Why Advisors Shouldn’t Sit On The Sidelines Heading Into 2024

Despite Election Year Emotions, Recession Risk And High Money Market Rates, Selective Bond And Equity Investments Serve Clients Better Than Complacency In Cash

This year, investors have largely received the best of both worlds from the financial market backdrop. On the economic front, the U.S. has seen steadily declining inflation and above-trend growth supported by a resilient consumer.

Within the corporate landscape, a more stringent focus on costs has led to a rebound in profit margins, with both the number of S&P 500 companies surpassing earnings estimates and the magnitude of those beats reaching multi-quarter highs. In fixed income, momentum has gathered on the back of expectations for less upward pressure on interest rates from the Federal Reserve.

As we look toward 2024, we are surprised by the level of complacency that is apparent across the investment community. With money market yields at 20-year highs, increasing chances of an economic slowdown and a presidential election year on the horizon, some financial advisors are comfortable sitting on the sidelines.

Whether driven by complacency or uncertainty, we believe that is doing clients a disservice, and history is on our side. Below, we will use historical data to refute viewpoints that are common across the industry.

As we look toward 2024, we are surprised by the level of complacency that is apparent across the investment community.

Bonds As Ballast

“The yields available from nearly risk-free money market funds are at 20-year highs. Why would I look anywhere else for the ballast of an investment portfolio?”

There is value in cash assets with yields north of 5%, especially for those with imminent liquidity needs. That said, the current opportunity in the traditional fixed income market is too compelling to ignore. Income distribution across the bond market remains robust with high quality fixed income securities such as investment grade corporate bonds, municipal bonds and Treasurys trading near 15-year highs from a yield perspective.

In addition, with the prospect of a Fed pause, bonds have the potential for price appreciation. The returns in the bond market generated by investing after the Fed pauses but before it cuts have historically outpaced the returns provided by investing after the central bank cuts rates.

Source: Blue Chip Partners with data from Bloomberg Finance L.P., as of Sept. 19, 2023. Bonds are represented by the Bloomberg U.S. Aggregate Index. Returns are calculated from the day the Fed stopped raising rates in 1984, 1989, 1995, 2000, 2006 and 2018.

The average forward returns for domestic bonds shown in the accompanying table serve as a telling reminder that waiting for the Fed to ease the baseline interest rate is not in investors’ best interest. For further evidence, see the relationship between the 10-year Treasury yield and the federal funds rate in the accompanying chart. The 10-year yield usually starts to move before the federal funds rate is adjusted.

Source: Blue Chip Partners with data from Bloomberg Finance L.P., as of Sept. 19, 2023.

As a final note, money market fund assets are at an all-time high, implying there is a wave of cash that may begin to splash the markets over the coming year.

The Opportunity Cost Of Neglecting Equity

“Economic data has started to soften, and there is meaningful potential for a recession in 2024. Why should I look to allocate to the equity market at this juncture?”

Cracks are forming underneath the hood of the U.S. economy. We expect recently observed items such as labor market weakness and softer consumer spending to persist in 2024. We view this as natural – the economy is a cyclical mechanism. Slower growth off of a relatively high base doesn’t necessitate an outright economic contraction, and trying to time exposure to the equity market is one of the most painful mistakes an advisor can make.

However, slower growth does imply the need for selectivity in the equity market. When investors perceive little economic slack late in the cycle, they question the potential for returns on corporate cash invested toward growth. Instead, they have historically rewarded companies that return cash to shareholders, as well as firms with strong balance sheets.

The potential opportunity cost of foregoing equity market exposure is large, especially for those with a lengthier time horizon. With that in mind, advisors shouldn’t ask whether or not to invest in stocks at this juncture, but rather thoughtfully analyze the composition of clients’ equity exposure.

Dispelling The Election Year Myth

“There is a presidential election in 2024, which may stoke elevated volatility in the equity market. Why shouldn’t I wait until there is less uncertainty to gain exposure?”

The short answer: Although bouts of volatility are possible in an election year if the trading environment turns to one driven by emotion rather than a normal, fundamentally driven environment, average returns exhibited by the S&P 500 Index during presidential election years actually outpace the long-term average.

Source: Blue Chip Partners with data from Bloomberg Finance L.P. Data from Dec. 31, 1927, to Nov. 30, 2023.

Regarding elections and markets, we find it important to zoom out and keep a “big picture” perspective. Economic and stock market volatility that stem from potential adjustment in public policies are generally contained within specific sectors and industries as opposed to the impact being felt by the economy at large or the broader domestic investment universe.

That said, a sector like health care may be prone to elevated volatility given meaningful dispersion between the typical stances exhibited by political parties. The same is true for energy, where the outlook for spending and regulation on renewables versus traditional oil and gas can be meaningfully different depending on who occupies the White House. Impactful policy changes require more than simple optimism from the executive branch. We maintain that staying the course while maintaining an element of selectivity can benefit investors in 2024.

Daniel Dusina is Director of Investments at Blue Chip Partners, an independent RIA headquartered in Farmington Hills, Michigan.

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