Q1 2024
INVESTMENT OUTLOOK
January 17
DBFitzpatrick
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INVESTMENT OUTLOOK | Q1 2024
Treasury Yields Fall as Disinflation Continues
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Equities Take Bond Market Fears in Stride
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TREASURY YIELDS FALL AS DISINFLATION CONTINUES Interest rates fell during the fourth It should be noted that, despite
Both agency mortgage-backed
quarter, as lower inflation and
the overall move downward
security (MBS) and investment-
weakening economic data
during the last three months,
grade corporate option-adjusted
convinced many investors that
inflation breakeven rates for all
spreads (OAS) fell in November
U.S. Federal Reserve (Fed)
time periods in the U.S. are
and December. Corporate
policymakers will soon begin
currently above the Fed’s 2.0%
bonds were aided by many
cutting rates. All but extremely
target. The market continues to
investors’ belief that Fed
short-term Treasury yields have
discount some risk that the high
policymakers will achieve their
fallen, with large moves
inflation of the last two years will
goal of a “soft landing” (a
occurring in all tenors of two
become embedded in
slowdown of growth without the
years and higher. The yield of a
economic actors’ longer-term
onset of a full-blown recession)
two-year Treasury note has fallen expectations. Bond investors will
for the U.S. economy, while MBS
90 basis points since the end of
be watching economic data
have been helped by lessened
September to 4.15% in mid-
closely in the coming months to
rate volatility and improved bank
January, for example, while the
see whether inflation picks up
demand. MBS OAS today are
yield of a 10-year note is down 63 again, or, in our view the more
close to their average of the last
basis points to 3.94%.
five years, while investment
likely outcome, that the
disinflation of the last few months grade corporate bond spreads As investors digested evidence of persists into 2024.
are below their average and
a slowing economy, inflation
appear tight given
breakeven rates (roughly what bond investors expect inflation to be in the future) also fell during the fourth quarter. The
U.S. Treasury Yield Curve
10-year inflation breakeven rate fell 17 basis points to 2.17% at year-end, while the two-year inflation breakeven rate fell three basis points to 2.02%. In the first half of January inflation breakeven rates retraced their steps a bit, with the 10-year breakeven climbing to 2.28%. Breakevens are still down considerably
from highs in October, however.
Source: Bloomberg
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INVESTMENT OUTLOOK | Q1 2024
macroeconomic conditions.
yields continue to retrace their steps and drift higher in the near-term. With inflation breakeven
We have avoided lower quality corporate bonds
rates still above 2.0% and the U.S. labor market
in our fixed income strategies and believe that
showing considerable strength, bond investors
there is heightened risk in the near term for this
may have gotten a bit too aggressive in their
sector. MBS spreads, on the other hand, are close forecast of multiple fed funds rate cuts occurring to historical averages despite the fact that most of in 2024 (the market is currently predicting six 25 the sector still faces limited prepayment risk in
basis point cuts to the fed funds rate by the end of
today’s interest rate environment. Consequently,
the year). Looking past the very short term and
we see MBS as attractive vis-à-vis Treasuries and
toward the longer-term outlook for bonds,
corporate bonds.
however, we believe that interest rates are likely to eventually fall further as the disinflation process
After the big fall of interest rates during November continues. and December, it wouldn’t surprise us if Treasury
U.S. Inflation Breakeven Rates
Source: Bloomberg
U.S. MBS and Corporate Bond Spreads
Source: Bloomberg
EQUITIES TAKE BOND MARKET FEARS IN STRIDE The stock market experienced
returning 22.8%. The technology regarding the impact of artificial
notable success in 2023, with the sector led the way, with investors intelligence on technology
MSCI All Country World Index
increasingly enthusiastic
companies’ earnings. The
5 Russell 1000 Technology Index returned 67%
consumer sentiment. The stock market’s recent
during the year, far outperforming all other major
performance has belied that prediction, however,
equity sectors. Consumer discretionary stocks
as equity investors continue to forecast solid cor-
also had a solid year and outperformed the
porate earnings results in the coming months.
broad market in 2023. More defensive sectors such as healthcare and utilities underperformed
Looking to the remainder of 2024, we’re forecast-
the market, with the volatile energy sector also
ing a weakening economy and continued disin-
underperforming in 2023.
flation. The S&P 500 is currently trading at 19.7x
2024 earnings estimates (using Bloomberg’s foreThe U.S. economy has remained robust despite
cast for earnings), a high valuation given today’s
the drag of elevated interest rates. The labor
interest rate environment and the bond market’s
market has been especially strong, with the U.S.
forecast of worsening economic conditions dur-
unemployment rate just 3.7% at the latest reading ing the coming 12 months. Given these lofty valin December. The bond market has been
uations, we believe that equity investors’ enthusi-
predicting a slowdown in the economy for
asm and optimism will be tested in the coming
roughly a year, based on the idea that the
weeks.
cumulative impact of higher interest rates will eventually dent the housing sector and dampen
- Brandon Fitzpatrick, CFA
Equity Returns
Source: Bloomberg
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INVESTMENT OUTLOOK | Q1 2024
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