Will the Fed Achieve a Soft Landing in 2024?


Soft landings, it has been said, are the holy grail of monetary policy, and as we look ahead to 2024, there are signs that we may be on the cusp of one. But what does it mean for the economy to have a soft landing? And conversely, what constitutes a hard landing?

Simply put, a soft landing occurs when the Federal Reserve raises interest rates to curb inflation and manages to do so without triggering a sharp increase in unemployment or pushing GDP growth into negative territory.

A hard landing, on the other hand, is when interest rates rise and inflation decreases, but at the cost of a recession and high unemployment.

Achieving a soft landing is exceptionally challenging. Noted MIT economist Rudi Dornbusch (1942-2002) famously quipped: “None of the post-war expansions died of old age. They were all murdered by the Fed.” Indeed, out of nine tightening cycles over the past five decades, the bank successfully engineered a soft landing only twice. The other seven instances culminated in recessions.

Princeton economics professor Alan Blinder offers some hope. If the need to combat inflation is not too extreme, he writes in a recent article, the Fed has demonstrated its ability to orchestrate an economic landing that either avoids a recession or induces a relatively mild one. The central bank’s reputation for causing hard landings “derives mainly from conquering the 1970s inflation—which took three landings,” Blinder says.

The key to predicting the outcome in 2024 lies in economic indicators, especially as experts project the consumer price index (CPI) in the U.S. to decline to 2.7% while the Fed’s target rate is expected to reach 4.50% by the end of the year.

A Global Leader in Numerous Industries

Despite the occasional gloomy predictions and forecasts, investors should be cautious about buying into the “America-is-in-decline” narrative, Merrill points out in its weekly Capital Market Outlook.

America’s share of global gross domestic product (GDP), estimated at 26% for 2023, has increased from 24.8% at the start of the decade. Over the past four years, the U.S. economy has added an additional $6 trillion to its economic base, bringing total U.S. output to around $27 trillion this year. Most impressively, since the beginning of the decade, the S&P 500 has consistently outperformed most developed and emerging markets.

Investors have been treated to a promising holiday season, characterized by strong consumption.

Mastercard reports a year-over-year increase of +3.1% in U.S. retail sales, excluding automobiles, during the 2023 holiday shopping season from November 1 through December 24. This measure encompasses both in-store and online retail sales across all payment forms and is not adjusted for inflation.

Finally, the Santa Claus rally appears to be in place. This phenomenon describes a period where the stock market closes higher during the last five trading days of the current year and the first three trading days of the new year.

“Where else in the world is there an economy that leads or dominates in so many diverse industries, ranging from agriculture to aerospace, education to entertainment, and technology to transportation, to name just a few sectors?” asks Joseph Quinlan, head of Merrill’s market strategy.

I couldn’t have said it better myself.

Gold’s Prospects in a Soft-Landing Scenario

In the context of a potential soft landing, historical trends suggest that gold may not perform as strongly. According to the World Gold Council (WGC), soft landing environments have typically resulted in flat to slightly negative average returns for gold.

However, every cycle is unique, and 2024 may bring surprises.

Heightened geopolitical tensions in a key election year for many major economies, combined with continued central bank buying, could provide additional support for gold. Central banks and official institutions have played a pivotal role in boosting gold’s performance over the past two years, with the WGC estimating that excess central bank demand added 10% or more to gold’s gains in 2023. This trend is likely to persist, potentially providing an extra boost to gold prices in 2024.

In the event that a recession becomes a reality, weaker growth could help steer inflation back toward central bank targets, eventually leading to interest rate cuts. Such an environment has been conducive to both gold and high-quality government bonds, making them appealing options for investors, the WGC says.

As we approach 2024, it’s essential for investors to remain vigilant, monitor economic indicators closely and consider the various possibilities that lie ahead. While the prospect of a soft landing offers optimism, the financial landscape remains subject to change.

By recognizing the strength of the U.S. in the global economy and staying attuned to market dynamics, investors can position themselves for success in the coming year.

Index Summary

The major market indices finished mixed this week. The Dow Jones Industrial Average gained 0.81%. The S&P 500 Stock Index rose 0.33%, while the Nasdaq Composite climbed 0.12%. The Russell 2000 small capitalization index lost 0.29% this week.

