New York - January 8, 2024 ~ The team at Infrastructure Capital Advisors has completed our new report providing key insights on current market conditions and economic outlook for this month and the coming months. See this month's full report below but be sure to JOIN our Monthly Market & Economic Outlook Webinar scheduled for Wednesday, January 17th at 1:30 pm ET where Jay Hatfield, CEO/CIO and portfolio manager will provide even more recent updates and insights to this report and the changing market and economy. Not registered for the webinar already? Click here to register. Also, by registering, we will send you a webinar playback video link if you are unable to join live.
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Summary of Recent Research & Critical Insights Outlook:
We are forecasting that a huge wave of global central bank rate cuts in 2024, with the Fed most likely lagging the pack. These rate cuts and associated increases in the Global Monetary Base (www.infracapfunds.com) are likely to propel the market to 5,500 by year end of 2024 and drive 10-year treasury rates into the 3-3.5% range. We believe that interest-sensitive sectors will outperform in 2024 as these rate cuts occur. Sectors that benefit the most from that are:
The financial sector, broadly defined, includes preferred stocks, financials, and REITS.
Within the financial sector, global investment banks, such as GS and MS, are likely to lead the sector as investment banking is very likely to boom in 2024 due to low volatility, lower rates, and rising stock prices.
In our view, Small-cap stocks are very cheap, particularly in the value sector, which has significant concentration in interest rate-sensitive sectors such as REITs, financials and utilities.
Our biggest contrarian call is that the Euro Zone is already in a recession with Euro Zone GDP Now-Cast tracking at a 1.2% decline for the fourth quarter and with last quarter’s GDP down .4%. The ECB is far too optimistic about 2024 GDP growth with an estimate of positive .8% based on a projected resurgence in consumer spending and the ECB is way too pessimistic about inflation with Y/Y likely to decline well below 2% (See Below). It is important to note that 45% of European mortgages are floating with the recent ECB rate increases yet to fully impact the consumer. October Y/Y EC retail sales were down 1.2%. Euro Zone Q4 will be out at the end of January.
We forecast that Euro Zone inflation will continue to decelerate rapidly:
The recent uptick in reported Y/Y inflation from 2.4% to 2.9% was solely due to base effects and the month/month increase was only .2%. For the last 8 months, inflation has only risen .8% so over the next 4 months 2.1% of the 2.9% y/y increase will roll off, resulting in a year-over-year increase of well under 2%.
The decline in the annual headline inflation rate well below 2% will be reported in May. This fact combined with the ongoing recession in the Euro Zone, particularly in Germany, will force the ECB to cut rates in the first half of 2024.
Natural Gas prices are down 58% year-over-year
November PPI came in at down 8.8% year-over-year. PPI is a leading indicator of CPI.
The deepening recession will accelerate the price decline.
Wages are a lagging indicator of goods inflation and are a deflationary force as real wages typically decline during a period of goods inflation. Euro Zone real wages dropped 5.3% in 2022. Contrary to most commentary, wages are not a key component of service inflation which is dominated by shelter (Driven by housing prices), airline fares (energy sensitive), auto insurance rates (parts price driven), auto repair (driven mostly by parts inflation), money management fees (calculated by AUM) and leased car prices (driven by auto prices). Euro Zone private unionization rates are higher than the US level of 6% but have declined well below 15% in most larger Euro Zone countries.
We project that the ECB will be forced to cut rates before the Fed in the first half of 2024, most likely at the June meeting post the release of April Y/Y CPI below 2. (Terminal Command “MIPR” is best way to track implied global rate cuts).
Germany is in a freefall with negative .8% growth over the last year and retail sales plunging, down 2.5% in November and negative 2.0% year over year. Construction spending, a critical leading indicator of recessions, is plummeting with the construction PMI well below 40 and housing prices down 10% over the last year.
We believe that the global bond sell-off in the Fall was sparked by an enormous $700 billion reduction in the money supply by the ECB in late July.
Bond Market Outlook:
We project that 2024 will be the Year of Global Rate Cuts. The futures market in all major economies imply an unprecedented number and magnitude of rate cuts. The global rate cuts are likely to drive the 10-year Treasury rate into the 3-3.5% range.
