Newsletter

FOURTH QUARTER, 2024

THE ECONOMY: INFLATION UNDER CONTROL AND NO RECESSION IN SIGHT

As we approach the end of 2024, the U.S. economy shows remarkable resilience amid a complex global environment. Concerns over inflation and interest rate policy have dominated discussions, but signs indicate the economy remains fundamentally strong, driven by a significant increase in factory construction.

The Federal Reserve’s accelerated pace of interest rate cuts should enable households to increase borrowing, supporting continued consumer spending. Strong consumer spending and elevated government consumption have led Harold Davidson & Associates, Inc. (HDA) to project U.S. Gross Domestic Product (GDP) growth of 2.5% for 2024, reflecting the economy’s health. HDA elevates its GDP growth projection to 2% for 2025, slightly slower than this year.

The Federal Reserve began its rate-cutting cycle in September, reducing the Federal Funds target range to 4.75%-5%. HDA anticipates further cuts of 25 basis points in both November and December, totaling 100 basis points for 2024. The rate-cutting cycle is expected to continue into 2025, with another 100 points in interest rate cuts bringing the Federal Funds to 3.25%-3.50% by the end of 2025.

The U.S. labor market remains a cornerstone of the economy’s strength. In September, nonfarm payrolls increased by 254,000, significantly exceeding expectations, and the unemployment rate fell to 4.1%. These numbers reflect continued job creation and ease concerns about the labor market weakening. The robust job market, combined with wage growth, supports consumer spending, a critical component of overall growth.

While the labor market remains strong, the manufacturing sector faces ongoing challenges. The ISM Manufacturing Purchasing Managers Index (PMI) has remained weak throughout the year, with production and new orders showing signs of weakness. Industrial production has grown at just 0.7% since 2022, below the historical average of 2.9%, trending sideways for nearly two years. This slowdown suggests some sectors may struggle to keep pace with broader growth
trends.

The housing market is influenced by fluctuating mortgage rates and low affordability. In October 2023, the average 30-year mortgage rate peaked at 7.8%, the highest since 2000. Although rates have since fallen by roughly 1.5%, housing affordability remains a major issue as home prices stay high. Housing starts have been declining since 2022, indicating lower consumer confidence. Nevertheless, home prices have not fallen in most areas, with the Case-Shiller National Home Price Index reporting a nearly 5% year-over-year increase through September 2024.

1801 Century Park East, Suite 2150 Los Angeles, California 90067 (310) 553-5551Inflation data is trending lower, providing relief to policymakers and consumers. The September 2024 Consumer Price Index (CPI) reading showed a 2.4% year-over-year increase, down from earlier highs but still slightly above the Federal Reserve’s 2% target. The Fed is optimistic that inflation will continue to moderate, projecting its preferred inflation gauge, the Personal Consumption Expenditure (PCE) index, will fall to 2.3% by the end of 2024 and 2.1% by the end of 2025.

However, the Federal Reserve must remain cautious in its approach to monetary policy, as history shows the risks of cutting rates too aggressively. Chairman Arthur Burns, during the Nixon administration, abandoned monetary discipline to boost the economy, leading to a resurgence of inflation. Similarly, Paul Volcker’s initial attempts to combat inflation were followed by a premature pullback, contributing to a recession. These historical examples remind the Fed to strike a careful balance in its rate-cutting strategy to avoid reigniting inflation.

Looking ahead, automobile sales are expected to pick up later in the year, particularly after the U.S. presidential election. Car buyers are waiting to see how potential changes in tax policy and subsidies for new car purchases will impact the market. Cox Automotive forecasts 15.7 million vehicle sales for 2024.

Oil prices have remained under pressure despite tensions in the Middle East and threats to Iranian oil fields. OPEC+ plans to increase production in December, which, coupled with soft demand from China, has kept prices in check. West Texas Intermediate (WTI) Crude is relatively flat year-to-date, now at $74 per barrel. Despite geopolitical risks, the oil market finds little support as global supply remains ample and demand subdued.

