Entering 2023, more than 85% of economists expected a U.S. recession before year’s end. They had good reason: The yield curve, usually a harbinger of recession, inverted in July 2022, when rates for two-year Treasury bonds surpassed those for 10-year bonds. Meanwhile, on Main Street, Google searches for the term “recession” hit the highest mark in history.
Recession expectations declined rapidly from 2023 to 2024
Sources: Capital Group, Financial Times, University of Chicago. Figures for December 2022 and December 2023 are based on survey results from 44 respondents and 39 respondents, respectively. The December 2022 survey did not include a specific option for 2025 as a potential start date for the next recession. Figures may not add up to 100 due to rounding. Latest data available as of December 27, 2023.
However, as we enter 2024, that recession has yet to materialize, and many of those same economists now expect a soft landing. With the U.S. economy expanding at a rate of 4.9% in the third quarter, unemployment under 4% and the Consumer Price Index down to 3.1% in November, it appears the U.S. Federal Reserve was able to tamp down inflation with rapid interest rate hikes while avoiding a recession.
If the recession expectations of 2023, and now 2024, come with any lesson, it is that the economy and markets can surprise you. Therefore, investors would be better off not trying to time the market. It has been proven over time to be extremely difficult, according to Steve Watson, a portfolio manager with New Perspective Fund®.
With $5.89 trillion in cash sitting in money market funds (according to the Investment Company Institute) as of December 27, 2023, investors who stayed on the sidelines earned yields fluctuating between 4.53% and 5.63% for the year (based on the benchmark 3-month Treasury) as recorded by the St. Louis Federal Reserve, but missed out on gains of 26.29% and 5.53% for the S&P 500 Index and Bloomberg U.S. Aggregate Index, respectively. Investors should consider leaning into the discomfort and uncertainty, following the Wall Street adage that time in the market beats timing the market.
“If I could count up 23 or 24 downturns over roughly 35 years in the business, that's one every 16 months,” Watson notes. “We recover. It’s easy to say at moments of crisis in the markets that I'm going to wait for clarity before I invest — I’d rather wait to see catalysts for a turnaround. I've come to the conclusion that it's not worth trying.”
Not all recessions or economic cycles are the same but looking back on underlying conditions — and focusing specifically on technology, banking and housing — provides a roadmap to how and why the U.S. avoided a recession in 2023, and perhaps how the same can be done in 2024.
1. Lofty tech valuations supported by earnings growth
The rise of the “magnificent seven” (Apple, Microsoft, Alphabet, Amazon.com, NVIDIA, Tesla and Meta Platforms) has been compared to the excesses of the dot-com era in the late 1990s. But there are important differences today, says Mark Casey, a portfolio manager with The Growth Fund of America®.
“In 2000, companies were overvalued to a much greater degree than the market leaders are now,” Casey asserts. “At the top of the internet bubble there was lots of fluff that imploded. This time around, there is less fluff, and most of the mega-cap stocks are legitimate investments.”
P/Es ratios today are far lower than during the dot-com bubble
Sources: Capital Group, FactSet, Nasdaq, National Bureau of Economic Research, Refinitiv, Standard & Poor's. P/E ratios represent forward 12-month price-to-earnings ratios. Weight reflects the company market capitalization as a percentage of the overall index market capitalization. As of December 29, 2023. Past results are not predictive of results in future periods.
Looking at one common valuation metric, the average price-to-earnings (P/E) ratio (a measure of share price relative to earnings per share) of the NASDAQ 100 was 32.5 at the end of 2023. At the end of 1999, just preceding the stock market crash in March 2000, that figure was a whopping 79.59.
The magnificent seven stocks have captured a majority of returns in a narrow market, making up a combined 59.1% of the Nasdaq 100 at the end of 2023. However, their relatively high valuations are backed up by earnings and cash flows that lend merit to their status as market leaders.
Take Microsoft, the largest Nasdaq constituent by market cap at the end of 1999, and second largest behind only Apple as of late 2023. At the end of 2023, Microsoft had a P/E ratio of 29.1. Compare that to the end of 1999, when Microsoft sat at 60.8.
Investors may be wary of elevated prices for some of these mega-cap stocks. However, given the growth potential for some of today’s market leaders, they may make sense as holdings within a balanced portfolio, according to Casey.