The Hang Seng Composite gained 4.44% this week; while Taiwan was up 1.90% and the KOSPI rose 2.13%.

The 10-year Treasury bond yield fell 1 basis point to 3.88%.

Airlines and Shipping

Strengths

The best performing airline stock for the year was SkyWest, up 216.4%. Chinese domestic travel was strong this year, with domestic air ticket spending tracking 30% above pre-COVID levels (pricing and traffic +15% above pre-COVID levels). Japan saw strong domestic leisure and inbound volumes with holiday reservations at pre-COVID levels.

Contrary to the continuing downtrend in spot rates, share prices of Japan’s Big 3 shippers outperformed TOPIX by 10% in 2023. The reasons behind this include: 1) relatively close interest in dividend yields which are much higher than for Japanese stocks in other industries, and 2) the current turnaround in dry bulk market prices (due to the positive effects of China reopening).

Southwest Airlines revised its December quarter revenue outlook to the better end of its prior range due to stronger-than-expected close-in bookings. The company expects unit revenue to be down 9% to 10% year-over-year versus down 9% to 11% prior. JetBlue published an investor update narrowing its fourth quarter net loss per share guidance to ($0.25) to ($0.35) from ($0.35) to ($0.55) prior. The improved outlook was primarily driven by better-than-expected revenue trends with top-line guidance now down 5.5% at the midpoint versus -8.5% prior.

Weaknesses

The worst performing airline stock for the year was Frontier, down 46.9%. Domestic leisure fares trended down during 2023. Airlines with a larger component of long-haul international traffic continue to see strong demand, but there have been warning signs of pricing declines. ARC Corporation reported domestic fares declined 6.5%. This data only reflects agency sales and misses web sales, but the trend may continue through at least mid-2024.

According to Drewry Maritime Research, the order book stands at more than 900 ships, with deliveries in 2024 expected to add 1.4 million TEUs (twenty-foot equivalent units, a standard measure of cargo capacity). That’s equal to about 5% of the current global total. New capacity is expected to increase by a record 2 million TEUs in 2024 and 2.1 million in 2025 to reach 27.2 million, up almost 50% from a decade earlier, according to Drewry.

Regarding the Pratt and Whitney jet engine issue, the FAA estimates 20 engines are affected on U.S.-registered aircraft. Pratt has instructed operators to remove affected engines for inspection and Raytheon has indicated that 200 engines meet these criteria; therefore, the 20 engines are the U.S. portion of this 200. Among U.S. operators, Spirit Airlines said that it has 13 of the 200 engines with potentially four more at JetBlue.

Opportunities

Alaska Airlines entered into a definitive agreement to acquire Hawaiian for $18 per share in an all-cash transaction. The deal represented a total equity value of $1 billion, in addition to the assumption of $900 million of Hawaiian’s net debt, for a total transaction value of $1.9 billion. The combined company plans to operate the brands of Alaska Airlines and Hawaiian Airlines separately while integrated under a single operating certificate, collective bargaining agreement for each labor group, and loyalty platform. Management expects $235 million of run-rate synergies or 2% of combined 2023 revenue.

Based on Clarkson’s data, average sailing speeds in 2023 were 14.5 knots for vessels larger than 8,000 TEU, 12% lower than the 2013-2019 average. Assuming a vessel spends, on average, 30% of the trip duration in port, a further 10% decline in speed could take out 7% incremental capacity.

Travel budget expectations increased in 2023, with improvement expected to continue into 2024. Next year’s budgets are expected to be up nearly 8.5% year-over-year, signaling that there is still room for recovery and/or growth.

Threats

Alaska Airlines cited approximately one-third of its revenues are tied to California, a region it expects to remain weak in 2024. Similarly, given its larger corporate exposure to tech companies (38% of corporate business), West Coast business remains less recovered than other regions.

According to Morgan Stanley, the volume of newly built container ships in 2023 was 11% of its forecast for new supply in 2023. The group expects concerns about supply/demand deterioration due to pressure from the supply of new ships to kick in fully at some point.

According to Cowen, an overcapacity situation is developing in the North Atlantic that could likely lead to lower air fares. U.S. airlines were among the first to add back international capacity after the pandemic. European airlines increased capacity for summer 2024. Cowen forecast that airlines will grow capacity to Europe by 8.6% for the first nine months of 2024 versus 2023. For the entire region (including India, the Middle East, and Africa), the group forecasts an increase of 7.4%, which follows an increase of 18.3% in the nine months ending September 2023.

Luxury Goods and International Markets

Strengths

Despite predictions of a recession in 2023, the U.S. economy has proven resilient and appears poised for continued strength in 2024. During the third quarter of the current year, the GDP experienced an impressive, annualized growth rate of nearly 5%. This remarkable expansion can be attributed to vigorous consumer spending and a robust employment landscape. Additionally, yields have likely increased while inflation is on a downward trajectory. In a surprising move, the Federal Reserve announced its intent to implement rate cuts next year, further boosting economic prospects.

In 2023, the most expensive luxury vehicle sold at auction was a 1962 Ferrari 250 GTO, with a price tag of $51.7 million. This was also the most expensive car ever sold at auction from the Italian manufacturer. The record-breaking sale took place at Sotheby’s in New York as the car was offered publicly for the first time in 38 years.

Royal Caribbean and Carnival Corporation, two cruise line companies, emerged as top performers within the S&P Global Luxury Index in 2023, posting impressive gains of 161.97% and 130.02%, respectively. They were among the hardest-hit stocks during the COVID-19 pandemic, and as the pandemic ended allowing people to travel again, they recorded massive gains.

Weaknesses

Stocks trading on the Hong Kong Stock Exchange (measured by the HSCI Index) declined 10.69% this year, while equities trading on the mainland (measured by the SHCOMP Index) lost 3.85%. China’s economy is encountering difficulties in achieving its targeted growth rate, facing multifaceted challenges throughout the year, including escalating geopolitical tensions, mounting debt issues, and a slower post-pandemic recovery.

In addition to China, the Eurozone underperformed. The region is expected to see 0.8% growth in 2023, down from the 1.1% that had been previously predicted. It is expected to post growth of 1.3% in 2024, down from 1.6% forecast. The 20-member bloc entered a recession in the first quarter of the year. The economic slowdown is a result of weakened demand due to high inflation rates, the European Commission said. Germany, the largest economy in Europe, has been hit by higher energy prices and slowing demand in China.

Faraday Future Intelligent Electric Inc., a California-based global shared intelligent electric mobility ecosystem company, was the worst performing S&P Global Luxury stock this year, losing 99.01% in 2023. At the beginning of the year, the company finally unveiled its long-anticipated luxury electric car, the FF 91 Futurist. The FF 91 2.0 Futurist Alliance, a high-end SUV, had a starting price of $309,000, while other versions of the FF 91 began at $249,000. To cope with the high production costs and slow deliveries, especially given the hefty price tags, the company has been actively seeking additional funding.

Opportunities

Lower-than-anticipated inflation figures in both the United States and the Eurozone could indicate that central banks might conclude their tightening measures. During its December gathering, the Federal Reserve caught many market watchers off guard by proposing multiple interest rate reductions in 2023. This could lead to a further decline in yields and an uptick in equity markets.

The global luxury industry witnessed robust expansion in the preceding year, but it is showing signs of deceleration this year, with the possibility of reaching its lowest point in the first quarter of 2024. According to RBC Capital Markets, luxury sector sales are forecasted to reach their lowest point in the first quarter of 2024, followed by an improvement in the latter half of the year. On a sector-specific basis, RBC anticipates an average growth rate of 9% in its sporting goods segment and an average of 5% in the luxury sector.

CLSA, one of Asias top brokers, predicts that the global luxury goods sector will grow 6.5% from 2022 to 2025, slightly surpassing the 5.5% growth over the past two decades. This will be driven by Chinese demand recovery on the back of reopening and outbound travel resumption. In 2019, the Chinese comprised one-third of the global personal luxury sales at $92 billion, and it will continue to rise, reaching EUR100 billion by 2025.

Threats

Bain & Company, a consulting group in the luxury sector, said that the sector is experiencing normalization. Last year the sector was able to grow on average at 20%. This year the growth rate should be around 8-9%,…



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