Solid Foundations

By Dr. Charles Lieberman, Co-Founder & Chief Investment Officer 

The market has largely wrung out unrealistic expectations of a recession and a rapid sequence of rate reductions in 2024.  It is now more realistically expecting about three rate cuts this year, which is in keeping with the Fed’s latest published projections.  Risks are now fairly balanced.  But solid economic growth should enable stocks to perform well in a flattish interest rate environment.

Economic growth remains solid even as the unemployment rate remains low.  There is still no recession in sight and little reason to think one is coming anytime soon.  It is, therefore, something of a stretch to hope that inflation will continue to moderate to the Fed’s 2% target without some lucky breaks or other policy changes.  So, a touch of wishful thinking remains in place.  More likely, inflation will remain stuck around current levels, which means that it will difficult for the Fed to justify many rate cuts.  In our view, there is an even chance the Fed will end up keeping policy rates unchanged all year.

Nonetheless, investors are likely to continue expecting rate cuts all year, even if none occur.  Instead, rate cut forecasts would tend to be pushed further into the future.  As they say, hope springs eternal.  So, the interest rate environment will nicely complement economic growth and provide a solid foundation for equities.  Equities will, of course, remain volatile, which is normal.  But the uptrend should remain intact.

Stock buyback activity has picked up, which provides another support for equities.  Over $200 billion was repurchased by companies in Q4, 20% more than in Q3.  As usual, this reflects the rise in corporate profitability rather than market valuations.  The best time to buy back shares is when prices are depressed, but companies more typically buy when free cash flow increases.  These buybacks should continue all year and are likely to increase over the course of the year.

Political issues will remain a distraction, of course, especially in a presidential election year with a majority of the public unhappy with both leading candidates.  Most likely, economic developments will matter more for the election results than political developments will matter for the markets.

Sector performance reflects circumstances that apply specifically to different parts of the economy.  Spending shifted to goods during the pandemic and back to services once the economy reopened, creating near recession levels of activity narrowly in goods production.  Slowly, activity is improving in goods demand, so the economy will likely become more balanced over the course of the year.  Within good production, technology stocks mostly reflect AI developments.  Companies at the center of this opportunity have performed exceptionally well, but there are opportunities in companies that will benefit indirectly.

Bank and real estate stocks mostly reflect concerns and fallout from commercial office real estate issues.  A few institutions are overly exposed, but these are the exceptions and unlikely to bring down any firms of size.  Small lenders who get in trouble can easily be merged into larger firms, even if this tests the government’s opposition to bank mergers.  Lenders may also choose to roll over loans on the cusp of difficulty rather than force a default.  This kind of muddling along allows time to pass to heal marginal situations.  A major string of defaults remains unlikely, in our judgment.

Domestic energy also has plenty of runway.  OPEC is holding together surprisingly well, which has positive implications for domestic energy production.  Exports of domestic LNG will continue to grow rapidly as liquefaction infrastructure comes on line.

So, we find plenty of opportunity in various equity sectors in the context of a solid economy.  We will try to avoid being distracted by the ongoing political evolution.

The foregoing content reflects the opinions of Advisors Capital Management, LLC and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns. Securities investing involves risk, including the potential for loss of principal. There is no assurance that any investment plan or strategy will be successful.