The Good, The Bad And The Ugly For 2024

Troy Gayeski is Chief Market Strategist at FS Investments. He is a frequent contributor to Bloomberg, Fox Business, Yahoo Finance and CNBC.

With the overwhelming good news coming out of the U.S. economy in the first months of the year, investors are seeing what started as an optimistic “Dare to Dream” scenario fast become the consensus base case. But an “ounce of preparation,” as true cowboys say, “is worth a pound of cure,” and volatility is still very much a possibility.

As a Chief Market Strategist, I’ve seen investor sentiment lock horns with market reality across more than 20 years of good, bad—and truly ugly market scenarios. So, here are the three most likely market scenarios for 2024—and their potential implications for key strategies.

The Good—A Dare To Dream Scenario

The latest data series on the U.S. economy continue to show a Fed that’s threading the needle, bringing inflation into merciful retreat without spiraling markets into recession.

If we stay in this “good” scenario, we’ll keep seeing strong job numbers and consistent consumer spending (though keep in mind the pandemic savings surplus has to eventually run out). Business fixed investment, construction financing, and state and local government investment would keep cranking along, while housing would sustain its flip to a gross domestic product (GDP) contributor, instead of languishing in an eight-quarter drag.

The labor hoarding we’re seeing now would continue to reduce the typical catalyst for corporate America to start handing out pink slips as soon as profit margins erode; and with profit margins bouncing back, the pressure to protect those margins from layoffs would continue to be less of an issue than in the past year.

Of course, all of this is what’s happening now. If it continues, we may very well see a return to 1%–2% real GDP growth and 4%–5% nominal.

If a good outcome continues to play out in the U.S. economy, investors will likely see equities continue to perform well, while bonds suffer.

Earnings continue to grow in an economic expansion, which could drive further gains in equities if multiples/valuations don’t compress. Plus, the Fed won’t cut rates significantly any time soon, which can drive higher bond yields and lower bond prices (not as badly as in 2022, but similar to August through October of 2023 … the dreaded bear steepener for bond perma-bulls).

Yet, the potential issue with equities remains elevated valuations, with considerably muted upside and potentially much greater downside.

But for now, U.S. economic growth is what’s on the menu, and one of the most optimal and attractive ways to make the most of future U.S. economic growth is middle market private equity. Based off recent historical performance, it offers the potential for low teens annualized performance, sustained mid-20% EBITDA growth of underlying companies, meaningfully cheaper valuations, lower leverage and a more transparent, sustained exit path than megacap private equity/leveraged buyouts (PE/LBOs). However, there could clearly be downside risks if the economy enters a severe recession.

In a good market scenario, the task is to take advantage of potential market opportunities. But in a “bad” scenario, diversification becomes (even) more of a priority.

‘The Bad’—A Mild Recession

There are a lot of economists out there these days hanging outside television studios, scuffing their boots and feeling a little sheepish about all the time they spent forecasting that imminent post-pandemic recession. But their caution was far from off base—monetary policy lags can be long and variable—and almost every classic recession indicator has been in red or orange light territory for a while. A bad scenario could mean a mild recession, with investors likely seeing earnings growth estimates collapse.

A mild recession could potentially be the worst outcome for equities and the best outcome for bonds.

In a recessionary outcome, earnings decline, which drives stock prices lower, while bond yields drop as the Fed cuts rates (which in turn drives up bond prices).

Even still, with stock/bond correlation sitting at a 40-year high, investors interested in growth, income and real, honest-to-goodness diversification may want to consider exploring the potential portfolio applications of alternative strategies, such as:

• Attractive income/total return.
• Low beta/lower duration.
• Downside mitigation.
• Lower volatility.
• Deep alpha proposition.
• User-friendly structures.

While financial advisors have been seeking solutions for a mild recession for a while now, it’s important to also keep in mind the potential for an even uglier market scenario.

‘The Ugly’—The Ultimate Showdown

It’s the worst possibility but you can sleep (relatively) easy because it’s also the least likely according to current markets.

How might it happen? If inflation reaccelerates, which forces the Fed to tighten further, investors could find themselves contending with a mini repeat of 2022 when both equity and bond markets got pummeled. In this scenario, inflation would stay entrenched and nominal GDP growth would continue to dwarf real GDP, with markets seeing more multiple compression and higher yields.

Even in the best economic environments, increasing correlation has significantly challenged the capacity of the traditional 60/40 mix of stocks and bonds to offer real diversification. In a full-blown recession, it could be even more essential for investors to explore alternatives.

Conclusion: The Only Bad Move Is No Move At All

The Fed is doing their darndest to thread the needle on monetary policy, and so far, they’ve managed to keep up the momentum of a surprisingly resilient U.S. economy.

While a good, bad or even ugly scenario could come into play, the only real potential mistake would be to keep your head in the sand with 2023’s old defensive positions. It’s been so-far-so-good for investors that began the year rotating out of cash into the right alternatives, with many alternative strategies (commercial real estate (CRE) lending, corporate private credit, middle market PE, multi-strategy and tactical credit) outperforming cash so far this year.

The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.

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