The U.S. economy avoided a much-anticipated recession in 2023 and made significant progress toward a soft landing. The key surprise was much stronger-than-expected economic growth as the labor market continued to rebalance and inflation continued to fall. In the U.S. and across many parts of the world, inflation declined, approaching but not reaching central bank targets, while importantly (and amazingly) avoiding a major slowing of growth or a pickup in unemployment. As we exit 2023, the risks are more symmetric: the risk of inflation remaining sticky and above target, and the risk of weaker economic activity exists as well.
2023 was a year of valuation expansion, which is unusual for the late stages of an economic cycle. Market optimism was related to above-expected economic growth, fiscal stimulus, consumer spending, expected Fed rate cuts, and AI. Earnings actually fell somewhat short of expectations, so P/E expansion led by mega cap stocks (especially the Magnificent Seven) was the story. The average stock trailed the major averages by more than 1,000 basis points despite market broadening toward the end of the year. August to October recorded a slightly above 10% correction that was followed by a 15% rally into mid-December. Overseas, India passed China as the world’s most populated country and the Indian economy trounced China.
The key economic question for 2024 is whether central banks can continue the “landing of the plane” (soft landing) without a crash (recession). The consensus view of 2024 is a “Goldilocks” environment; i.e., not too hot and not too cold. Expectations include a soft economic landing, a continued decline in inflation towards targets, and double-digit earnings growth. We think that fairy tale is unlikely, meaning either 1) the economy weakens enough for a bumpy ride (perhaps a recession) and earnings fall short (most likely), or 2) the economy remains strong enough to support double-digit earnings growth at the risk of little progress on inflation and Fed rate cuts. It is with this backdrop that we proceed as usual with fear and trepidation (and hopefully some good, educated guesses).