2024 Economic & Market Outlook: The Final Stretch

Are We Back To Disinflation?

The hotter-than-anticipated reads on inflation to begin the year reverted to a disinflation trend as we head into Q4. There is no question that price pressures have come a long way from their peak reading exactly two years ago. However, inflation readings remain above the Federal Reserve’s (Fed’s) 2% inflation goal.

With such improvement now in the rearview mirror, we continue to ask whether that “last mile” toward the policy maker’s goal will prove to be a bit more difficult to achieve. As Fed Chair Powell mentioned at his recent Federal Open Market Committee (FOMC) presser, housing inflation, i.e., rents, has proven to be a sticking point, but the “direction of travel is clear.” We anticipate that disinflation will continue to be prevalent moving forward, but either way, it appears that reaching the Fed’s 2% goal has become a bit more of a grind than previously anticipated.

Fed Policy Impact

After much anticipation, the Fed finally delivered a rate cut at the September FOMC meeting. The actual amount had been the subject of a great deal of speculation, but as we now know, the Committee decided on a half-point reduction to kick off this easing cycle, bringing the new Fed Funds trading range down to 4.75%–5.00%.

According to Chairman Powell’s often-used reference at the September FOMC presser, this front-loaded half-point reduction represents a “recalibration” of its monetary policy stance. In addition, the Chairman referenced the point that if the policy maker had the August jobs report for its prior meeting, there’s a good chance the first-rate cut would have been enacted at that time. In other words, the half-point reduction at the September FOMC gathering could be described as a “make-up” 25 basis point (bp) rate cut combined with a “regular” 25-bp decrease.

For the remainder of 2024, the policy maker’s updated dot plots see two more rate decreases (assuming 25 bps from here on out). An interesting “twist,” though, was that nine out of 19 members actually projected one or no more rate cuts for the rest of this year.

As investors look ahead to 2025, there has been some disconnect between official Fed forecasts (dot plots) and the money and bond markets’ rate-cutting expectations. Indeed, as of this writing, implied probabilities for Fed Funds Futures are pointing toward about six (down from eight earlier) more rate cuts by Q4 of next year as compared to the Fed’s new dot plot of four reductions, once again assuming quarter-point cuts. The actual amounts would translate to 150 bps for market expectations but only 100 bps for the Fed members’ projections.

In terms of its dual mandate, employment has now surpassed inflation as the primary driver for Powell & Co. As a result, the monthly jobs report has now taken on even greater importance, if that’s possible. The debate surrounding how the current rate-cutting episode will play out will remain a fluid one through the autumn months and into next year.

“The debate surrounding how the current rate-cutting episode will play out will remain a fluid one through the autumn months and into next year.”

The U.S. Election And Policy

With November rapidly approaching (and early voting already beginning), policy implications are beginning to come into focus. Differences between respective policies are abundant, but there are areas of agreement and continuity—regardless of which party wins the presidential race—that should be kept in mind. Tariffs and other harsh trade rhetoric (particularly toward China) will be rampant between now and November 5, as both candidates have used them. With the all-important swing states polling tightly between the two candidates, the most popular talking points will be emphasized in the coming weeks.

While the presidential race garners much of the focus, the House and Senate are as important for the economic and policy outlooks. Currently, betting markets1 are suggesting the most likely result is a divided government with neither party “sweeping.” With numerous toss-ups and the ever-present risk of surprise polling swings, the House and Senate are worth watching more than the presidential election. If you cannot pass bills and enact legislation, the policy implications of either party winning the executive branch fade dramatically.

We are watching developments closely but do not see significant market shocks emanating from November. Markets do not like uncertainty, and elections are inherently uncertain. Dramatic polling swings in either direction could alter this sanguine attitude, but that is more likely to come from the House and Senate races—not the presidential election.

“Markets do not like uncertainty, and elections are inherently uncertain.”

1 PredictIt and Polymarket as of the date of this publication.

Trends In Equity Markets

Easing into a Stock Market That Sits at Record Highs

Assessing the market’s performance after the first Fed rate cut puts us in a pickle. The last three first rate cuts’ dates were 2001, 2007 and 2019. Each was followed by ugly stock market action in some way, shape or form.

However, we know with the help of hindsight that each of those cycles had something seriously busted that needed unwinding. For example, software spending for Y2K was front-loaded in 1999, leaving a void once the clock switched to 2000. In 2007–2009, the U.S. had a housing market with too much supply and prices in silly season. During COVID-19, tens of millions of people were laid off in early 2020; they didn’t know they were going to be showered with stimulus and also get their jobs back.

