Transamerica Asset Management, Inc. 2024 Mid-Year Market Outlook

Source: GDP — Bureau of Economic Analysis, as of 3/31/24, third release 6/27/24

Following a slowing pace of GDP growth in 1Q 2024, we see a combination of economic headwinds and tailwinds at force with one another for the remainder of the year. Headwinds include the ongoing impact of previous Federal Reserve rate hikes, declining consumer savings rates, and rising credit card debt. Tailwinds include potentially declining rates of inflation, Federal Reserve rate cuts, and rising corporate earnings growth. On balance, we see a net advantage for the tailwinds resulting in positive economic growth for CY 2024 of about 2%, which we would view as a favorable environment for both stocks and bonds. 

Source: Bureau of Labor Statistics, as of 5/31/24

A major reason we believe positive economic growth can continue despite the presence of headwinds is the extremely strong jobs growth experienced over the past year. While we expect this rate of employment gains to slow in the months ahead, we believe the foundation of this existing labor base to be strong enough to sustain positive consumer spending into 2025.

As of 4/30/24; Revolving Consumer Credit Outstanding. Source: Federal Reserve; Household Savings Rate Source: Bureau of Economic Analysis

We view perhaps the predominant headwind on consumer spending as being the combination of increasing aggregate consumer credit card debt and declining monthly household savings rates. This cross correlation of less money to spend and more bills to pay is potentially a future drag on economic growth in the year ahead.

CPI Source: Bureau of Labor Statistics, as of 5/31/24; PCE Source: Bureau of Economic Analysis, as of 4/30/24

After we saw encouraging inflation trends throughout 2023, closely watched measures flatlined through the first three months of the year, as seen in the year-over-year CPI core and PCE core inflation rates. After falling impressively over the previous 12 months, these two metrics declined by only 0.1% from January through March to 3.8% and 2.8%, respectively. Since then, core CPI has shown some renewed movement to 3.4% for May. Our expectation is inflation will likely resume its downward trajectory in 2H 2024, perhaps to the lower 3% range for core CPI and into the lower 2% range for core PCE. We believe such a scenario would provide the Fed with enough of a downward trajectory to potentially reduce interest rates in 4Q 2024, which we would view as favorable for the economy and the markets.

As of 6/13/24; Source: Bloomberg

The previous nine inverted curves dating back to 1966 have averaged a tenure of 11 months, with a range of five to 18 months. The current 3-month to 10-year inverted yield curve, in place since October 2022, is now in its 21^st month, surpassing the longest previous inverted curve of December 1978–May 1980.

As of 6/13/24; Source: Bloomberg

When taking this history into account, as well as inflation trends over the past two years, we believe the current 3-month to 10-year Treasury yield curve is likely to flatten to a less inverted slope between now and year-end 2024 before fully normalizing back to an upward slope during 2025. Given the prospect of two rate cuts in 4Q, we see the 3-month Treasury yield dropping to 4.75%, with the 10-year yield settling out at about 4.25%. We would then expect the yield curve to eventually normalize to an upward slope following more rate cuts during CY 2025 while the 10-year yield holds steady.  

In this changing environment, we see two viable approaches for fixed income investors. Investors may consider intermediate-term bonds in the 6–9 year maturity range 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). Investors may also consider the highest possible yields at the short end of the curve (1–2 years). However, we recognize there is the risk of rolling over those shorter maturities into lower yields if the Fed continues easing monetary policy in 2025, as we believe will likely be the case.  

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 6/12/24

We continue to be drawn toward intermediate-term, investment-grade bonds as being perhaps the best segment of the fixed income markets from a risk-reward standpoint. Yields on A and BBB rated corporate bonds are now close to three times higher than at the start of 2021, before the higher inflation and rising interest rate environment began. Therefore, as inflation and interest rates potentially further normalize to some extent in the year or two ahead, the case to lock in these yields on investment-grade bonds is likely a strong one, in our view.

High-yield credit spreads represented by the OAS for the ICE BofA US High Yield Index; investment-grade credit spreads represented by the OAS for the ICE BofA US Corporate Index, Source: ICE Indexes, as of 6/13/24

While we view the ongoing credit environment as relatively benign, we still prefer investment-grade bonds to high yield due to the historically tight credit spreads currently on high-yield bonds versus comparable maturity U.S. Treasury bond yields. In the event of some economic slowing in the months ahead, we see investment-grade bonds as less likely to experience credit spread widening and are therefore the preferable choice from a risk-reward standpoint.   

