising earnings growth against a backdrop of declining inflation and less restrictive monetary policy from the Fed. We believe S&P 500 net operating income could achieve close to $250 in CY 2024 with double-digit earnings growth to follow in CY 2025. We therefore view an expected earnings range for CY 2025 to be $275–$280 and, given expectations of declining inflation and Fed rate cuts, believe a fair price-earnings forward multiple on CY 2025 profits to be 18x, implying a prospective year-end 2024 price range of 4,950–5,040 to which we would round the mid-point to 5,000. 

We also reiterate our belief that the equity markets likely put in their bear market lows in October 2022 and could see a full recovery back to their previous record highs of early January 2022, perhaps occurring by as early as spring 2024. This would be based not only on a more favorable macroeconomic environment and potential earnings acceleration in 2H 2024, but also the expected recovery of stock prices back to previous record highs based on the last 10 bear markets over the past 65 years. 

 ¹ Assumes Bear Market Conclusion as of October 12, 2022

 ² Estimate based on Historical Bear Market Averages 1957–2020

Source: "Stock Market Historical Tables: Bull and Bear Markets" Dr. Edward Yardeni, October 28, 2022

https://www.yardeni.com/pub/sp500corrbeartables.pdf

As markets enter 2024, the lost decade of relative performance for international stocks versus their U.S. counterparts continues. However, we believe global investors can still benefit from owning overseas developed equities. This is predominantly based on the ongoing valuation gap between international developed versus U.S. stocks and what could be some level of convergence within that differential during 2024, as well as what also could be a turn toward more accommodative monetary policy at global central banks.   

Source: Bloomberg. As of: 11/30/23
Indexes are unmanaged and an investor can not invest directly in an index. Past performance does not guarantee future results.

Despite risk of lapsing into a mild recession in 1H 2024, eurozone equities could be poised for gains in the year ahead as inflation has recently receded to a two-year low and the European Central Bank (ECB) could embark upon cutting rates in 2H 2024. This might present a situation in which markets will begin to discount a combination of declining interest rates and improving economic growth in CY 2025 against a backdrop of sub-3% headline inflation, all of which could be well received by the markets following 10 consecutive ECB key interest rate increases over the past 18 months. Therefore, eurozone stocks could be well positioned for the year ahead.  

As of 10/31/23, Source: Eurostat

As the Nikkei 225 now stands within eyesight of its record high achieved almost 35 years ago, we believe market-oriented changes in Japan could continue to provide opportunities for international investors. Specifically, a concerted effort by the Tokyo Stock Exchange (TSE) to increase valuations of publicly traded companies could be a continuing catalyst for Japan equities. Historically, Japanese companies have maintained a strong bias toward holding cash resulting in lower price-book valuations versus other regions. However, upcoming listing requirements could soon force companies trading below book value to submit plans to the TSE as to how to improve capital management. This could result in increasing dividend payments and/or stock buyback activity on a widespread basis, likely proving favorable for the Japan equity markets.

Source: Bloomberg. As of: 11/30/23
Indexes are unmanaged and an investor can not invest directly in an index. Past performance does not guarantee future results.

Emerging markets could require patience throughout 2024 in large part due to ongoing challenges in China, where declining real estate markets and rising youth unemployment are hindering growth opportunities. We view India as perhaps the most appealing economy within this asset class where recent GDP growth has exceeded 7%. For these reasons, we believe emerging markets portfolios are likely best positioned with higher allocations to India and lower weightings in China.