For now, what we think we know is that nothing is broken in the system, aside from known quantities in the form of domestic commercial real estate, namely office property, and China’s debacle. These trouble spots have been well-known in the popular psyche since 2020 and 2021, respectively.

Looking at the tape, there is a clear correlation that has persisted since April 25: bonds are rallying, and so are stocks. That is well and good on the upside, but it also brings forth the risk that this market “pulls a 2022,” whereby some unknown trouble in the bond market is accompanied by the S&P 500 on the downside. It doesn’t help that the stock market isn’t exactly cheap: the S&P 500 is at record highs and trades for 23x forward earnings.

However, we are hard-pressed to identify something beyond commercial real estate that will bring bank solvency or contagion onto the radar. In fact, if anything, it would appear lending standards are easing; the Fed’s Senior Loan Officer survey has been on the mend for five consecutive quarters.

In the meantime, the U.S. consumer has several levers of support if the Fed truly wants to take a couple hundred basis points out of overnight money. For one, credit card rates will probably decline, as will auto loan rates. They can also get a deal on the car itself, especially because used cars, specifically, are in outright deflation.

Also, the prime rate marches in tandem with Fed Funds: it dropped from 8.5% to 8.0% after the September Fed meeting. Going back to the Carter administration, we measure the low in mortgage rates as having come 21, 32, 55, 28, 65 and 27 months after the first prime rate drop of each cycle. We are looking at the very real prospect of a 2025–2026 mortgage refi mini wave for a few million COVID-19-era homebuyers who are gasping for oxygen under the burden of their 6%–8% mortgage.

Additionally, we are generally confident—or as confident as strategists can be—that inflation may be truly licked. We calculate societal wage growth by taking the total number of employed persons and multiplying that by average weekly earnings and hourly wages. In August, that figure was +3.7% year-over-year (YoY), outpacing what has become a tepid headline Consumer Price Index (CPI) figure of 2.6%.

Finally, we have a few consumer call options in this market, courtesy of both major political parties’ willingness to open the fiscal floodgates. On the list are SALT reinstitution, bipartisan support for gimmicks such as “no tax on tips” and small business tax credits.

Though we find the historic sector performance record iffy due to changes in market structures, here is what we know: we count 11 notable “first rate cuts” since the Ford administration. In eight of those 11, Consumer Discretionary and Health Care went on to outperform in the subsequent year. Weak spots after the start of Fed easing cycles are Tech, Telecom and Utilities.

The effect of interest rate directionality on the stock market is also currently of acute interest. Year-to-date, the three sectors that have been most positively responsive to declines in the 10-Year T-Note yield are Utilities, Financials and Real Estate. Those three have outperformed the S&P 500 in 71%, 59% and 59% of the weeks that have seen yield declines this year, respectively.

Notice how tough this is: in prior cycles, we found that Utilities didn’t like rate cuts, but don’t tell it to the stock market of 2024. Utilities ran all summer. The primary reason for it was the prospect of a friendly bond market.

As for rising rate weeks inside 2024, the batches that have had high success rates at outperforming have been Tech and Communication Services, two growth index populators. They have beaten the market in 60% and 65% of the rising yield weeks this year, respectively. Based on historical instances, for investors with a strong opinion on where interest rates are headed, the setup is clear: Value is for falling rates and Growth is for rising rates.

“The effect of interest rate directionality on the stock market is currently of acute interest.”

U.S. Equity Action Plan

Follow along with this concept of bond yield direction because we think it squares up a value investor’s thesis.

Going back to 1962, we see a clear pattern that we think we could explain to an Econ 101 lecture hall: When short rates fall hard, long rates fall. Maybe they don’t fall so hard, but they fall. That should come as little surprise.

Using rolling monthlies of the quarterly changes in 3-Month T-Bills from January 31, 1962, to August 31, 2024, we count 55 periods where money market rates fell 100 bps or more. Of those, 45 witnessed T-Note yields fall too (by various orders of magnitude).

There were 66 periods where T-Bill yields fell by “only” 50–100 bps over a single quarter. Of those, 52 saw T-Note yields fall too.

Right or wrong, the Street is pricing in another 193 bps of Fed rate cuts by this time in 2025. If 10-Year Treasuries decide to move at all in sympathy with said cuts, we should again review the stock market action that has accompanied the bond bull since around Independence Day: The groups that are “on” have been Utilities, Real Estate and Financials. The group that is clearly “off,” at least relative to the S&P 500, is Tech.

