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Haverford Trust and Hank Smith are nationally recognized investment leaders committed to informing and inspiring people to build better financial futures for their families. In his chats with authors, influencers and industry experts, Hank helps bring a sense of clarity and calm to the complexity and stress of personal finance. Topics range from quality investing, retirement resilience, market trends and behavioral psychology.
Season 2; Episode 1 - Economic Outlook
Transcript
Maxine Cuffe 00:01
You're listening to Speaking of Quality, Wealth Management Insights with Hank Smith, a podcast by the Haverford Trust Company. On Speaking of Quality, Hank chats with authors, influencers, and wealth management experts to bring a sense of clarity and calm the complexity and stress of personal finance. And now, here's your host, Hank Smith.
Hank Smith 00:21
Hello, and welcome to another episode of Speaking of Quality, Wealth Management Insights. I'm your host Hank Smith, Director and Head of investment strategy at the Haverford Trust Company. On this podcast we explore topics ranging from quality investing, retirement resilience, stock market trends, estate planning, small business ownership, behavioral psychology and more. Today, we're welcoming three dynamic minds to our podcast for the first time to dive into our 2024 Economic and Market Outlook. First, we have Joe McLaughlin, our Chairman and CEO. Joe has been with the firm since 1992 and has worked in the investment industry since 1984. Next up, we have Tim Hoyle, our Chief Investment Officer, Tim has been with Haverford Trust since 2003 and is an integral part of our firm, ensuring the quality, consistency, and implementation of our investment philosophy. Last but certainly not least, we have John Donaldson, Vice President and Director of Fixed Income. John Donaldson has been with Haverford since 2008 and has more than 40 years of experience in the investment industry. Together, Joe, Tim, and John form a powerhouse panel. And we're excited to tap into their collective wisdom to get a deeper understanding of our outlook for 2024. So without further ado, let's jump in today's conversation with these esteemed guests. Joe, let's start with you. Why don't you provide our audience with a State of the Union of the Haverford Trust Company and how we're positioned for the future?
Joseph J. McLaughlin, Jr. 2:00
I'd say we're positioned better than ever. And as you know, we have an expression within our company that our size is our advantage. And what we mean by that is wealth management and clients are at the center of everything that we do. And within our industry, we're nearly $14 billion under management. And that gives us the ability to offer the products and services of larger competition, but we feel that we can execute, that we can anticipate and plan better than our competition without the bureaucracy. And our culture of communication and collaboration is key for that. Our company now has about 140 extremely talented, accessible people who practice the Golden Rule every day by putting the client first. And it truly matters to us who works with the team. We take a lot of time developing the staff to get to know them before they join. And in that process, the prospective employee also has an opportunity to learn just as much about us as we do about them. And it's the process that really works and has enabled us to have an employee retention rate of about 95%. Notably, early in 2023, we had a transition in leadership, Keith Aleardi joined us as president. And since Keith's been on the scene, the transition has been seamless both with our clients and with our team. So your question is, how are we working to ensure that our clients’ needs are being supported? I'm reminded of a powerful sentiment that was expressed by Morgan Housel, who was the author of The Psychology of Money, and he emphasized it's impossible to plan for what you can't imagine. And that sentiment holds true at Haverford. We believe that successfully imagining what the future can hold begins with a reflection of where we are today. And it's our mission to become essential to our clients and to form lifelong relationships with them through quality investing, and through our five-star service model, and that commitment to excellence has enabled us to enjoy a client retention rate of 97%. So as we enter 2024, I can unequivocally say that Haverford's commitment to our quality investing philosophy, and our investments in our people, our technology, our process, and our portfolios position us better than ever, to have our clients continue to build long term financial futures with us. I want to mention just a minute or so more on last year's market gains, which were dominated by just a very few narrow group of stocks, that mostly benefited from a lot of hype around artificial intelligence. And I don't mean to discount artificial intelligence. But while it's rare we've seen this play out before. Most notably, I can remember 1999, and what we know is these periods don't last forever. And I think that increasing clarity around the Fed’s direction should enable the market to broaden out more, much like we've seen over the last two months. And a key element of our quality investing philosophy is the control risk. And dividend paying companies with strong balance sheets, and strong cash flows are an important element in containing risk. This approach that we've stayed disciplined to for so many years, has enabled us to weather many challenging periods. I think about six recessions, including the great financial crisis, the pandemic, numerous geopolitical events, and even wars. And throughout all of it, that discipline has allowed us to stay true to our most important goal, and that is to grow and protect our clients’ wealth. And history has told us that commitment, the consistency, and the conviction aren't trends, but they're timeless. So I feel really, really terrific about the future of our company, and the future of our clients with our company.
