Dear Friends,
We wish you and your families a happy holiday season. Looking back at 2023, it has been a complex year full of challenges and opportunities. We experienced the fear of recession, the Fed’s hiking and tightening policy, a banking crisis, a potential government shutdown, and long-term yield pressure. As the year progressed, we also witnessed decreasing inflation, a resilient economy, and a technology rally resulting from the Artificial Intelligence (AI) boom. Looking forward, 2024 appears to be another year with multiple factors complicating the path to recovery though a soft landing seems feasible. Our detailed market view of 2024 can be found in this week’s newsletter.
Our Market View of 2024
Tightened monetary policy will continue putting pressure on the fundamentals of the US economy in 2024. Riskier assets will be more attractive as the Fed recently indicated the potential for multiple interest rate cuts in mid-2024. Currently, investors have $5.8 trillion of liquidity held in money market funds, and where and when that money is deployed will play a significant role in determining the market’s direction for 2024.
For US large-cap equities, we believe that quality companies with consistent operating results and low leverage will continue to outperform given the S&P 500 is trading at a high valuation level compared with the historical average. US small-cap companies are becoming more attractive because of the improving economy and their relatively cheap price when considering the high valuation gap between the Russell 2000 small-cap index and the S&P 500. With expected rates cut in 2024, multiple rate-sensitive sectors, such as real estate, are poised to benefit. The dollar is expected to continue weakening due to decreasing long-term treasury yield, which releases pressure on international equity performance. This opens up opportunities, particularly in the European and Japanese markets. On the other hand, emerging markets are not expected to benefit in the same way because global trade and supply chains have been affected by deglobalization trends following the pandemic and war in Ukraine.
Fixed income will be center stage for 2024 with expectations to generate both income and capital gain. We anticipate long-term yields to continue to decrease and the Fed to cut rates in 2024 allowing for long-term government and agency bonds with higher duration to capture more total return from both interest and capital gain. We believe extending the duration will come back for the core fixed income strategy. Developed countries’ bonds issued in hard currency (money that is issued by a nation that is seen as politically and economically stable) are likely to provide a premium since the dollar is weakening. We keep a neutral view on investment-grade bonds and high-yield bonds while holding an underweight review on short-term floating-rate bonds.
There are still challenging factors for global capital markets such as geopolitical risks and unsustainable government spending that will need to be navigated next year. It is critical to keep the appropriate balance between asset classes while at the same time retaining flexibility to respond as clearer signals develop. The Legacy Foundation will continue to help our clients navigate the challenging global markets
Economy, Geopolitics, and Commodities
1. Inflation Is Approaching Fed Target
Inflation retreated further in November, and consumer spending rose, another indication the U.S. economy can avoid a recession while bringing prices under control. The personal consumption expenditures price index fell 0.1% in November from the previous month, the first decline since April 2020. It was up 2.6% on the year. Excluding food and energy prices, the index was up 0.1% on the month, the same as in October. On the year, core inflation was up 3.2% in November, down from 3.4%. The Federal Reserve targets 2% annual inflation using the PCE price index. On a six-month annualized basis, core inflation eased to 1.9%, suggesting the Fed is well on its way to reaching the target.
Consumer spending, meanwhile, was up 0.2% on the month in November, down from 0.1% in October. Overall personal income was up 0.4%, down from 0.3% in October, a sign of confidence in the economy on the part of American households. Separate data set for release Friday morning by the University of Michigan will show the final reading of December consumer sentiment. A preliminary reading showed a 13% increase from the prior month. Americans’ incomes are rising when adjusting for price changes “because of lower inflation, steady job growth, and steady wage gains,” said Bernard Yaros, lead U.S. economist at Oxford Economics. “And that bodes favorably for real consumer spending,” which will support the overall economy next year.
2. US Labor Market Resilience Keeps Economy Afloat as Year Ends
The number of Americans filing new claims for unemployment benefits rose marginally last week, the latest suggestion that the economy was regaining some momentum as the year winds down. The smaller-than-expected increase in weekly jobless claims reported by the Labor Department on Thursday followed recent data showing retail sales unexpectedly rising in November, while single-family housing starts and building permits scaled 1-1/2-year highs. Those reports prompted economists to boost their growth estimates for the fourth quarter. The economy added 199,000 jobs in November, fewer than the monthly average of 240,000 over the past year, but more than the 150,000 positions created in October. The Fed held interest rates steady last week and policymakers signaled in new economic projections that the historic monetary policy tightening engineered over the last two years is at an end and lower borrowing costs are coming in 2024.