In other words, it appears that Jay Powell is playing nice for the power company, the struggling office tower and the savings and loan, not Silicon Valley. We have conviction in Value over Growth.

Opportunities Beyond the U.S.

Internationally, we maintain our constructive view on Japan.

The unwinding of the yen carry trade in early August took us by surprise because it was blamed on a Bank of Japan rate hike that we thought everyone knew was coming. It was the worst three-day decline in Japanese equities on record.

However, we are heartened by the idea that anyone was hurt in that comeuppance has probably reassessed how much risk they want to put on.

We do not think anything has changed for Japan’s bull case. The so-called “Name and Shame List” succeeded in getting many firms to outline specific plans to rally their stock prices. Additionally, Japan has also-rans in the form of Korea and China, both of which are trying to mimic the country’s reforms to aid their own beleaguered stock markets. Anyone with a Japan overweight should root for those neighbors to get their houses in order, as it would seemingly catalyze a regional valuation re-rate.

Adapting to Currency and Global Market Dynamics

Many of our developed market equity concepts that hedge the currency are showing up as low-vol leaders on long-term windows. This is intuitive; investors who wake up on any given morning to a sea of red will more likely dump British pounds and Australian dollars to buy U.S. dollars.

Picking on European equities, investors often find themselves getting double duty on the downside and also double duty in bull trends, a situation that creates a volatility nightmare if time passes and the exchange rate just ends up right back where it started.

That is what happened with the euro over the last decade.

The currency bounced all over the place and found itself right back where it started. The exchange rate is $1.11. That was also the exchange rate at some point in 2015, 2016, 2017, 2019, 2020, 2022 and 2023. People bore a ton of volatility in their equity basket over that time, only to end up right here, 10 years later, hanging out at $1.11. In our opinion, investors should simply stop overthinking it and just hedge the euro.

“Japan’s investment outlook remains strong despite recent volatility, supported by corporate reforms and regional growth, while currency-hedged developed market equities provide lower volatility amid euro fluctuations.”

Money In Motion In A New Rate Regime

With the Fed moving into a rate cut cycle, investors will more than likely be witnessing allocation shifts within fixed income portfolios. Fed rate cuts will be occurring in a landscape where fixed income yields are at readings that a whole generation of investors have never experienced before. This “money in motion” phenomenon will be occurring against the backdrop of a new rate regime. Even with an easing in monetary policy, overall yield levels will likely remain elevated compared to the years leading up to and including the COVID-19 pandemic. We suggest investors use laddered and/or barbell strategies for their fixed income portfolios.

“With the Fed moving into a rate cut cycle, investors will likely witness allocation shifts within fixed income portfolios, especially in a landscape where fixed income yields are at levels many have never experienced before.”

U.S. Treasuries

Within the U.S. Treasury (UST) market, the summer rally pushed yields down in a rather noteworthy fashion. While the closely watched bellwether 10-Year yield had fallen by more than 100 bps, the 2-Year has experienced a plunge of around 150 bps, as the UST arena has discounted an aggressive Fed rate-cutting cycle. A valid argument can be made that a lot of “good” news has now already been priced in, and for UST yields to remain at or below the levels that are being registered as of this writing, validation needs to occur.

Another headline event that occurred was the “un”inversion of the yield curve. However, this development has been confined to the UST 2-year/10-year spread. The other closely watched measure, the UST 3-month/10-year curve, is actually still in negative territory. With Fed rate cuts now underway, we believe the trend for each of these constructs will be a steepening one in the months ahead. However, as we’ve been witnessing, the road to “un”inverted territory may not necessarily be a straight line.

Fixed Income Asset Allocation

The resiliency in the economic backdrop has provided a supportive landscape for U.S. credit in recent years; U.S. corporate bonds—both high-yield and investment-grade—have generated a sizable return premium to Treasuries in the last two years. The market activity drove the incremental yield spreads offered by corporate bonds to relatively tight levels, providing less cushion if moderation in economic growth exceeds expectations and the resiliency is called into question, such as the vulnerability we saw in August.

This doesn’t preclude spreads from either drifting lower or staying firm in what we expect to be a range- bound (higher) for a longer-term backdrop in Treasury rates, but investors should expect outperformance to be more measured and driven by income. With economic growth moderating and the Fed shifting policy direction, the ability of corporations to adapt to the changing economy will be tested. We believe corporate bond investors need to stay vigilant, given the “good news” that is already priced into corporate bond valuations. For this reason, we remain focused on high-quality issuers that offer good sources of steady income.

