What Happens After the Soft Landing?
A funny thing happened while investors foolishly obsessed about both the timing and number of Federal Reserve (Fed) rate cuts this year — the long anticipated US economic soft landing transpired over the past 12 months or so. Distracted investors likely missed it. But for only the fourth time since World War II and the first time in 30 years, the US economy, guided by the Fed, stuck the rare soft landing. The economy slowed, but never entered recession. US GDP expanded at an annual rate of 4.9% in the third quarter of 2023, moderating to 1.6% for the first quarter of 2024.1
Despite slower economic growth, the labor market remains remarkably resilient. The US has added about 2.8 million jobs over the past 12 months, averaging monthly job gains of 234,000.2 Initial jobless claims data continue to suggest that businesses are reluctant to let go of qualified skilled workers. And, at 3.9%, the unemployment rate hovers near an all-time low.3 Gainfully employed consumers will go on spending, repelling recession for at least a little while longer.
Meanwhile, considerable progress has been made over the past couple of years to tame inflation. According to the Bureau of Labor Statistics, the Consumer Price Index (CPI) peaked at an annual rate of 9.1% in June 2022, cooled to 3% a year later, and sat at a still-too-hot 3.4% in April 2024.4 The Fed is likely pleased, but not satisfied, with inflation’s deceleration.
Yet, the first quarter earnings season reveals that businesses are in exceptionally good shape. Seventy-eight percent of S&P 500® companies reported a positive earnings surprise for the first quarter. Year-over-year earnings grew by 5.7%. S&P 500 companies’ net profit margin of 11.7% is above the previous quarter, year ago, and 5-year average. Analysts are predicting that S&P 500 companies will grow their earnings by 11.1% this year and an even better 14.1% next year.5
At the same time, several major economies including the United Kingdom, Europe, Japan, and China are now emerging from past bouts of economic malaise.
Investors have enthusiastically celebrated the soft landing by pushing global stock markets to all-time highs. Credit spreads are extraordinarily tight, and most measures of capital market volatility are restrained.
Must All Good Things Come to an End?
Although the environment for risk assets remains largely attractive, early gains from achieving the soft landing are likely in the rearview mirror for investors. It’s going to get tougher from here. The soft landing, resilient labor market, falling inflation, spendthrift consumers, strong businesses, and potential Fed rate cuts are already reflected in stretched valuations and record-high asset prices. Risks are decidedly skewed to the downside for the remainder of the year.
The increasing likelihood of a Fed monetary policy mistake, stubborn inflation, disappointing earnings results, toppling over the US fiscal cliff, rising geopolitical tensions, and contentious elections all pose serious risks to the rally.
But, after such strong first half performance, it’s likely that capital markets will deliver solid results for investors this year, especially if the typical post-US election rally unfolds. Investors should consider these three strategies when constructing investment portfolios for the second half of 2024:
