SUMMARY
Doubts persist over how much cash to hold as well as the outlook for growth, inflation and rates. We present our views and highlight potential opportunities for portfolios.
As we look ahead to 2024, investors maintain $5.8 trillion in money market funds.1 Many believe that inflation has become a permanent problem and that the Fed will keep rates high, even if it means recession. In fact, a recession would be oddly useful as an “all clear” signal for investors to re-enter markets.
2023 has seen major short positions in equity markets and similarly big bets that interest rates will rise much further. Though these extreme views proved wrong, they were great sentiment indicators.
But what if there is no typical recession or V-shaped recovery on the horizon?
Expectations for a more normal economy are small. Yet, normalization is the story for 2024. That is why we have chosen these four questions from investors. The answers provide a baseline for reconsidering their assumptions and their predisposition to wait for a better time to invest than now.
The inflation rate in the US peaked at 8.9% in June 2022. Inflation was fueled by excessive fiscal and monetary stimulus designed to bridge the US and global economies across the pandemic, by dislocations in supply/demand relationships and by geopolitical issues, including the war in Ukraine. The Fed’s actions to support the economy were its most accommodative actions since WW2.
Therefore, when the Fed started hiking rates, it was not raising them from a neutral rate. The Fed was, itself, a source of inflation. The real Fed funds rate (Fed Funds Target minus year-to-year Headline CPI) was an astonishing -8.3% in March of 2022. That was 2x more accommodative than the Fed was during the ’08-09 financial crisis
American corporate profits, while linked to overall US economic activity, do not follow trends in the US labor market linearly. The economic factor most closely correlated to corporate profits is industrial production, which has lagged payrolls growth for much of the past year. Given our view that “rolling recessions” will end in 2024, we expect a broadening of US industrial activity next year. Note that a greater share of S&P 500 constituents is engaged in goods-related production, whereas there is a greater proportion of US jobs engaged in service businesses.
For many investors, the allure of 5% overnight cash rates remains high. After all, if you can get 5% in money market funds, why not take the interest and run? Today money market fund assets in the US are $5.8T1 so investors are obviously similarly inclined. With the Fed holding their short-term rates at peak levels for now, this may seem a conservative strategy. For some, cash is being held aside to make opportunistic future investments. For other, cash is “safe money” for emergencies. But both rationales may lead to contradictory outcomes.