Continuing claims have mostly increased since mid-September blamed largely on difficulties adjusting the data for seasonal fluctuations after an unprecedented surge in filings for benefits early in the COVID-19 pandemic. Economists expect the distortion will be smoothed out when the government revises the data next year. Labor market strength is underpinning the economy. In a separate report, the government confirmed that economic growth accelerated in the third quarter. Gross domestic product increased at a 4.9% annualized rate last quarter, revised down from the previously reported 5.2% pace, the Commerce Department’s Bureau of Economic Analysis (BEA) said in its third estimate of third-quarter GDP. It was still the fastest pace of expansion since the fourth quarter of 2021. Economists had expected GDP growth would be unrevised. The economy, which grew at a 2.1% rate in the second quarter, has been expanding at a pace far above what Fed officials regard as the non-inflationary growth rate of around 1.8%. The downward revision to GDP growth last quarter reflected downgrades in consumer spending and inventory investment.
3. Housing Heats Back Up
Mortgage rates have come back down, and that is going to help would-be home buyers. It will help home builders even more and has already helped their stocks a lot. The Mortgage Bankers Association on Wednesday reported that in its latest survey of lenders, the average contract interest rate on a 30-year mortgage fell to 6.83% last week from 7.07% the previous week. That is still steep, but it is much better than the 23-year high of 7.9% registered in October. It brings mortgage rates back to their June levels.
Already the decline in rates appears to have rekindled interest in home buying: The National Association of Home Builders on Monday said that traffic among prospective new home buyers has picked up from last month. And builders are acting as if there are good times ahead: The Commerce Department on Tuesday reported that a seasonally adjusted 1.143 million single-family homes were started in November, at an annual rate, versus 969,000 in October and the most since April 2022. New building permits for single-family homes—a leading indicator of home construction activity—hit their highest level since May of last year. This counts as good news for the economy. Earlier this month economists were pretty sure that housing would weigh on the fourth-quarter gross domestic product. Now it looks as if it might provide a bit of a boost. Even though mortgage rates have come down, they would probably need to decline much more to substantially unlock the market for previously owned, or existing, homes. The National Association of Realtors reported that a seasonally adjusted 3.82 million existing homes were sold in November, up from October’s 3.79 million, but outside of that the fewest since August 2010.
4. Bank of Japan Keeps Policy Targets Unchanged
Japan’s central bank left its ultra-loose monetary policy unchanged at its final meeting this year, a move that unraveled the recent yen rally as the policymakers chose to wait for more concrete signs of meaningful wage growth. The BOJ decided unanimously to keep interest rates at -0.1% while sticking to its yield curve control policy that keeps the upper limit for 10-year Japanese government bond yield at 1% as a reference, according to a policy statement released Tuesday.
“Uncertainty over the outlook is extremely high and we have yet to foresee inflation sustainably and stably achieve our target. As such, it’s hard to show now with a high degree of certainty how we can exit [from ultra-loose policy],” BOJ Governor Kazuo Ueda said Tuesday afternoon at a press conference, according to a Reuters translation. “If we were to exit the negative rate, interest rates would rise slightly. But inflation-adjusted real borrowing costs will remain low, so accommodative monetary conditions will be sustained,” he added. Yields for the 10-year Japanese government bond fell to 0.622%, and the yen weakened after the BOJ decision and was trading more than 1% lower at 144.33 against the greenback in the late afternoon. The Nikkei 225 stock index climbed 1.4% to its highest closing level in nearly two weeks.
5. ECB Keeps Rate on Hold but Lowers Inflation Forecast
The European Central Bank has signaled it still has “work to be done” to tame price pressures after leaving interest rates unchanged, even as it cut its inflation forecasts for this year and 2024. ECB president Christine Lagarde pushed back against market expectations for it to cut rates as early as March, saying “we should not lower our guard” against inflationary pressures. The central bank’s decision on December 14th came as investors ramped up their bets that major central banks are getting closer to lowering borrowing costs, following signals from US Federal Reserve officials that they expect to cut rates more aggressively than previously planned next year.
