Welcome to 2024. In this edition we bring to you our annual summary of changes to various tax, estate/ gifting, and retirement plan rules, followed by a 2023 postmortem and look ahead.
The maximum employee contribution to a 401(k), 403(b) or 457 plan for 2023 has increased from $22,500 to $23,000. The maximum that may be contributed by the employee and employer combined is $69,000, up $3,000 over 2023. The additional “catch-up” contribution that can be made by those age 50 and over remains unchanged at $7,500.
The annual contribution limit to IRA accounts has increased from $6,500 to $7,000. The additional “catch-up” contribution for those 50 and older remains unchanged, at $1,000. There have been slight increases to the income phase-out ranges that determine eligibility to make tax-deductible traditional IRA contributions. The deductibility of IRA contributions depends, in-part, upon participation in an employer retirement plan. If married, deductibility considers whether one, both or neither spouse participates in such a plan.
The income phase-out ranges for Roth IRA contributions for 2024 have increased. For single persons, the phase-out range is $146,000-$161,000. Below $146k, a full contribution is allowed. After $161k no contribution is allowed. Within the boundaries, a partial contribution is allowed. For married filing jointly, the phase-out range is $230,000 to $240,000.
If you wish to make an IRA contribution for 2023 (Traditional or Roth), you may still do so, if your contribution is deposited or post-marked by Monday, April 15th, 2024.
Health Savings Account Contribution Maximums have increased from $3,850 to $4,150 for Single persons and from $7,750 to $8,350 for families of 2 or more. The “catch-up” contribution for those over the age of 55, remains unchanged at $1000.
The annual gift tax exclusion increased from $17k to $18k per year per person.
Social Security Cost-of-Living-Adjustment in 2024: +3.2%
The standard deduction for income tax has increased:
- Single: From $13,850 to $14,600
- Married Filing Jointly: From $27,700 to $29,200
- Head of Household: From $20,800 to $21,900
- Married Filing Separately: From $13,850 to $14,600
Many industries have fundamental, bedrock doctrine that is distilled to catchy phrases for lasting, easy recall. Two of these that apply to the investment management business are: 1) Don’t fight the Fed, and 2) Never bet against the US economy. The purpose of fundamental doctrine is to provide a guiding light in times of haziness, to be something around which to formulate important decisions when uncertainty abounds. In theory, fundamentals should be complimentary such that strict subscription to all will lead to good outcomes, especially over the long term. But what happens when fundamentals are contradictory, such that adherence to one means opposition to the other? In 2023, the Fed and the US economy seem to have been equal and opposing forces.
Headlines: December 29th, 2023.
“How I, and Everyone Else, Got 2023 So Wrong”, James Mackintosh, Wall Street Journal
“What Did Wall Street Get Right About Markets This Year? Not Much.” Gunjan Banerji, Wall Street Journal
And similar headlines were everywhere throughout the close of 2023 and into 2024. Market events of 2023 will be the subject of countless PhD papers for years to come. Recession indicators (with sixty years of backing data) flashed red throughout the year. The Federal Reserve itself called for a recession. The economy bent, consumers balked, a short-lived banking crisis developed, but the economy proved far more resilient in 2023 than any serious person thought possible.
Inflation and GDP
We felt that inflation would fall to acceptable levels by the end of 2023 but that the US economy would be collateral damage in the Fed’s quest to tame inflation. Historically, in similar circumstances, this has always been the case. Inflation has fallen to 1.86% annualized over the past six months, using the Fed’s preferred measure, core PCE. The US economy likely grew by 2.9% for the full year. Inflation has fallen below the Fed’s target, while economic growth has remained above expectations. Barring any severe adverse economic events, Federal Reserve Chairman Powell should be clearing space on his mantle for a Nobel Prize, which has been awarded for far less impressive performance than achieving the elusive “soft landing”, following a period of runaway inflation.
The Labor Market
Throughout the year, we were keenly interested in how the labor market would develop, as it was the last major factor preventing the economy from recession. The housing market tanked (by sales volume), new business orders and corporate profits both contracted, but the labor market never materially softened. Unemployment peaked at 3.9% in 2023, which would not be considered high in any honest evaluation.
