VTWO - Soft Landing: Investment Implications For 2024

2023-12-19 23:49:25 ET

Summary

• The economy is on track for a soft landing, with inflation reduction and positive economic growth.
• The Fed's potential interest rate cuts in 2024 has caused the stock and bond markets to surge.
• Analysts suggest investing in cash-related investments, bond funds, and even longer duration bond funds to profit from the soft landing.
• Areas of the stock market that could excel are consumer staples, energy, health care, utilities, and small cap stocks.

It now appears that the economy is set for a soft landing, that is, a reduction in inflation while economic growth remains positive and avoids high unemployment rates or even a recession. Although soft landings resulting from when the Fed raises interest rates to avoid too high inflation are relatively rare, it looks now as if we are on track for one. That's why the markets have been exploding higher lately, especially since the Fed's latest meeting that suggests it may start dropping interest rates some time in 2024.

Of course, both the stock and bond markets love falling rates, increasing the value of existing investments. In fact, the stock market tends to do best of all when fed fund rates are being held steady (For further on this topic, see my two previous articles on Seeking Alpha here and here ).

As of now, such rates have been unchanged since July 2023. Analysts are now expecting no further rate changes, up or down, until at least March or possibly into mid-year 2024. The Fed has to maintain a delicate balance between raising rates too high and possibly tanking the economy, or further inflaming inflation by cutting rates prematurely and creating an overheated economy. My guess is also that rates will not change for many more months as to not risk either outcome.

So, if you also agree, as I do, that we are now experiencing the start of one of those highly infrequent soft landings, how might you position your portfolio to best profit from it?

Let's first review what a few other analysts have suggested.

Analysts' Opinions

-According to an article on cnbc.com going back to early August 2023

"The fact that we may see a soft landing or avoid a recession altogether doesn’t mean people should change their strategy of building up a safety net and hopefully recession-proofing their portfolio ...

The article goes on to state that cash-related investments, such as money market funds or Treasury bills, are now much more attractive than when rates were much lower.

My own comment would be these should be included in any diversified portfolio but only on a relatively small basis depending on your risk tolerance.

And total returns, when investing in bond funds, should now be more promising as well. As noted above, bond prices should increase in value if and when the Fed begins cutting rates. Some advisors may also be advocating increasing the duration of their bond portfolios. Thus, while some suggest moving from short duration funds, such as short-term bond funds, to intermediate term duration funds, others will go as far as recommending even longer duration bond funds to get the most "bang for your buck."

-In a more recent article published by Fidelity Investments in mid-November:

A soft-landing scenario would involve a slightly below trend slowdown across major economies, with no major shocks to knock markets off track. The decision to keep interest rates higher for longer would bring inflation to a level with which central banks are comfortable. This would then allow them to pivot and cut interest rates, easing pressure on indebted households and companies.

... there would be particular opportunities for growth stocks, real estate logistics, and cyclical credits. There would be particular opportunities for growth stocks, real estate logistics, and cyclical credits. Less defensive and mid-cap names likely to outperform the market.

Further, it states:

... good news for equities - especially those beyond the big names that have driven S&P 500 performance in 2023 - and moderately positive for bonds. High yield would also do well in a good environment for risk assets ...

And

... there should be room for both investment grade credit and some careful, well-researched purchases in high yield assets, where there are high single digit yields on offer.

-In an article published about the same time in the Wall Street Journal, the author states:

Shares of ... small companies have been flashing a recession signal, lagging behind the S&P 500 by the widest margin since 1998, according to Dow Jones Market Data. These companies are especially sensitive to borrowing costs and tend to generate more of their revenue domestically.

And

This suggests that investing in an ETF such as the Vanguard Russell 2000 ETF ( VTWO ) may make sense.

-Finally, in a Dec 8, 2023 article here , it quotes the opinions of several investment experts. According to one, 70% of the S&P 500's double-digit advance was a result of merely seven large cap technology stocks, while the remaining 493 "haven't gotten much love." This expert expects health care, energy, and industrials, performing poorly in 2023 to catch up in 2024.

My Point Of View

The diversity of opinions described above may seem too varied to act upon, but now I will give you what I consider to be your best bets.

While I agree with most of the above opinions, when I look at segments of the economy, I can see instances of gross overvaluation of some, while mild undervaluation of others. The latter cases would seem to be better choices than the former.

Investments that appear to be too overvalued to thrive, even in a soft-landing scenario, are technology and growth, and even the large cap Vanguard S&P 500 ETF ( VOO ).

Areas of the market have been lagging behind the market, especially this year, are consumer staples, energy, health care, and utilities. These areas all seem likely to stage a comeback in 2024 under the soft-landing scenario.

As stated above bonds, such as the Vanguard Total Bond Market ETF ( BND ), should do much better than in the last few years, and in the unexpected outcome of a recession, even better yet. And long-term bond ETFs, such as Vanguard Long-Term Treasury ETF ( VGLT ) could hit an investment home run.

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