After the ECB maintained its benchmark deposit rate at its highest-ever level of 4 percent for the second consecutive meeting, policymakers repeated their determination to keep borrowing costs at “sufficiently restrictive levels for as long as necessary”. The central bank forecast consumer price growth would slow to its 2 percent target within the next three years — clearing a key hurdle for them to consider cutting rates. But Lagarde said policymakers would be “a little bit more severe” and aim to hit that milestone by 2025. The ECB said it expected headline inflation to average 5.4 percent in 2023, 2.7 percent in 2024, 2.1 percent in 2025, and 1.9 percent in 2026, a “downward revision” for 2023 and 2024 from September’s projections. The ECB also announced a change to its remaining bond-buying program, bowing to calls from hawkish members of its governing council to stop purchases earlier than planned. The central bank would reduce the reinvestments of maturing securities in the €1.7tn portfolio it started buying in response to the coronavirus pandemic from the second half of next year, instead of continuing them until the end of 2024. The reinvestments would be cut by €7.5bn a month from July before ending completely at the end of next year.
Financial Markets
1. Indexes Extend Run of Weekly Gains
Stocks finished mixed on the last day of trading before the Christmas holiday, with all three leading U.S. indexes booking an eighth consecutive week of gains. Fresh figures released Friday indicated that inflation has continued easing. Prices fell in November for the first time in more than three years, personal-consumption expenditures price index data showed. The Federal Reserve’s favorite inflation gauge came in less than expected. The November core personal consumption expenditures price index rose just 0.1% last month, and gained 3.2% from a year ago, about in line with expectations. Economists polled by Dow Jones anticipated a monthly increase of 0.1% and 3.3% from a year earlier. Meanwhile, Chinese regulators sprung an unwelcome surprise on investors in tech stocks such as Tencent and NetEase that spilled into U.S. trading.
U.S. stocks were mixed on the day. The S&P 500 and Nasdaq managed gains, while the Dow ticked lower. The S&P 500’s eight-week run of advances marked the longest such stretch since 2017. Stock in Nike, the sneaker giant and Dow constituent, dropped after it cut its revenue outlook. Shares of companies like Under Armour and Foot Locker also fell. Benchmark Treasury yields ticked higher. The 10-year yield settled Friday at 3.907%, ending a second straight week of losses. Oil prices wavered as concerns over Red Sea shipments lingered. Benchmark U.S. crude ticked lower, ending the week down 2.5% to $73.56 a barrel.
2. Tesla Supplier Panasonic Drops Plan for Oklahoma EV Battery Factory
Tesla supplier Panasonic said Wednesday that it has decided against building a multibillion-dollar electric vehicle battery factory in Oklahoma. Panasonic already has an EV battery plant under construction in Kansas and has been eyeing Oklahoma as a potential additional location. The Japanese company already operates a joint-venture EV battery plant with Tesla in Nevada. In April, Panasonic entered into a formal agreement with the state of Oklahoma to explore building a factory in the state. Panasonic said Wednesday that it has decided not to move forward with the plan. It cited “a wide range of factors” without naming any.
Panasonic has battled high costs at the Kansas construction site, people at the company have said. With help from the Biden administration’s Inflation Reduction Act, plants to make batteries, semiconductors, and other products the U.S. views as strategic are being built at a rapid pace, raising the prices for construction and factory equipment. The above-estimate costs in Kansas have made it harder for Panasonic to commit to building another similar plant, people at the company said. The EV business in the U.S. is facing uncertainty as growth in demand has been slower than some companies expected. Some companies are moving more slowly with their expansion plans, including General Motors, which is delaying the opening of a large electric pickup truck factory in Michigan.
3. Bristol Myers to Buy Karuna Therapeutics for $14 Billion
Drugmaker Bristol Myers Squibb reached a deal to buy neuroscience-drug developer Karuna Therapeutics KRTX 47.37% increase; green up pointing triangle for $14 billion. Under the terms, Bristol would pay $330 a share in cash for Karuna and its experimental schizophrenia drug now up for U.S. government approval. Bristol expects the deal, which includes $1.3 billion in cash that Karuna has on hand, would close in the first half of next year. The acquisition, announced on Friday, would raise Bristol’s bet on selling psychiatric and neurological drugs, a large and growing market that has drawn interest from companies because of advances in understanding the molecular roots of various central-nervous-system diseases.