2023 ended with a lot of market enthusiasm, and we’ll take the rally, thank you very much. But it is important to realize that over the past two years, 2022-2023, the S&P 500 is nearly unchanged, US small cap equities are down 10%, and the aggregate bond market is down 8%. It’s been a brutal run for any diversified portfolio, especially for more conservative investors.
If we had known in early 2023 what we know now, we would have moved away from the conservative portfolio positioning that was effective in 2022. But given the same set of facts, and without a crystal ball, we would make the same decision today. Many economic data points flashed recession throughout 2023, some with perfect track records predicting recessions, such as a deeply and persistently inverted yield curve. The only rationale for adding risk to portfolios would have been strict adherence to the dictate that one should never bet against the US economy, which would have meant placing an active bet against the Fed and a host of economic indicators.
After having missed the recession call and remaining rather conservative through the first several months of the year, our capital markets analysis suggested that 4,200 on the S&P 500 and a 5% yield on the US ten-year Treasury would be reasonable entry points with the potential to provide good long-term value, even if a mild recession were to take place. Both of those levels were realized, briefly, in late October. We tactically rebalanced all Schwab accounts at that point, adding investment dollars to both stocks and bonds. Both asset classes rallied convincingly, perhaps excessively, into the end of the year.
Market Data and Investor Expectations
It's customary for investment firms to make grand predictions at the start of a new year, and it’s also customary for those predictions to be wildly incorrect. 2023 was a stark reminder of that fact. Perhaps a better way is to look at what market data is signaling to investors now.
The main story here is that the bond market is pricing seven rate cuts from the Federal Reserve in 2024. That’s a lot. One typically only sees that many rate cuts when the Fed is trying to stimulate a slowing economy. Inflation appears to be under control, which does provide the Fed room to lower interest rates. But if the Fed lowers rates too far, too fast, there is a risk that inflation will do a U-turn and move higher.
There are minimal signs of economic slowdown in the data, but they are there. A few forward-looking indicators that showed improvement in the October/November time frame are turning negative again. The Fed’s “Beige Book”, a qualitative evaluation of the US economy, had a slightly ominous tone when it was released at the end of November. The labor market is showing some mild weakness. It’s taking job seekers a little longer to find work today, and it’s mostly just the healthcare and government sectors that are hiring.
Frankly, most economic datapoints looked worse in March of 2023 than they do today. A lot can happen between now and 2025, but it seems that we’re not facing the type of scenario that would call for interest rates to fall from 5.25% to 3.5% in one year. For context, the last time the bond market was pricing as many rate cuts as it is currently, the financial crisis was raging.
The wildcard here is the election in the fall. The Fed generally doesn’t like to be seen as influencing elections, so it is possible they will make proactive rate cuts in the spring and summer months in anticipation of a slowdown to avoid any accusations of political involvement. To the extent any of these concerns are valid, one should put extra emphasis on economic data in the first half of the year. A few weak payroll reports could come close to justifying market sentiment. The market is expecting an unemployment rate of 4.2% by the middle of 2024, up from 3.7% currently. If the unemployment rate inches above 4.2% in the next six months, the bond market will likely be correct in assuming seven rate cuts for the year.
One of the hallmarks of the bond market over the past two years has been unusually high volatility. Unfortunately, that trend looks to remain in place. It appears that there is more risk than reward in rate-sensitive bonds today. The see-saw of interest rate changes will likely continue at least for the short term. In plain English, the bond market recovery over the past few months has moved too far too fast and will likely need to move sideways or down for a few months.
The Fed will likely cut rates in 2024, but no one knows by exactly how much; the labor market and inflation readings will answer that question. For us, this outlook does not require wholesale changes to our portfolios. A balanced bond allocation with an emphasis on quality and income largely shelters us from extreme market sentiment.
