February 23, 2024

2024: The moment of truth

THE REPORTER – 2024 OUTLOOK

2024: THE MOMENT OF TRUTH

On August 24, 2001, Captain Robert Piché made history in civil aviation by landing a flight carrying 306 passengers after it ran out of fuel. Considered one of the most spectacular emergency landings ever undertaken, Piché manoeuvred the plane for an unprecedented 19 minutes without power.^{page note 1}

As he faced this daunting task, Piché reached a moment of truth where he had to carefully choose the right strategy. These moments are often turning points that greatly influence the outcome of important events, whether it's controlling a plane mid-flight or managing a portfolio.

When it comes to portfolio management, 2024 is shaping up to be a crucial year for investors as they'll finally get answers to their nagging questions. For example, will the central banks manage to reach their 2% inflation target or will the dreaded recession rear its ugly head? With all this uncertainty, we think that 2024 will be the moment of truth. Hence the title!

"Scenarios are not about predicting the future, rather they are about perceiving futures in the present." -Peter Bernstein, American author and economist

Even though this was the first time Captain Piché had ever faced such a critical situation on board, it's worth mentioning that airline pilots receive ongoing training to manage a range of scenarios, including rare and exceptional circumstances. This comprehensive training helps them deal with a myriad of in-flight situations. Through repetition and practice, pilots are able to keep calm and respond automatically when faced with real-world conditions.

Looking to the financial sector, careful preparation is just as important when navigating a complex environment. In developing our portfolio strategy for the current year, we drew on 4 economic scenarios centred around 2 key issues: inflation risk and economic growth. These scenarios incorporate a wide range of economic, financial and political risk factors, which led to us inviting 2 experts to our annual online conference: financial strategist François Trahan and political scientist Rafael Jacob. They were able to shed light on complex issues and, in doing so, gave us new perspectives to inform our 2024 investment strategy. We've ranked these 4 scenarios in order of probability, from least likely to most likely.

No. 1: Recession-inflation (5%)

Recession-inflation, also known as stagflation, is an unusual and complex economic scenario to manage. During a recession, there's usually a widespread and prolonged downturn in economic activity. Prices tend to go down because of decreased demand as consumers and businesses cut costs. In periods of stagflation, however, the opposite occurs. Despite a weakened economy, inflation continues to rise, which drives up the price of goods and services.

Such a scenario poses a significant challenge for governments and central banks since their efforts to boost the economy and counteract the recession could lead to another hike in the cost of living. On the flip side, initiatives to curb inflation could make the recession worse. This was especially true in the 1970s, when a sudden surge in the price of oil led to a global economic slowdown. The energy crisis caused prices to skyrocket, creating major headaches for many countries. So it's not surprising that equities and bonds tend to underperform in such a scenario.^{page note 2} In the current climate, for example, this could mean sustained armed conflict in the Middle East. While this is a possible outcome, it's also very unlikely.

No 2: Economic resilience (20%)

Unlike the previous scenario, inflation remains under control if the economy is resilient, but it takes some time before it reaches the 2% target. With the economy growing at a steady pace, central banks aren't able to lower their key rates too quickly. On January 24, for example, the Bank of Canada announced that it expected gross domestic product (GDP) to grow moderately by 0.8% in 2024 and that the inflation rate wouldn't return to its target until 2025.^{page note 3}

While economic growth in the US surpassed expectations in 2023, a slowdown is forecasted for 2024. Still, the question remains: Can the US Federal Reserve (Fed) keep its promise to cut the interest rate 3 times in the midst of such robust economic activity? If we look at the December 2023 data from the CME FedWatch Tool, about 90% of bond market participants anticipated that the Fed would lower its key interest rate in March 2024. This figure currently sits at 40%.^{page note 4}

In terms of performance, bond prices go down if interest rates go up. There's a more neutral effect on equities. As long as the economy can support earnings growth, rising interest rates can be seen as favourable.

No 3: Soft landing (20%)

This scenario represents the best of both worlds. On the one hand, economic growth is holding steady or slowing down gradually to prevent a recession. On the other hand, inflation continues to decelerate, getting closer to its 2% target. This dynamic gives central banks the latitude to swiftly cut key rates. It should be noted that the economy was already on track for a soft landing at the end of the year. According to the CME FedWatch Tool, we expect the key rate to be lowered 5 or 6 times this year,^{page note 4} even though the Fed indicates that only 3 cuts are planned. Against this backdrop, it's unsurprising that stock and bond markets traditionally perform well.

As mentioned in The Reporter – Fourth Quarter 2023, the S&P 500 forecast provides good grounds for optimism. With a closing price of 4,770 points on December 29, the S&P 500's price-to-earnings ratio is 19.5 times higher than the projected earnings of $245 per share in 2024. These expected earnings represent an 11% increase over the $221 share price recorded in 2023.

No 4: Moderate recession (55%)

Here's what we think is the most likely (55%) scenario for the economy this year. This economic outlook will form the basis for our portfolio strategy. But before diving in, we need to set the stage a little more.

Based on the warning signal from our forecast model and the concept of a transmission lag—the time it takes for the cumulative effect of interest rate hikes to have a negative impact on the economy—we believe the likelihood of a recession remains high. Strategist François Trahan explains that it takes about 2 years after the first policy rate hike for a series of increases to be fully reflected in the economy.^{page note 5} This points to an economic slowdown south of the border beginning in March.

Given these conditions, it seems reasonable to expect a moderate recession this year. So we're likely to see this type of recession, which is characterized by a relatively limited and short-term economic slowdown and a moderate decline in gross domestic product (GDP). The impact on employment and spending would be generally contained, thus avoiding the more serious consequences typical of severe recessions. Despite the ongoing and entrenched labour shortage, US consumers seem to be on solid financial ground.

For example, the net worth of the median US household surged around 25% since 2020 according to the Federal Reserve's Survey of Household Economics and Decisionmaking. This increase is largely the result of the excess savings accumulated through government financial assistance intended to support the economy during the pandemic.

We should see an end to this household surplus in 2024. November estimates from the Federal Reserve Bank of San Francisco suggest consumers have "only" $290 billion in excess savings from stimulus remaining—down from $2.1 trillion^{page note 6} at its peak in August 2021.^{page note 7}

So we're easing our way through 2024 as it's a year that promises to be a pivotal one for inflation and the economy. If you'd like some more insight into this outlook, make sure to watch the playback of our first conference of the year, Plan de vol 2024 (in French only). There's even a bonus segment!

Sources:

Bank of Canada (2024). Bank of Canada maintains policy rate, continues quantitative tightening, January 24.

CME Group (2024). CME FedWatch Tool. Accessed January 25.

Laurentian Bank (2024). 2024 Economic Outlook. Economic Research and Strategy.