Karuna’s crown jewel, an experimental drug called KarXT, is the product of such new insights. The Food and Drug Administration is reviewing KarXT for the treatment of schizophrenia. The drug is also in development for conditions related to Alzheimer’s and bipolar disorder. The drug could surpass $6 billion in yearly sales if it is approved for various uses, according to Mizuho Securities analysts. Bristol Chief Executive Christopher Boerner said the acquisition would accelerate the company’s efforts to establish a beachhead in neuroscience drugs and power new sales growth as its older products begin losing patent protection and face lower-price competition. “We are in the process of writing a new chapter for Bristol Myers Squibb,” he said in an interview. Drugs for multiple sclerosis and schizophrenia have already been among the pharmaceutical industry’s top sellers, and analysts expect Alzheimer’s treatment will eventually become a huge category. Researchers are also excited about the prospects for treating Huntington’s and other diseases.
4. Amazon in Talks to Invest in Diamond Sports
Amazon is in talks to invest in the biggest regional sports programmer, a move that would advance the e-commerce giant’s aggressive push into sports content as it takes on streaming rivals like Disney and Netflix. Diamond Sports Group, which carries the games of more than 40 major sports teams across the country and filed for bankruptcy earlier this year, is actively negotiating with Amazon about a strategic investment and a multiyear streaming partnership, according to people familiar with the matter. If an agreement is reached, Amazon’s Prime Video platform will eventually become the streaming home for Diamond’s games.
Diamond, which has the local rights to about half the teams in Major League Baseball and the National Basketball Association and about a third of the National Hockey League teams, would continue operating its cable networks through its existing partnerships. For Amazon, which already has rights to stream National Football League games and is expected to pursue a deal to carry NBA games, adding popular local teams through Diamond would further boost its Prime Video platform. It already has deals with league-owned streaming services from the MLB and the NBA. Amazon has already dipped its toe in the regional- sports-network business with a stake in the YES Network, the TV and streaming home of the New York Yankees and Brooklyn Nets.
5. GM Buys Out Half of Its Buick Dealers
General Motors has bought out about half of its 2,000 Buick dealers nationwide, based on their decision to not sell electric vehicles, according to a company spokesman Wednesday. Dealers who are taking the buyout would give up the Buick franchise and no longer sell the brand, he said. The dealer can continue to sell other GM models, such as Chevrolet or GMC, that often account for a higher percentage of sales. The Wall Street Journal reported in late 2022 that the automaker planned to offer buyouts to its U.S. Buick dealer network. The move came after the Detroit automaker gave the dealers a choice: Invest at least $300,000 to sell and service electric vehicles or exit the Buick franchise. The investments would cover EV chargers and worker training, among other initiatives.
GM is ending the year with about 1,000 Buick dealers.GM offered a similar buyout program for its Cadillac brand starting in 2020 that trimmed the luxury brand’s U.S. dealer network by roughly one-third, the automaker has said. The automaker has allowed dealers to exit from the Buick network voluntarily and with the full support of the National Dealer Council, the spokesman said. Dealers across the country have expressed concerns about leaning in too much on EVs when customers are worried about the range, reliability, and high price of these models. Automakers have been encouraging a more direct-sales model for EVs, in which buyers purchase the vehicle from the manufacturer or go through a no-haggle process with a dealer. This shift, which executives say will better match supply with demand, also reduces how many battery-powered models are kept on dealer lots.
Sources:
(1) www.bloomberg.com
(2) www.factset.com
(3) www.wsj.com
(4) www.barrons.com
(5) www.reuters.com
(6) www.cnbc.com
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual security. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. Economic forecasts set forth may not develop as predicted.
Bonds are subject to market and interest rate risk if sold prior to maturity. Bond and bond mutual fund values and yields will decline as interest rates rise, and bonds are subject to availability and change in price.
Investing in stock includes numerous specific risks, including the fluctuation of dividends, loss of principal, and potential illiquidity of the investment in a falling market.
Investing in foreign and emerging market securities involves special additional risks. These risks include but are not limited to currency risk, geopolitical risk, and risk associated with varying accounting standards. Investing in emerging markets may accentuate these risks.
Investment advice offered through Private Advisor Group, a registered investment advisor and separate entity from The Legacy Foundation.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.
The Legacy Foundation and LPL Financial do not offer tax advice.
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