The Equity Markets
There is no clear narrative for the equity markets, but there are plenty of clues to what the market may have in store for 2024. The consensus bottom-up forecast is for a 7% gain in the S&P 500, which is approximately the long-term average. Our analysis in October of 2023 suggested that 4200 for the S&P 500 was a reasonable entry-point to add to equities. That level proved to be valid, as the market bounced off it like it was a trampoline. If we run the same analysis today, we come up with 4300. There’s a 10% range from what our analysis suggests is fair value at the low end, to analysts’ expectations at the high end. It would not be unusual to see the market trade at both levels over the course of the year.
2023 was the year of the Magnificent Seven. Just a handful of large tech names drove most of the gains in the S&P 500. One question for 2024 is whether the market will remain enthusiastic about the large tech company space. Earnings growth for these firms is expected to slow, and history does suggest that these top names lose some of their luster after such a banner year.
The story for 2024 could be that the laggards catch up to the winners. From an earnings perspective, many sectors of the economy did face a profits recession in 2023. Cyclical sectors such as energy, financials, real estate, healthcare, and materials all saw earnings fall on a year-over-year basis. Analysts expect that all these areas will see earnings growth in 2024. It is typically during an earnings recovery that we see the best equity performance. It’s entirely possible that these sectors, and not the Magnificent Seven, will lead the market this year.
We added exposure to cyclical sectors in November. We’ve grown skeptical that the top 7 companies will drive the entire US equity market for consecutive years. The tech sector is as expensive relative to the rest of the market as it was during the height of the 2000 tech bubble. We’re not calling for a tech sector collapse, but there certainly are other opportunities in the market.
Careful readers will notice that the equity market and the bond market are painting different pictures. The bond market is expecting enough economic weakness that interest rates can fall at the fastest pace since the Financial Crisis, but the equity market is expecting earnings improvement in the most economically sensitive sectors. Investors seem to be thinking that the market will be just right, strong enough to grow the earnings of the cyclical sectors listed above, but weak enough to allow the Fed to cut rates without inflation flaring higher.
Our view is that having just experienced a huge rally, the market isn’t sure what will come next. The economy has proven resilient, and inflation has fallen to largely acceptable levels over the past few months. This suggests that Fed actions may go from being restrictive to supportive. The market is yet to decide just how supportive the Fed will be. A more broad-based and balanced equity market seems to be in the cards for 2024.
One of the more interesting aspects of market pricing now is how many of the forecasted changes are expected to happen by mid-year and then flatline. The labor market is expected to weaken into mid-year then stay steady at an unemployment rate of 4.2%. Corporate profits are expected to expand for the first half of the year and then remain steady in the back half. Same for headline inflation; it’s expected to fall and then flatline at 2.6%. It could be that analysts are not comfortable predicting where the economy will be as we move closer to the November election, given how dramatically policy may change based upon the outcome. With that in mind, 2024 is a year to avoid sweeping predictions. Our investment thesis for 2024 is to remain balanced and nicely diversified.
Neither of the previous two years has been typical for capital markets. A spike in inflation that caught the Fed off guard resulted in a series of rate hikes that devastated both the equity and bond markets in 2022. Through the first several months of 2023 only 7 companies drove the return of the S&P 500. At various points in the year, 493 of the 500 companies in the S&P 500 had an aggregate return of zero, or less than zero. Such narrow market leadership is incredibly rare. More unusual even, is that the US bond market had a -13.02% return in 2022 (lowest in our lifetimes), followed by a return of +5.65% in 2023, resulting in a 2-year period of net negative returns.
We recall the prior two years to acknowledge what all investors have experienced and to thank you for the trust you place in PIM to navigate us all through periods such as this. It is our general view that moving forward we will experience a return to normalcy. What does normalcy mean? Typical volatility, historically average returns, less drama. There are risks capable of derailing this economic nirvana, the Fed’s ability to effectively manage interest rates throughout the year primary among them. But we are hopeful.
We will continue to deliver commentary approximately every 6 weeks throughout the year. In the meantime, please reach out to your PIM Financial Advisor with any questions or to schedule a review meeting.
Our very best wishes for a sunny end to what has so far been a pretty mild winter. Those extra 2-3 minutes of daylight per day can make all the difference 😊.