On screen copy:
2024 Midyear Outlook
Bridge to a more bullish future?
On-screen disclaimer:
Please read important information at the end of this program. Recorded on 06/12/2024.
[Chris Hyzy speaking throughout]
On screen copy:
Chris Hyzy
Chief Investment Officer
Merrill and Bank of America Private Bank
CHRIS HYZY: Hello and welcome. I'm Chris Hyzy, and I'm pleased to be hosting this mid-year conversation we're calling 'Bridge to a More Bullish Future'. So far, 2024 has offered investors some compelling reasons for optimism.
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Midyear 2024: Outperforming expectations
- Economic and market growth
- Strong corporate earnings
- Healthy labor market
- Consumers still spending
The economy continues to grow, and markets, instead of cooling after a surge in 2023, have built on last year's momentum. Even after record rate increases by the Federal Reserve to counter inflation, corporate earnings still remain strong, and the labor market, despite a recent and modest decline in the rate of job growth, remains healthy. And consumers, while becoming a bit more selective in their purchases, continue to spend.
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Midyear 2024: Recognizing the risks
- Wars and geopolitical tensions
- Election year volatility
- Stubborn inflation and interest rates
Amid these positives, it's important to stay aware of risks that could still slow the economy or drive volatility. Geopolitical tensions remain elevated, with simultaneous conflicts in Ukraine and the Middle East and the potential for ongoing concerns over Taiwan and US-China relations. We're also in an election year, which often brings short-term volatility historically. Moreover, stubbornly high inflation and interest rates make it harder for businesses and individuals alike to buy homes or make other large purchases.
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A bridge from pandemic disruptions to more normalized long-term growth.
So, how can investors make sense of these positives and risks? As the title of this program indicates, we see the current economy as a bridge from the lingering effects of the pandemic to a new era of sustained and normalized growth.
[Headshot of Aditya over his name and title.]
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Aditya Bhave
Senior U.S. Economist
BofA Global Research
First, I'll be joined by Aditya Bhave, Senior US Economist for BofA Global Research. We'll get his thoughts on the election, geopolitical risks, and where the labor market and the economy are headed next.
[Headshots of Marci and Matt over their names and titles over a flagscape.]
On screen copy:
Marci McGregor
Head of Portfolio Strategy, Chief Investment Office
Merrill and Bank of America Private Bank
On screen copy:
Matthew Diczok
Head of Fixed Income Strategy, Chief Investment Office
Merrill and Bank of America Private Bank
Next, I'll be joined by Marci McGregor and Matt Diczok, two of our top strategists with the Chief Investment Office. We'll discuss the current outlook for stocks and bonds, which sectors of the economy may hold promise, and how investors can explore potential opportunities while still ensuring their portfolios are properly diversified and invested towards their personal goals. With that, let's turn to my discussion with Aditya Bhave for his views on the economy.
[DIP TO WHITE - Transition to Chris Hyzy and Aditya Bhave discussion]
CHRIS HYZY: Aditya, thanks for joining me. On a scale of zero to 10, where where are we in economic health, with five being neutral?
On screen copy:
Aditya Bhave
Senior U.S. Economist
BofA Global Research
ADITYA BHAVE: I would probably give it around a seven or eight, right? We're, we're in a good state. We have a low unemployment rate. We have solid GDP growth. But even as inflation slows, there is this lingering issue that price levels are way higher than they were before the pandemic.
CHRIS HYZY: Let's talk about the resiliency of the U.S. economy heading into '24, coming off of a relatively strong year in '23. There was this thinking that the economy was going to struggle, whether it was the consumer, whether it was, you know, maybe a fiscal bridge that slows down later on, most likely maybe that's '25. But give us your thoughts overall, not just on the health of the U.S. economy, but what is still driving it?
ADITYA BHAVE: So, the big story last year was a very large supply shock, much larger than what we were expecting, and that allowed for around 3% growth with disinflation. We added a lot more jobs than expected, with wage inflation still coming down. Going into this year, it looks like the labor supply shock is slowing. Which is consistent with our expectations.
On screen copy:
What to expect on inflation
- Steady but slow improvement
- Inflation may not reach 2% until 2026*
- The last mile may be the hardest
*Source: FXStreet.com, "Fed's Mester: Probably won't get to 2.0% inflation until 2026," June 14, 2024.