ECB implied rate cuts are currently 6 (145BP)
Euro Zone GDP Now implying a 1.2% recession in Q4.
CPI data in the Euro Zone is likely to cool dramatically over the next 4 months due to base effects.
Every OECD country except Japan is projected to cut rates with the average cut well over 1%.
The US has 5 rate cuts priced in which was partially validated by the Fed dot plot implying 3 rate cuts. The Fed pivot marks the first time since the Pandemic started that the Fed has responded appropriately to real time data.
The Fed is likely to be slower to cut than most central banks as the US economy is stronger than most and the Fed still believes in the Urban Myth that 70s inflation was caused by starts and stops in monetary tightening while ignoring the 1200% rise in energy prices as the key culprit.
Smaller central banks such as Hungary and Chile are already cutting rates.
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Stock Market Outlook:
We are bullish on the market for 2024 and have established our target on the S&P of 5,500 based on 20.5x the 2025 EPS consensus estimate of $270, which assumes a 10-year treasury rate of 3.5% to justify the 20.5x multiple. We believe that central banks will ease in 2024, led by the ECB as Europe has already entered a recession. We project that lower long-term global interest rates, a resilient US economy, and the ongoing AI boom will drive the S&P to our target by year-end 2024.
Many forecasters are too bearish about the consensus implied earnings growth rate of 10% as they fail to recognize that all aggregate earnings growth comes from the reinvestment of retained earnings and depreciation and is not driven by margin expansion or dependent on high GDP growth. The normal S&P earnings growth rate is over 10% as 70% of earnings are retained and reinvested at approximately a 15% after-tax rate.
Corporate savings represent almost 75% of gross domestic savings in the US.
We expect the US economy to be resilient in 2024 with the shortage of homes in the US causing the housing sector to hold up. Housing crashes are almost always the key driver of recessions.
We expect that in a falling interest rate environment, financial-related sectors, including preferred stocks, bank stocks, and REITs as financial related stocks are well below fair value due to rising rates and a volatile stock market in 2023. These asset classes are likely to outperform in 2024 on a risk-adjusted basis as global interest rates decline.
The S&P 500 High Dividend Index is trading at only 11X 2024 Earnings and yields over 5%.
We launched our InfraCap Small Cap Income ETF (SCAP) two weeks ago and we believe that small cap value stocks are undervalued trading at only 14.2X 2024 earnings vs. a historical average 0f 17x.
Financials and REITs are undervalued. MS, AB, and BXP, are examples of companies likely to benefit from lower rates in 2024. As a note, these are held by ICAP and SCAP and private funds as of January 8, 2024.
Active Management is Critical for Fixed Income:
Fixed-income securities have call risk, interest rate risk, and default risk which must be actively managed to optimize performance.
Equity securities have none of those idiosyncratic risks and often the “worst” stocks do the best with an extreme example being meme stocks.
Funds managed using “HI” have huge advantages over index funds or rules-based funds.
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Fed and ECB Outlook:
We expect CPI/PPI in December to print cool as the over 15% plunge in gasoline prices since the beginning of October will gradually bleed into the core. There is a 5% bleed-through of energy prices to the core. The most obvious examples are airline fares and food prices as both have a 40% energy cost component.
Energy represents almost 9% of lower-income household expenses, which means a 20% drop in energy costs will boost consumer spending and ensure that the US does not enter a recession.
The Fed does not understand the energy bleed-through effect which is why it has developed a whole body of urban mythology about the inflation of the 70’s when actually 90% of the problem was a catastrophic 1,200% (not a typo) increase in oil prices. The oil price explosion was exacerbated by draconian price caps on US production.
The Fed meeting will be critical for the market with all the focus on the SEP (dot plot). The last dot plot had 1 rate cut implied whereas the Fed fund futures imply almost 5 rate cuts, setting up the potential for a disappointment given a Fed bias toward being hawkish given their focus on the discredited “expectations” theory of inflation.
The Bank of England has launched an inquiry led by Ben Bernanke to determine what went wrong with the central bank’s policy framework that led it to miss the surge in inflation.
The Fed should launch a similar inquiry and revise its policy framework as it raised rates 3 months after the BOE so was even more incompetent than the BOE.
