On January 30, the International Monetary Fund (IMF) raised its outlook for 2024 global growth from 2.9% to 3.1%. At its press conference, IMF Chief Economist Pierre-Olivier Gourinchas explained their rationale: “The global economy continues to display remarkable resilience, and we are now in the final descent toward a soft landing with inflation declining steadily.” That sentiment defined much of January’s U.S. market performance and the data, broadly, backed it up.

U.S. Gross Domestic Product (GDP) rose 3.3% in the fourth quarter of 2023, according to the Commerce Department’s January 25 report. The figure shocked markets—consensus expectations were for growth near 1.5%, less than half the reported rate—and the growth was encouragingly broad based. Consumer spending was up 2.8%, business investment accelerated and government spending rose. Even improvement in housing conditions (pending home sales surged 8.3% in December), contributed to the economy’s unexpected strength.

Meanwhile, the Personal Consumption Expenditures Price Index (PCE), the U.S. Federal Reserve’s (Fed) preferred measure of inflation, fell below 3% for the first time since early 2021, when inflation was just starting its rapid acceleration. Core PCE (which excludes the more volatile food and energy components) rose just 2.9% in December 2023 from December 2022, down 0.3% from the 3.2% year-on-year rise reported in November. The month-on-month changes were even more encouraging. With the December data, the Core PCE’s annualized monthly rate of inflation over both the last three and six months is now below the Fed’s 2% long-term average target.

While confidence has been growing since early November that the Fed may have achieved a soft landing, January’s data largely puts the debate to bed. The S&P 500^® Index initially surged in January, hitting new record highs and exceeding the consensus forecasts for the Index’s total 2024 annual return by January 24. However, a late month correction retraced some of its gains, only to see the Index set new highs again in early February.  

The Fed, unsurprisingly, neither raised nor lowered its policy rate at its January meeting, the fourth straight meeting with no changes. While the month began with investors giving a roughly 50% chance of the Fed cutting interest rates at its March meeting, those hopes faded over January. In an interview in early February, Fed Chairman Jerome Powell made it clear the Fed is optimistic inflation would continue to decline but was also cautious: “We want to see more evidence.” 

Outlook: Recent inflation data, in our view, confirms the Fed’s interest-rate hiking cycle has ended. The question now is how soon—and by how much—the committee will feel comfortable lowering interest rates in the face of robust U.S. (and global) economic strength.

In our 2024 outlook we argued the four to five rate cuts then priced into the market were optimistic. We maintain that view despite better-than-expected inflation data because we believe the Fed is determined to be conservative. The Fed created justifiable concerns about its credibility as stewards of moderate growth and low inflation when it was slow to raise rates in the face of rapidly rising inflation. We don’t think the Fed can afford to make the same mistake twice and will thus favor lower inflation over more accommodative monetary policy until it is confident inflation is not just correcting lower, but is at a stable, fundamentally-based equilibrium closer to its target.

We remain optimistic on U.S. equities, despite recent strength. Once again, much of the recent gains have been dominated by the largest, mega-cap companies. We expect sustained economic growth (and, eventually, more accommodative monetary policy) will allow stronger earnings growth to spread across the broader market, favoring sectors such as the small- and mid-cap markets, companies with relatively lower credit quality and the more value-oriented stocks which have lagged the overall market.

We also maintain our positive outlook on bond markets. We believe U.S. Treasury yields are near their peak for this economic cycle, and believe both long- and short-dated Treasuries will end 2024 at significantly lower yields, justifying long-term exposure. However, we expect periods of optimism will be balanced by periods of skepticism, keeping volatility relatively high during the transition from a restrictive to a more accommodative monetary policy.

Corporate bonds, which offer a yield spread over similar maturity Treasuries, provide both higher income and the potential for greater capital appreciation should credit spreads tighten as yields fall. While current valuations may already be pricing in a more optimistic outlook, some of this richness could be explained by the simple fact these bonds offer compelling yields. After a decade of paltry bond yields, investors can be forgiven for happily earning around 5% a year on investment-grade corporates, regardless of their potential for capital appreciation if spreads tighten.

Markets are currently optimistic on improving growth and the prospects for interest-rate cuts in 2024. While we agree that 2024 is likely to deliver positive total returns in both stocks and bonds broadly, we remain mindful that volatility can spike or remain elevated for extended periods as economic or geopolitical uncertainty rises. While the short-term effects of volatility can be alternatingly elating and painful, these same periods can also offer opportunities for actively managed portfolios and investors who have heeded our words of caution and retained some flexibility to add risk when valuations become more attractive.