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2. Banking contagion was contained
The March 2023 banking crisis was an interest rate issue rather than a credit issue — an outgrowth of one of the fastest hiking cycles in history. As interest rates rose, the market value of the banks’ bond holdings plummeted, triggering customer worries that the banks would not have enough liquid assets to secure their deposits.
“Liquidity providers were able to breathe a huge sigh of relief when the Federal Deposit Insurance Corporation reminded nervous investors that no losses would be taken by depositors,” explains Will Robbins, a portfolio manager with American Mutual Fund®.
Additionally, the Federal Reserve provided liquidity through the Bank Term Funding Program. This emergency lending program offered banks up to one-year loans with the use of Treasuries and other qualifying assets at their original price instead of their lower market value.
Much as the regulators learned lessons in the 2008 banking crisis that helped in their response in 2023, investors can learn from apprehension in 2023 as they approach 2024 markets.
3.Housing supply and demand dynamics have changed
Investors currently worried about the housing market can take some solace from the fact that it is very different than it was in 2008.
Today, the Fed’s rate hikes have dampened home sales alongside changes in housing patterns in the wake of the pandemic. All of this has served as a backstop for the volatility that occurred 15 years ago.
“Back then we built a ton and had an oversupply of housing inventory. Today we have the opposite,” says Capital Group U.S. economist Darrell Spence. “We underbuilt for many years so that when COVID hit the housing market was pretty tight.”
Spence adds that a strong labor market with near full employment and low-rate refinancing over the last decade have been helpful in the current environment.
Were the recession indicators a signal or just noise?
According to Spence, while economic models haven’t quite broken down, the system has absorbed many distortions.
“People talk about the COVID ‘recession’ and maybe it's because we don't have a better word,” Spence explains. “Output did contract, but not because of ‘normal’ recessionary forces. It was intentional. Governments threw money at the problem, and the economy has needed time to adjust.”
If the Fed succeeds in managing a soft landing, it would be useful to look at the ISM Manufacturing PMI, or Purchasing Managers Index, a measure of industrial activity that has dropped in concert with every recession over the last three decades. A number below 50 means a contraction of manufacturing activity, while a number above 50 represents an expansion. The current PMI (as of November 30, 2023) was 46.7. The last time it hit lows around 45 without triggering a recession was in in June of 1995.
A recent PMI downturn has not seen a corresponding hike in unemployment
Sources: Capital Group, Bureau of Labor Statistics, Institute for Supply Management (ISM), National Bureau of Economic Research. Figures reflect the seasonally adjusted survey results from ISM's Manufacturing Purchasing Manager's Index (PMI); a PMI reading above 50 percent indicates that the manufacturing economy is generally expanding; below 50 percent indicates that it is generally declining. As of November 30, 2023.
They say history doesn’t repeat itself, but it rhymes. In 1995, part of the market insecurity was the near doubling of the federal funds rate from 3.25% to 6.00% in just seven increases. Rate cuts in the back half of 1995 and early 1996 kept a recession at bay. The outcome this time around could be similar. The bullish view of the recent slowdown in industrial output is that it is simply an outgrowth of supply imbalances from the pandemic.
While economic conditions today appear solid relative to history, the bottom line is that there are sure to be surprises in the year ahead, as there always have been. Rather than waiting for an all-clear signal to get back into stock and bond markets, maintaining well-diversified, balanced portfolios through economic cycles remains a sensible approach for long-term investors.
Mark L. Casey is an equity portfolio manager with 23 years of investment industry experience (as of 12/31/2023). He holds an MBA from Harvard and a bachelor’s degree in history from Yale University.
William L. Robbins is an equity portfolio manager with 32 years experience (as of 12/31/2023).He holds an MBA and a bachelor's degree from Harvard.
Darrell R. Spencecovers the United States as an economist and has 31 years of investment industry experience (as of 12/31/2023). He holds a bachelor’s degree in economics from Occidental College. He also holds the Chartered Financial Analyst® designation and is a member of the National Association for Business Economics.
Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.
Bloomberg U.S. Aggregate Index represents the U.S. investment-grade fixed-rate bond market.
Nasdaq Composite Index tracks the performance of more than 3,000 stocks listed on the NASDAQ and is often viewed as an indicator for the newer sectors of the economy.
Nasdaq 100 Index consists of equity securities issued by 100 of the largest non-financial companies listed on the NASDAQ index.
S&P 500 Index is a market capitalization-weighted index based on the results of approximately 500 widely held common stocks.
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