We expect the US economy to slow but avoid a recession and execute a soft landing with economic growth decelerating to the 2% range as credit tightens and long-term rates rise due to Fed policy, offset by post-pandemic tailwinds. The housing sector, which usually is the leading cause of recessions, continues to be resilient with an ongoing shortage of total homes for sale. The recent increase in mortgage rates increases the probability of a recession, but we expect rates to peak and start to decline as the European economy continues to contract.
There are currently 7.9 million construction workers employed which is an all-time high and has been steadily rising during the Fed tightening. We expect this to continue as the housing shortage and spending on infrastructure supporting the sector. Construction spending totals $1.8 trillion representing over 8% of GDP and is the most volatile of all sectors.
During the housing crisis of 2008, 2.7MM construction workers were laid off, representing a 30% decline, and 2.0MM related manufacturing and transportation workers were also laid off, representing 2/3rds of the job losses during the great recession. Every post-WWII recession has had large construction layoffs that on average caused a 14% loss of construction workers.
We project that the impact of the infrastructure bill, IRA, Chips Act, and ARPA will add approximately $200 billion per year to construction spending, which should offset the slowing in the construction of office buildings and other commercial real estate.
Many investors and strategists don’t seem to appreciate that the economy does not spontaneously combust. All 11 post-WWII recessions were caused by high inflation, which caused the Federal Reserve to raise rates, resulting in a contraction in business investment. A decline in consumer consumption has never precipitated a recession. Consequently, focusing on minor influences on consumer spending, such as student loan payments or Pandemic savings, is not relevant to predicting a recession.
The average post-WWII recession has been precipitated by a sharp drop in investment averaging over 13%. This drop causes large layoffs in the construction and manufacturing sectors which constrains consumer spending.
Consumption is 66% of GDP and investment is 21%, BUT investment is highly variable and consumption very stable, which results in investment being the driver of recessions.
Personal consumption growth during recessions has been slightly positive.
The US consumer is relatively strong due to strong labor markets and strong housing markets, with homeowners benefiting from higher real estate prices and low fixed mortgages.
Lower-income households who do not own a home are under pressure from stagnant wages and high inflation in rents and energy over the last two years.
Most consumers are not economists, so they are more concerned about inflation over the last 2 years vs. just 1 year as much lower-income consumer’s wages have not kept up over the last 2 years.
The average post-WWII recession resulted in a 2.3% decline in real GDP.
The only type of government spending that is counter-cyclical when the economy is at or near full employment is investment spending.
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Commodity Outlook:
Recent Oil Price Weakness Driven By Warm Winter:
We maintain our $75-95 range estimate for oil in 2024 as continued production constraints from OPEC+ and steady demand growth support the price.
We attribute the recent weakness to seasonal/weather factors partially offset by the uncertainty created by Houthis attack on Red Sea shipping lanes.
December of 2023 was the warmest in 150 years.
China’s Economy is Way More Resilient Than Perceived which Benefits Commodities:
China is the only major global economy that is loosening monetary policy. China increased its monetary base to over $140 billion in September representing a 2.9% increase vs. a $300 billion drop in the Global Monetary Base.
China is projected to grow by 5% this year.
China saves 45% of GDP vs. less than 20% in the US, which results in much higher long-term growth as the critical driver of economic growth is savings and investment.
The property crisis is a concern, but if it starts to generate contagion, the central government is likely to intervene.
The China recovery story is bullish for global commodities and growth.
The utopian vision of an all-electric economy has now completely imploded as average consumers have limited interest in all-electric autos, and renewables development falters due to nimby opposition to offshore wind and massive cost overruns. Europe’s failed energy transition is likely to exacerbate a recession and lead to regime change in many countries.
The failed attempt to push an all-electric vision has hurt the environment as there was less focus on hybrid electric cars and using natural gas to supplant coal.
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QUICK TIP:
The key to national economic growth is competitive corporate tax rates as corporations are the key driver of economic growth and earnings growth is fueled by after-tax corporate earnings. High corporate tax rates encourage corporations to relocate operations to lower-tax countries and reduce after-tax corporate earnings.
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