Hank Smith 6:45
And I would just add, Joe, you and I have worked together for 33 years. And I don't think there's a previous point in time in which the culture has been stronger than it is right now. And a lot of it has to do with how we responded when we worked 15 months out of the office, and the communication we had amongst all teammates, and it continues as we're back into the office. So I would agree with you the future looks very bright for Haverford Trust, and I'm very happy to be part of it. Tim, a year ago, at this time, the consensus among economists and Investment Strategists was a recession was imminent in 2023, it was only a matter of whether it be a mild recession or a deeper recession. And in fact, we stated that our expectation was for a mild recession is likely, but not inevitable. And in the early part of the summer, we changed that to a soft landing is likely but a recession can't be ruled out. So where did economists and strategists miss this forecast? And tell us a little bit about some of the surprises in 2023?
Timothy Hoyle 8:06
Yeah, I think at the broadest level, we underestimated or economists underestimated the strength of the jobs market and the ability for consumers to continue to spend through higher prices and to weather higher prices, and not be daunted by them, the jobs market has remained much stronger than anyone expected. When we started 2023, one of the ways that we were going to measure the success of the Fed’s tightening cycle, and the ability to orchestrate a soft landing was to look at the number of job openings versus the number of jobs created and inflation levels. And when you look at it, really everything that could go right, did go right. To begin the year, the jolts survey showed something upwards of 11 or 12 million job openings, that's down to 8 million. At the same time, wage growth has stayed about 4%. And we've added hundreds of 1000s of jobs every month on average. So that in itself is what happened, the strength of the economy. We also underestimated the liquidity that would continue to be pumped into the system, there is a larger budget deficit, when you look at what occurred after the Silicon Valley Bank crisis, no one would have expected the FDIC to come out and essentially insure every dollar of deposit for every depositor in the country. But by acting quickly and decisively, the federal agencies stemmed what could have been a crisis. There's a saying that the Fed raises rates until something breaks, something did break. But the actions taken by the Fed and the FDIC stemmed what maybe could have become a recession trigger. Some of the things that went right in 2023, you had a technological step change, as Joe talked about, and it's fueled a lot of optimism around that and we're seeing it in certain companies that we own being able to charge for AI and being able to monetize that. We had the linear decline in inflation. It was in many ways transitory. It's coming down as fast as it went up, and energy prices came down. And there was an expectation that energy prices would go the other way and they didn't. All of that fueled a much stronger economy than many expected.
Hank Smith 10:20
John, has been quite a year in the fixed income markets in 2023. At the start of the year, you said, one thing is for certain that quantitative tightening will mean more volatility. And we certainly had that. And you also talked about three myths that were likely to be broken. Can you explain that for us?
John Donaldson 10:41
Sure, and the little-known fact, even as we're only in early in the new year is the 10-Year Treasury, the benchmark 10-Year Treasury, began the year at 3.88%. It was 3.88% at the end of the year, but oh my goodness, what a ride. We talked about one of the myths was, and this was widely held, that the US economy was so fragile, that it couldn't survive without ultra-low, if not zero, rates. Well, everything that Tim has already articulated about jobs, staying strong, employment staying strong, people surviving through recessions, or a lack of recessions, actually, and inflation ... the economy did okay. You know, myth boom, not there. Wecond one was that there was a Fed put; that the Fed would backstop each and every little thing. Certainly, the Fed will backstop a great financial crisis, it will backstop a global pandemic, it will provide whatever necessary tools, when you have banks the size of Silicon Valley or signature banks go, it is not going to backstop, a run of the mill mild recession or a run of the mill 6% decline in the stock market, it's not going to be there for that. Its eventual target will be to stop buying all kinds of assets and go back to its historical balance sheet position of only owning US Treasuries. And you can see that as it winds down its balance sheet positions. The third myth, from the point of view of investors is that they would have plenty of time to see the peak in rates before getting invested and have plenty of opportunities. We had two occurrences during 2023, that look anything other than that - first during the bank crisis. Two-year treasury was it 5.07%, two weeks later, it was at 3.77. So you had a drop of 130 basis points in two weeks. In October, that benchmark 10-Year Treasury hit a peak of 5%. By the end of December, it was at 3.8. So 120 basis points. And oh, by the way for the broad market indices for both investment grade bonds, and tax exempt municipal bonds, November of 2023 was the best month broad bond markets had since the 1980s. That belies any belief that Oh, you'll have plenty of time. Now, one of the other things that's been very good and beneficial, that people haven't given full credit to, is all of the extra income coming to investors from actually having yield on their cash for the first time in a decade. And from having higher yields on their bonds. I mean, one calculation had it at over a trillion dollars in extra income coming to investors, which offsets at least a little bit of the dent in spending power from inflation, if there's a trillion dollars more in income to both individuals and corporations.