ADITYA BHAVE: On inflation, we do expect things to get better, but we expect things to get better rather slowly. We don't have inflation getting back to 2% until 2026, and as of the latest Fed meeting, it seems like the Fed actually agrees with us.
ADITYA BHAVE: So, we're moving in the right direction. We're just doing that quite slowly, and the big debate, I think, late last year was how difficult was that last mile going to be? And now it looks like, yes, that last mile will actually be quite difficult.
CHRIS HYZY: How does that segue over into consumer spending?
ADITYA BHAVE: What it looks like is happening with the consumer right now is that good spending has clearly softened up a lot, but that's after a period of unexpected strength in the first three quarters of last year, while services accelerated a bit. So now the question is, going into the summer, can we continue this momentum in services? Will services continue to pick up the slack for goods, right? And one interesting data point on that is airport travel.
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Packed airports demonstrate consumer willingness to spend on experiences.
CHRIS HYZY: And it doesn't matter what time. You can show up at 5 a.m.
ADITYA BHAVE: Exactly.
CHRIS HYZY: It's still very crowded.
ADITYA BHAVE: Airports are still jam-packed. This is completely consistent with my anecdotal experiences. And so we probably will see even higher peaks going forward.
CHRIS HYZY: Productivity. We've had an enormous increase, at least partially anecdotally, but also factual, when it comes down to the amount of money that's in things like generative AI. And it's just beginning. But broadly speaking, capital expenditures and the level of productivity, how do you view that this year and into the next few years?
ADITYA BHAVE: Usually, productivity cycles are very diffi-, difficult to call. They are super cycles, in the sense that they might not start at the same time as a business cycle takes off. But then once they get going, they'll probably go, they'll span several business cycles, right? So, with AI, it's probably a bit too early to see it in the macro data, but we'll wait and see.
CHRIS HYZY: Are the same drivers still at play for the trend in economic growth over the next five years, or are we seeing new things that we have to come to understand better?
On screen copy:
Intellectual property investments are a driving force in the business cycle.
ADITYA BHAVE: See, if you look at what drives the business cycle, it's actually investment, and that should remain the case. But within investment, intellectual property investment has really taken off. It's, it's a much, much more important component of investment than in prior cycles. It's relatively less sensitive to interest rates, and that probably has impacted the overall economy's sensitivity to interest rates.
CHRIS HYZY: We talk about the Fed policy. Let's talk about, between now and the end of the year, let's talk about projections for potential cuts through the cycle and the reasoning behind it. What are your thoughts there?
ADITYA BHAVE: Right, so, we expect the Fed to start cutting rates in December, and that's consistent with our view that inflation will be quite sticky on the way down. Once they do start, we expect a pace of 25 basis points per quarter through next year and then mid 2026. So, seven cuts in total, for a terminal rate of 3.5 to 3.75 percent. Typically, the policy rate takes the elevator up or the stairs up and the elevator back down. This time around, it's the opposite. It seems like we've taken the elevator up and we expect to take the stairs back down. And the reason for that is that we think the Fed will be cutting to cement a soft landing, to get policy rates back to neutral rather than to accommodate a recession. Now, if our forecast is wrong and you do get a significant downturn, then we know that the Fed can cut very fast and probably will.
CHRIS HYZY: Aditya, thanks for joining me.
ADITYA BHAVE: Thank you for having me.
[DIP TO WHITE - Transition to Chris Hyzy]
On screen copy:
Investment ideas to consider now
CHRIS HYZY: Let's go now to my conversation with Marci McGregor and Matt Diczok.
[DIP TO WHITE - Transition to Chris Hyzy, Matt Diczok, and Marci McGregor discussion]
CHRIS HYZY: Matt, Marci, thanks for joining me today.
MARCI MCGREGOR: Good to be here.
MATTHEW DICZOK: Great to be here, Chris.
CHRIS HYZY: Matt, let's start with you. In terms of monetary policy, interest rates, and the economy, what has surprised you most here as we sit here at the halfway mark, and what's the outlook for the remainder of the year?