We believe securitized assets offer better valuation prospects and a complementary source of income to corporate bonds. We suggest a small overweight allocation in the sector, using a core of agency MBS pass-throughs and collateralized mortgage obligations supplemented by a plus component of non-agency mortgage-backed positions and other securitized credit positions.

Thus, we think investors should allocate across diversified sources of income, taking small, calculated positions across investment-grade credit, U.S. high-yield credit and securitized assets (relative to Treasuries). Keeping some allocation to short-term fixed income could also make sense with the continued inversion of the yield curve and to take advantage of opportunities as they evolve.

WisdomTree Asset Allocation Views

Equities

• We remain neutral on stocks relative to bonds.
• We remain overweight in U.S. equities with tilts toward dividend payers and companies that rank highly on profitability metrics.
• Value stocks are priced at significant discounts compared to growth, and the Fed cutting cycle may invigorate a broadening out market rotation beyond mega-cap technology names.
• After significant volatility in August, we continue to have a constructive view on Japan, which is benefiting from significant corporate governance reform, improved market sentiment and positive investment flows.

Fixed Income

• We are neutral from a duration standpoint.
• While the Fed is cutting rates, yields are starting from much higher levels than were observed throughout the prior decade.
• We remain allocated to short-duration bonds, including Treasury floating rate notes, and continue to suggest that investors utilize barbell strategies within bond portfolios.
• The resiliency in the economic landscape provides a supportive environment for U.S. credit, but spreads have largely priced this in.
• We see better valuation prospects in securitized assets, and we are over-weight in agency mortgage- backed securities.

Alternatives

• For investors who are hesitant to reduce their allocation to equities and fixed income, efficient core strategies may provide an innovative solution to free up capital for alternative strategies.
• With the possibility that stock-bond correlations could remain in positive territory, we believe trend- following and other liquid alternative strategies can play an important role in multi-asset class portfolios.
• We continue to favor strategies that seek to generate uncorrelated returns in periods of heightened volatility.

IMPORTANT INFORMATION

Investors should carefully consider the investment objectives, risks, charges and expenses of the Fund before investing. For a prospectus or, if available, the summary prospectus containing this and other important information about the Fund, call 866.909.9473 or visit WisdomTree.com/investments. Read the prospectus or, if available, the summary prospectus carefully before investing.

There are risks associated with investing, including the possible loss of principal. Foreign investing involves special risks, such as risk of loss from currency fluctuation or political or economic uncertainty. Investments in emerging or offshore markets are generally less liquid and less efficient than investments in developed markets and are subject to additional risks, such as risks of adverse governmental regulation and intervention or political developments. Funds focusing their investments on certain sectors and/or regions and/or smaller companies increase their vulnerability to any single economic or regulatory development. This may result in greater share price volatility.

Dividends are not guaranteed, and a company currently paying dividends may cease paying dividends at any time.

Fixed income investments are subject to interest rate risk; their value will normally decline as interest rates rise. High-yield or “junk” bonds have lower credit ratings and involve a greater risk to principal. Fixed income investments are also subject to credit risk, the risk that the issuer of a bond will fail to pay interest and principal in a timely manner or that negative perceptions of the issuer’s ability to make such payments will cause the price of that bond to decline.

Diversification does not guarantee a profit or eliminate the risk of a loss.

You cannot invest directly in an index. Index performance does not represent actual fund or portfolio performance. A fund or portfolio may differ significantly from the securities included in the index. Index performance assumes reinvestment of dividends but does not reflect any management fees, transaction costs or other expenses that would be incurred by a portfolio or fund, or brokerage commissions on transactions in fund shares. Such fees, expenses and commissions could reduce returns.

This material contains the opinions of the authors, which are subject to change, and should not be considered or interpreted as a recommendation to participate in any particular trading strategy, or deemed to be an offer or sale of any investment product, and it should not be relied on as such. There is no guarantee that any strategies discussed will work under all market conditions. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. This material should not be relied upon as research or investment advice regarding any security in particular. The user of this information assumes the entire risk of any use made of the information provided herein.

Kevin Flanagan, Chris Gannatti, Rick Harper, Jeremy Schwartz, and Jeff Weniger are registered representatives of Foreside Fund Services, LLC.

WisdomTree Funds are distributed by Foreside Fund Services, LLC, in the U.S.

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