Hank Smith 14:32
Yeah, for many years, there really wasn't much reason to give too much time to fixed income because there was no income in fixed income. And now there is as you’ve just pointed out, and it's pretty exciting. So let's stay with fixed income. One of the other points you said as far back as 15 months ago, whatever the terminal rate is on the Fed funds rate, and let's just say there's a general consensus that we're at the terminal rate at five and a half percent on the Fed funds rate, that it will stay there longer than most market participants expect. And so today the Fed Funds Futures markets are pricing in nearly six quarter point rate cuts for 2023. We don't agree with that. Can you elaborate?
John Donaldson 15:23
Sure, there's a couple things, I think one is the institutional memory at the Federal Reserve. While Tim mentioned how much inflation has come down on a headline level, and how it mirrors the upside, we all know that in the 1970s, you had inflation that went up and came back down, and then had a big second wave. And I think the Fed’s psychology, in terms of their policy moves, is to ensure we don't repeat that process. And they're going to be more willing to be a little late in getting started than to risk being too early and letting inflation pop back up.
Hank Smith 16:08
So our forecast is for something along the lines of maybe two Fed rate cuts in 2024, not six?
John Donaldson 16:19
Six seems like there would need to be something else happening. And again, contributing to our overriding theory about volatility is that as market perceptions change, from thinking, oh, there may be as many as six rate cuts, to there might be only three, there might be two, there might be four, that'll change how the rest of the bond market is being priced as well. Hence, volatility.
Hank Smith 16:23
And certainly, Tim, if we had six rate cuts, it would imply a very weak economy, if not a recession. And that is not our forecast at all. We do not expect a recession in 2024 into 2025, can you discuss a little bit of our thinking there?
Timothy Hoyle 17:09
The consumer is going to remain strong in 2024. And the jobs market is structurally strong, structurally tight. The number of labor participation is low on a general basis 63%. But that's being driven down by the aging of the baby boomers, and just more and more people over 65 retiring and that number is bringing down participation. But when you look at everyone aged 25 to 55, participation rates are at 83%. It's high as it's been, it was a little bit higher in the in the 90s. When you look at female participation it’s is as high as it's been since the 90s. So there's a tight labor market out there, jobs are plentiful, wage growth is going to persist. And that's going to drive a strong economy in 2024.
Hank Smith 18:01
And a strong consumer when you consider the stock market at near all-time highs, house prices are near all-time highs, inflation is coming down. That is not the environment for a recession, particularly when you consider that consumer spending makes up about 70% of GDP. And I would also throw in although we try to avoid politics at all costs, we are in an election year and an incumbent administration first term wants to be a second term administration. So they're gonna pull every single lever they can to ensure that fiscal policy is supportive of an expanding economy. That's not the recipe for a recession, you know.
Joseph J. McLaughlin, Jr. 18:48
Also help helping the consumer is the fact that, you know, for most people, their biggest debt is their mortgage. And while mortgage rates are higher now, most people that have a mortgage, have a mortgage probably in that 3% range. Right, you know, so that's also helping them relative to other periods in time when interest rates were increasing.
Hank Smith 19:09
Very good point, the rise in interest rates has not had the impact as it has in previous cycles. Be a large part of that being a locked in low rates.
Timothy Hoyle 19:25
Hank, you bring up the presidential cycle. It's uncanny how the market has mirrored the average presidential cycle going back over time. The second year of a president's term in office often is the worst for the market. S&P was down 18% in2022. The third year is often the best, the markets rebounded spectacularly in 23 and in election years, when an incumbent is running for reelection markets usually have a low double digit return on average. So if the past is prologue, then you would expect a strong market this year. Now there's we've never had two people running for president with such low approval ratings. There could be some fly in the ointment there. But the expectation is, is that that this type of setup is good for markets.