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Matthew Diczok
Head of Fixed Income Strategy, Chief Investment Office
Merrill and Bank of America Private Bank
MATTHEW DICZOK: So what surprised me most is that there's been a massive change in expectations from the Fed from the beginning of this year to the middle of this year, but asset markets have actually performed quite well in spite of that. That was the biggest surprise, that, that shift in market expectations, but then no downdraft in equities on a much tighter Fed policy expected. Now, we've taken the view for over a year now, again, not focusing on the short-term, but the longer term. The Fed's at or near the end of the rate hike cycle, in our opinion. So, we believe the next move is a cut.
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Forecasting a Federal Reserve interest rate cut in December.
Our forecasts are expecting one cut in December. If there's a risk, there might still be two cuts this year, but our base case is one cut this year in December.
CHRIS HYZY: It's not necessarily, the cut itself. It's most likely the magnitude of cuts, the time-frame of, but the reason behind it. What would be the reason behind, given where we are with inflation and other items, that we're still worried about?
MATTHEW DICZOK: That's exactly the right question. If the Fed is cutting because they're very concerned about the economy, obviously, that's very different than what we expect the cut to be, which is just fine-tuning based on what they're seeing in the economy. We are starting to see a slowdown. It takes a while for rate hikes to work their way through the economy. They do a proactive Fed cut to just fine-tune inflation, that's a good place to be, and that's where we think they're going to be at the end of this year.
CHRIS HYZY: If that's the case, which we believe it's the case, there's a reason why equity markets have kind of powered through all of this. You want to explain a little bit more about that, Marci?
On screen copy:
Marci McGregor
Head of Portfolio Strategy, Chief Investment Office
Merrill and Bank of America Private Bank
MARCI MCGREGOR: Yeah, there's so much debate right now. Are we late-cycle, early-cycle? I would fade all of that talk and remember that we're still normalizing in terms of policy, ah, in terms of rates, in terms of quirks in the economic data from the COVID time.
On screen copy:
Reasons for equity resilience
- Corporate earnings recovery
- Ample liquidity
- Range-bound interest rates
- Generative AI and innovation
But when I think about why markets may be shrugging off this shift in Fed expectations, it's because the fundamentals are in place. And for me, it all comes back to corporate earnings. We are in earnings recovery. Our expectation is that's going to broaden as we get into the back half of this year, look ahead into 2025. There's ample liquidity. Interest rates have stayed range bound. And I would argue that Generative AI and the innovation that's taking place is why we believe that this bull trend could continue.
CHRIS HYZY: With all of that as the baseline, first 100 days, US stocks, large cap US stocks, S&P 500 have been up approximately 10%. What's in store for the second half?
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Amid potential election volatility, stay focused on fundamentals.
MARCI MCGREGOR: Well, we do have to remember this is a presidential election year. And what happens in, we've seen historically is a pickup in volatility in the equity market. Call it from July till Election Day. But that's when I say, take a step back, look at the fundamentals, because the pattern also tells us that once the election's in the rear-view mirror, you start to see markets refocus on fundamentals and you tend to have a stronger end of the year.
CHRIS HYZY: Matt, let's switch over a little bit to to rates. Let's switch over to duration, the yield curve, longest inversion on record, arguably speaking. What does it mean and where are we headed with the curve from this point forward heading into 2025, at least the second half of '24?
MATTHEW DICZOK: So, what the inverted yield curve is telling us is that the Fed is likely to cut in the coming 12 to 24 months. When longer rates are lower than short-term rates, that's just telling you the Fed's going to have to cut if they want to continue the economy in the right path, not going too slow, not growing too quickly. The Fed's gotten inflation down from around 9% on CPI to about 3-and-a-half %. Meanwhile, bond yields right now are in the mid fours on the 10-year Treasury. So, we're in a much better place now. And so, the inverted yield curve should not be a concern for investors. And while it's difficult to want to extend that duration because you're getting paid on cash, usually that's the right time to extend your duration slightly.
CHRIS HYZY: Marci, take us through a portfolio as we sit here in the second half of 2024. And as we carry ourselves into the next two or three years, talk about portfolio strategy in the context of value and growth, small and large, and US and non-US.