Source: Bloomberg, as of 6/13/2024
Indexes are unmanaged and an investor cannot invest directly in an index. Past performance does not guarantee future results.

The run in U.S. stocks since the depths of the recent bear market has been substantial and impressive. However, we believe the combination of rising corporate earnings growth and market history following the full recoveries of bear markets (similar to what markets experienced in January), and the prospects of lower inflation and Federal reserve rate cuts suggests U.S. equities are capable of double-digit, annualized total returns between now and the end of CY 2025.

In looking at the previous five bear markets (defined as a 20% or worse decline in the S&P 500) dating back to 1980, stock investors have typically benefitted from owning stocks immediately following the full recovery of those bear market losses. Such was the case after full recoveries of S&P 500 bear market losses in November 1982, July 1989, March 2013, and August 2020, all of which proceeded to post extremely strong returns until the next bear market. 

The only bear market deviating from this profile over the past 44 years was the full recovery of the 2000–2002 bear market, which then soon rolled into the global financial crisis bear market in 2007, now viewed by history as a “double top” in which the S&P 500 did not confirm its total recovery at higher levels. The average tenure following these five previous bear market complete price recoveries until the start of the next bear market was 4.8 years, with average annualized price gains of better than 15%.

Source: Bloomberg. as of 6/13/24

The most recent bear market, beginning in January 2022, reached a complete price recovery on the S&P 500 in January 2024 and appears to have confirmed itself at higher levels since that time. We believe catalysts for stocks in the year or two ahead include rising economic and corporate earnings growth, declining rates of inflation, and Federal Reserve rate cuts. All of this we view as consistent with price targets on the S&P 500 of 5,800 for year-end 2024 and 6,300 for year-end 2025.

Historical EPS Source: FactSet Earnings Insight; as of June 14, 2024; Estimate Source: Transamerica Asset Management as of June 14, 2024

Of these catalysts, we view the most meaningful as being rising corporate earnings growth. When looking at S&P 500 net operating income estimates for 2024 and 2025, it appears as though, following three years of close to flat earnings from 2021–2023, corporate profits could be primed for a notable breakout over these next two calendar years in the 11%–14% range. Given these expectations and what we believe could be some degree of upside to CY 2025 estimates amid a declining rate environment, we believe it is fair to anticipate annualized total returns on stocks over the upcoming year or two to be similar to earnings growth, which is also consistent with our price targets on the S&P 500 of 5,800 for year-end 2024 and 6,300 for year-end 2025.  

Source: Bloomberg, as of: 5/31/24

We view the current market environment as one that can be favorable for growth and value stocks. Over the past decade, growth stocks have dramatically outperformed value stocks, as seen in this total return comparison of Russell 1000® Growth versus Russell 1000 Value indexes.

As of 5/31/2024. Source: Bloomberg
Indexes are unmanaged and an investor cannot invest directly in an index. Past performance does not guarantee future results.

Over the past 10 years, the MSCI EAFE has materially underperformed the S&P 500, representative of a lost decade for international developed stocks versus their U.S. counterparts.

Source: Bloomberg
Indexes are unmanaged and an investor cannot invest directly in an index. Past performance does not guarantee future results.

Looking forward, we believe there could be some degree of catchup in relative performance for international developed stocks given historically wide valuation differentials between the S&P 500 and MSCI EAFE indexes. This could allow for certain catalysts to come to the forefront for international developed stocks. These could include eurozone inflation, which has fallen at a faster pace than in the U.S., corresponding ECB rate cuts, and a more shareholder-focused market environment in Japan.

Eurozone CPI Source: Eurostat; as of 5/31/2024; ECB Deposit Facility Rate, Source: European Central Bank as of 6/13/2024

Eurozone inflation has declined rapidly from its cycle peak almost two years ago. This descent has resulted in the ECB cutting key interest rates for the first time since 2019. We would view declining inflation and further ECB rate cuts as potential tailwinds for eurozone stocks in the year ahead.