Hank Smith 20:15
And talking about historical trends you pointed out 15 months ago, 14 months ago, that the returns after a midterm election, 12 months after a midterm election are positive going back to 1942. That's a lot of data points and that whenever the market enters into bear market territory, 86% of the time, the following 12-month return is positive. Those were historical trends worth paying attention to last year didn't really get much attention.
Timothy Hoyle 20:48
And tying into the election cycle and tying into the economic forecasts for next year. Oftentimes, presidents have plenty of levers to pull in an election year to boost the economy, you can look to what they're doing with student loan debt, you can look to the redemption of the Employee Tax Credit, which might be coming back in 24. There are things that could occur, Congress is talking about reinstating elevated Child Tax Credit. Also, flying under the radar is the fact that the US is producing more oil per day now than ever before. We're above levels in the Trump Administration. So there is policy out there to keep the economy strong through the election year.
Hank Smith 21:32
So one forecast that we did not get right in 2023 but remains our forecast for 2024 is seeing a broadening out of the market and we clearly did not see that. Maybe at the very tail end of 2023, it started to broaden out a little bit. As Joe pointed out earlier, this has been a market just dominated by seven to ten stocks, but the seven stocks in particular CNBC, dubbed The Magnificent Seven as a play off of the 1960s western. And if you've never seen that Western, I highly recommend it. It's one of the all-time greats. But we continue to forecast a broadening out of the market. Can you delve into that a little bit?
Timothy Hoyle 22:19
Yeah, well 2023 was one of the narrowest on record. 75% of the constituents in the S&P underperformed the S&P, that's the second worst showing on record. And that "Magnificent Seven" accounted for well over half of all the returns. Now, the multiple for those stocks has now risen to something like 32 times this year’s earnings, 28 times next year's earnings. They’re expensive on most relative gauges. Those companies though in 23 were the only companies to produce earnings growth on average. So when you look at the earnings for the year for the S&P in 23, it came in about flat. The "Magnificent Seven" showed 30% earnings growth, the despicable 493, showed negative earnings growth, we think that's going to turn around and 2024. The "Magnificent Seven" is still going to grow earnings, but the earnings growth for the for the rest of the market is going to is going to pick up and we think somewhere around 10% earnings growth is expected.
Hank Smith 23:28
And part of that is margins because of all the cost cutting done in 2023. It is as if corporate America was anticipating a recession too and cutting costs almost ahead of it, a recession that never occurred.
Timothy Hoyle 23:45
Yeah, and for most of 2023, we talked about how those 493 were actually pricing in a recession, the fourth quarter of 2023, we saw a big rebound that probably an 11% rebound in small cap stocks and the average stock in the S&P. So now you might want to say that they're pricing in a soft landing, but there's definitely room for the multiples to come back together. The average stock still trades at 17 times earnings.
Hank Smith 24:10
So while diversification might not have played out in 2023, diversification is important and will benefit investors as we look forward over not just the next year, but the next two, three years. Beware of very concentrated portfolios, of which the S&P 500 became one in 2023 with such dominance in seven of the largest stocks. John, as we're looking toward 2024, how are you thinking about positioning fixed income portfolios?
John Donaldson 24:55
We think that you want to be more fully invested with a little more duration and interest rate sensitivity, than you had. Once you get yields up to 5%, you're getting paid enough to ride through some of this volatility. That said, we're not extending beyond that. We still think, in sympathy to expectations for the stock market, that corporate bonds will do well. Historically, there's been a tremendous correlation between the relative performance of corporate bonds and the performance of the equity markets. We think that'll continue. We like mortgage bonds for the first time in a couple of years, where you getting the government agency credit, so no credit risk, and you're getting a lot of yield for the when will we get paid risk, rather than whether we will get paid, and that for a lot of clients, both institutional and individual, throwing off monthly principal and interest for either spending needs or reinvestment is a nice cash flow option, we like that. We continue to like the larger and stronger parts of the municipal bond market. They've weathered all that we've been through in the last three years rather well, in fact, a lot of their excess cash at the states in the big cities, they were able to use that excess cash from the federal government to help fund their pension funds, which is their biggest, long-term liability. So there's been an advantage there, as well.
Hank Smith 26:36
Tim, in our written outlook, you have stated that 2024 will be the first normal year post pandemic. What do you mean by that?