On-screen copy:
Equities areas to consider
- A mix of large and small caps
- Energy
- Industrials
- Defense
MARCI MCGREGOR: We do have a preference for US equities over the rest of the world. And a large part of that is because of the innovation that's happening in the US economy. The US economy has also been quite resilient. So, within US equities, we like both large and small caps. I would tilt towards cyclical industries. Areas like energy, industrials, defense spending, even internationally, will likely continue. And energy as a way to position for this world where that last mile of inflation has been a little bit stickier and geopolitics remain a risk. But I would stay really diversified. You know, the lines have really blurred between value and growth. I would stay really balanced when I think about value and growth.
CHRIS HYZY: Matt, same questions as it relates to fixed income. Where are the opportunities?
On-screen copy:
At a time of higher yields, there's
less need to add portfolio risk.
MATTHEW DICZOK: Given how high yields are right now, you don't need to take a lot of risk. You don't really need to add a lot of risk to get really decent, reliable, predictable yields. So, we're favoring rate risk at the moment, slightly overweight Treasuries, slightly overweight instant mortgage backs, slightly underweight credit municipals, but only slightly. For instance, if you're a high tax rate client, munis are still probably the best asset class.
CHRIS HYZY: But let's talk about this concept that we have discussed recently, asset-light. An asset-light economy feeding into an asset-light S&P 500 relative to where we were a decade or so ago. Can you quickly explain what that means?
MARCI MCGREGOR: Yeah. If we think about the S&P 500 in 1980, it was dominated by manufacturing companies.
CHRIS HYZY: Right
On screen copy:
Tech-driven, 'asset-light' economy favors U.S. companies.
MARCI MCGREGOR: And now, fast forward, more than half of the index is going to be what we would consider asset-light or companies that focus really on intellectual property, ah, like technology, like healthcare. Asset-light companies are going to rely more on intellectual property and maybe less on human capital and workers. They're going to be more nimble. When I think about portfolio positioning, what this all comes down to is also an advantage for the US market over the rest of the world.
CHRIS HYZY: Great point. Matt, last question for you. Let's talk a little bit about the national debt, the high deficit. Of course, it worries all of us. What do we do about it from a fixed-income portfolio perspective?
MATTHEW DICZOK: So, yes, the deficit is a question. It's a longer-term question. There's a couple of ways the government can get out of it. They can spend less, tax more. But the way we usually get out of high debt levels is we grow the economy more. But the main point we tell investors who have, investors have a lot of concerns that, wow, when are rates going to spike? If the government has to keep selling so many bonds, when are rates going to go up? We would very much caution against that read-across. A lot of times, developed market economies, the last 20 or 30 years, you've seen higher debt levels at the federal government level can actually slow the economy. That can actually slow inflation. That can actually bring rates down.
On screen copy:
When yields are higher, it's a good time to consider extending bond duration.
If investors are using that as an excuse not to extend out duration because they're expecting a rate spike, they should probably rethink that in our expectations. It's a good time to extend duration when yields are higher.
CHRIS HYZY: Marci, Matt, I want to thank you for joining me today.
MATTHEW DICZOK: Thanks for having us, Chris.
MARCI MCGREGOR: Thanks for having us.
[DIP TO WHITE - Transition to Chris Hyzy]
[Music in background]
On screen copy:
Investment ideas to consider
- Focus on your goals
- Stay properly diversified
- Invest steadily according to your strategy
- Speak with an advisor
CHRIS HYZY: And thanks to all of you for taking the time to watch. We hope you find these insights useful. As you weigh the potential impact of the market and economic forces we've discussed today, keep in mind that the most important consideration is your long-term goals and what you're trying to achieve. While we believe strongly in the bridge to a more bullish future, the precise timing is impossible to predict, and unforeseen events can always occur. It's important to stay well-diversified both across and within different asset classes. Finally, avoid making sudden changes based upon today's headlines. Investing steadily, perhaps using an approach such as dollar-cost averaging, could help ensure that you stay invested and strategically add to your portfolio over time. If you work with an advisor, be sure to ask for their help. Thanks again for watching, and we'll see you again soon.
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Opinions are as of the date of this webcast 6/12/2024 and are subject to change.
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Concise, conversational, actionable: In just 15 minutes, the strategists offer their insights on the markets at midyear and ways you can prepare for the potential opportunities and risks ahead.