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As the Economy Normalizes, Financial Markets are Following Suit

As the Economy Normalizes, Financial Markets are Following Suit

February 06, 2024

Last year at this time, many economic indicators were a twisted mess and, despite the Federal Reserve’s efforts to engineer a soft landing, economists were largely aligned in assuming a recession was likely.

What a difference a year makes. Today, it looks like that soft landing is possible. 

2023 highlights

Inflation: In 2021, as the pandemic wound down, consumers and industry started spending again and inflation topped 4 percent for the first time in 30 years. It peaked in June 2022 at an annualized rate of 9.06 percent. 

On December 12, 2023 – the year’s final release of data from the Fed – the annualized inflation rate was down to 3.14 percent. That’s still higher than the long-term target rate of 2 percent. But it’s a healthy and sustainable level that allowed the Fed to signal an end of its two-year marathon of interest rate hikes to cool the economy.

Labor and corporate profits: The workforce is normalizing as well. In the four years since the pandemic’s onset, the labor market has been a roller coaster, characterized by record layoffs and record-setting job quits and historically low unemployment and wage stagnation and wage inflation. Government support to help people through the pandemic – essentially paying them not to work – had contributed to a drastic drop in labor force participation (see chart).

Now, we seem to be near the end of the roller coaster, where the hills are smaller and gentler.

Driven by the Fed’s tight monetary policy, U.S. corporations have spent the past two years focusing on important fundamentals that reduce the need to borrow money: strengthening balance sheets, reducing costs and recording strong profits. 

As corporations earn record profits, the workforce is finding its way to share in the gains. The high-profile union victories of 2023 – such as the Teamsters at UPS and UAW in the auto industry – are good for workers, and they don’t seem to be more than the companies can handle. For example, in late November, shortly after agreeing to a 25 percent wage increase plus other long-term improvements for its union workforce, General Motors announced a $10 billion stock buyback and a 33 percent increase in its common stock dividend. 

The union victories don’t affect a large enough number of workers to have much direct impact on the economy, but in 2024 they could have a ripple effect of modest wage increases across the nation.

Financial markets: The bond market set a dubious record between April and October last year, with six consecutive months of negative returns for the first time in history. 

But returns in November and December were strongly positive, and it looks like we’re at the beginning of a new bull market for fixed income investments.

Here’s some background: 

Stocks and bonds tend to move in opposite directions, which is why we use bonds as an offset to balance risk in equity portfolios. But they aren’t directly connected:

  • Stock prices are largely a function of overall economic sentiment: A strong economy drives higher returns in equities. 
  • Bond prices are tied to interest rates: Low interest rates raise bond prices, and high interest rates bring down bond prices.   

Inflation had been gently declining since the 1980s, resulting in near-zero interest rates. But when people started returning to work after the pandemic, consumer and business spending rose so quickly that the economy couldn’t keep up. You remember the result: supply chain disruptions, huge increases in the cost of basic goods and shortages of construction and manufacturing supplies. 

It was hard to have confidence in the economy, so stock prices dropped. And in its effort to manage inflation, the Federal Reserve started raising interest rates—which hit bond prices. So we had the rare situation in which neither bonds nor equities were doing well.

But today, as with inflation and the workforce, financial markets have been normalizing for months. Corporate profits are strong, supply chains have been repaired and interest rates have likely peaked. 

Holiday spending: Retail sales during the 2023 holiday season showed healthy year-over-year growth of 3.1 percent, according to early figures from credit card companies. It was a modest increase compared to 5.3 percent in 2022—but healthy and in line with historical data from before the pandemic.  

It’s another indication of a normalizing economy and a generally healthy consumer sector. 

2024 outlook 

We anticipate market gains for equities and bonds over the course of this year.

There are still reasons for caution. For the consumer sector, which accounts for two-thirds of Gross Domestic Product, the cost of rent and mortgage rates is still elevated, and student loan payments are starting up again. In the corporate sector, valuations appear to be on the high side, which puts downward pressure on stock prices. 

But the Fed has stopped raising interest rates, which gives us the ability to make an interesting comparison. Historically, in that period of time between the Fed’s last interest rate hike under a tightening monetary policy and its first interest rate cut of a loosening policy:

  • U.S. stocks have average returns of 23 percent
  • Bonds have average returns of 14 percent
  • Money markets return an average of 4.7 percent

There are obviously other concerns. There’s always potential for a big world event to bring sudden change. Whether that might involve Israel, Ukraine, Taiwan or something else is anybody’s guess.

Elections are another cause of volatility, and this year’s political cycle is sure to bring plenty of that. But from an investment standpoint, overall returns are positive over time no matter which party is in the White House. 

So as long as the consumer remains strong, we should have economic growth and continued easing of inflation—a general recipe for good returns.

Over the past few months, we’ve done some rebalancing to reflect the improving bond markets. 

In the equities markets, growth stocks have substantially outperformed value stocks, so we are weighting portfolios in that direction. 

The so-called “Magnificent 7” tech stocks (Apple, Microsoft, Alphabet, Amazon, Nvidia, Meta and Tesla) have consistently driven performance in the market. If you’re an index investor, you have substantial exposure to those companies across the board.

Our approach has been to reduce exposure to the fortunes of any one company by emphasizing diversification across the investment classes and within each of those classes. 

Our outlook remains long-term, and our strategies are built on time in the market, not timing the market. And our message to investors is that this is not a time to be sitting on large amounts of cash; you’d be missing out on potential opportunities.


Anthony Kulka is Chief Investment Officer for JK Investment Group, overseeing the firm’s overall research strategy through an approach based on Behavior Evaluation. He uses his strengths in quantitative analysis to translate information into insight. He earned an MBA with a focus on finance at Cleveland State University. Outside of work, he is passionate about Cleveland’s food scene and avid about all things outdoors.