Timothy Hoyle 26:47
John and I talk about this often, so many economic models were blown up by pandemic, whether it be just consumption models or interest rate models. And but so often, we get hit by recency bias, where we only can think about what's happened in the most recent past. And we forget that oftentimes, things don't just keep on happening in linear line. And so the last couple of years have been abnormal on many regards. Interest rates, the zero interest rate policy, the government spending and all of those issues, we believe that in the coming year, we're going to see a normalization on some of these levels, we're going to see real rates get back to normal, we're going to see the spread between the two and the 10-Year Treasury maybe actually become positive again and get un inverted wage growth, which was at five and a half percent, at some points during that pandemic is coming back to normal. CPI, which was elevated, is coming back to normal. So all of these economic indicators that are used to forecast and to think about how the economy is growing and define pit holes, or opportunities. Hopefully, these models are going to start to work again,
Hank Smith 28:01
You know, I mentioned earlier, I'll put it in a slightly different context that one of our rules of investing is investors shouldn't let their politics get in the way of their investments. And we're coming up to a very contentious presidential election where the country is almost evenly split and very, very partisan. Tim, you point out markets will shrug off election fever and investors would be well wise to do the same. I think we're saying the same thing.
Timothy Hoyle 28:34
The S&P 500 is nonpartisan. It is, I mean, it does well, under split governments, it does well under Republican leadership under Democrat leadership, it’s because the economy usually does well, despite or, or because of who's in power. So yeah, we think that the market is nonpartisan. And as we talked about before, Hank, the presidential cycle, elections aren't a bad thing for the economy or for the markets. They don't affect markets negatively. Now, there is one caveat there, sometimes open elections, meaning that there's no incumbent running introduces a level of risk or uncertainty that markets don't like and, and you could see that happening this year where the incumbent isn't running. That's definitely you know, in the cards, and not not, it's not a nonzero probability. So that could be something that throws a curveball to the markets. And it could be something that brings into focus things like the budget deficit, fiscal policy, geopolitical policies that would have impact on the market.
Joseph J. McLaughlin, Jr. 29:38
Some people might think too that after a terrific year, like 2023, it’s unusual to have a positive return after such a blowout year. But when you look at the markets, historically, going back to 1928, the markets had a 20% plus year 34 times and like two-thirds of the time, the ensuing year has averaged at least 9%. So it's not unusual to have back to back pretty good years in the market.
Hank Smith 30:09
That's right. And the easiest forecast is always forecasting a return that's in line with the historical average, which is about 10 and a half 11% for the S&P 500. And yet, so rarely does an annual return fall within a percentage point of that range, plus or minus. It's usually much lower or much higher. And given our forecast that a recession is unlikely, cannot be ruled out, because we're not growing so fast that we're immune to an external shock. And no one ever knows what an external shock would be. But it's unlikely that we're going to have a recession, but likely will have continued volatility both in the bond market as John has pointed out, and the stock market. It's very normal to have 10% corrections, once, sometimes even twice a year, even during a bull market. We're going to continue to stay the course, continue to implement quality investing, and, and I think our clients will be well rewarded. Thank you so much for this terrific panel for joining us on Speaking of Quality. And to our listeners, thank you for listening to this episode of Speaking of Quality: Wealth Management Insights. Our next episode will feature Sam Hankin, founder and owner of the award-winning Wellington Square Bookshop, an independent bookstore in Exton, Pennsylvania. Sam is also the host of the Avid Reader show, a podcast for book lovers featuring interviews, recommendations, and insider news. In the meantime, please send suggestions or questions for me or the Haverford trust team to marketing at Haverford quality.com. And don't forget to subscribe, rate, review and share this podcast. Until next time, I'm Hank Smith, Stay Bullish.
Maxine Cuffe 32:04
Thanks for listening to this episode of speaking of quality, Wealth Management insights with Hank Smith. To hear future episodes of speaking of quality, please subscribe on Apple podcasts, Spotify, Google podcasts, or wherever you listen to podcasts. To learn more about the Haverford Trust Company, please visit www dot Haverford quality.com. This podcast is provided as general commentary and market overview and should not be relied upon as research, forecast, or investment advice. And it's not a recommendation, offer or solicitation to buy or sell any securities or to adopt an investment strategy. Any opinions expressed are as of the date this podcast was recorded and may change at any time. And are the opinions of that commentator, not Haverford’s. Any opinion or information provided are believed by Haverford to be reliable at the time of this podcast recording but are not necessarily all inclusive or guaranteed for accuracy. Before making any financial decisions, please consult with an investment professional.