The Eurozone is expected to see modest growth in 2024. S&P Global projects Eurozone GDP growth of 0.8%, with stronger growth in Spain and France offsetting weaker performance in Germany. Looking ahead to 2025, Eurozone growth is projected to improve to 1.3%. Consumer spending and business investment are expected to drive growth, as real income growth accelerates, inflation perceptions improve, and interest rates decline. Inflation in the Eurozone is estimated to be 2.5% for 2024.

In China, growth is slowing, with GDP growth estimated at 4.8% for 2024, missing the government’s target of 5%. The Chinese government is relying on monetary stimulus, including lower borrowing rates and increased access to credit, to turn the economy around. However, the global impact of China’s economic slowdown is apparent, as its rising tide of cheap exports leads to heightened trade tensions. More tariff barriers are being erected to limit the influx of Chinese goods, and U.S. importers are diversifying away from China, whose share of U.S. imports has dropped from 21% in 2018 to 15% today.

Geopolitical risks, particularly in the Middle East, and domestic political uncertainty as the U.S. election approaches add complexity to the economic outlook. While the U.S. economy has proven resilient, navigating the path forward requires careful attention to both domestic and international developments.

THE STOCK MARKET: RALLIES CONTINUE AMID ECONOMIC OPTIMISM

The third quarter of 2024 saw strong performance for the U.S. stock market, building on momentum from the first half of the year. Major indices posted solid gains, reflecting resilient economic conditions, moderating inflation, and positive investor sentiment. Despite debates around high valuations and the uncertain path of interest rates, equities continued to perform well, driven largely by advancements in the technology sector and steady corporate earnings growth.

The S&P 500 Index rose by 6% during the quarter, boosting its year-to-date gain to 22%. The Dow Jones Industrial Average gained 3%, while the Nasdaq Composite surged by 8%. The technology sector has been a key driver, particularly companies involved in accelerated computing and generative artificial intelligence.

In addition to technology, companies focused on health and wellness have performed well, particularly those involved in weight-loss treatments. The broad-based rally reflects investor confidence in the resilience of the U.S. economy, even as interest rates and inflation remain important factors to watch.

During the third quarter, HDA rebalanced its portfolios to increase exposure to technology stocks while trimming positions in consumer staples. New investments included shares in a leading national discount retailer and a prominent artificial intelligence firm. HDA divested a national freight trucking company and reduced holdings in a global fast-food chain and an international beverage manufacturer. These moves reflect a strategic shift toward sectors with strong growth potential.

As of the end of the quarter, HDA’s asset allocation consists of: cash and cash equivalents — 1%; municipal bonds — 7%; corporate bonds — 7%; equity mutual funds – 11%; common stocks — 59%; real estate – 13%; and unit investment trusts – 2%.

Looking ahead, the stock market will likely continue to be influenced by key economic indicators, including inflation data and Federal Reserve policy. The S&P 500 is currently trading at a forward price-to-earnings (P/E) ratio of 21x based on 2025 earnings estimates, somewhat elevated but supported by strong earnings growth projections. Corporate earnings guidance during the upcoming earnings season will shape investor expectations for the remainder of 2024 and into 2025. While risks remain, HDA remains cautiously optimistic for the rest of the year, focusing on sectors driven by technology and innovation.

THE BOND MARKET: FALLING YIELDS AND FED RATE CUTS

The Federal Reserve’s recent interest rate cuts have significantly impacted the bond market, driving yields lower across corporate and municipal bonds. The tighter spreads present challenges for yield-seeking investors, but HDA has adapted its strategy to focus on shorter- duration instruments. By concentrating on money-market funds and short-term Treasury notes with yields ranging between 4.5%-5%, HDA has managed duration risk while capitalizing on favorable market conditions.
Although inflation is trending lower and economic growth remains solid, geopolitical risks, potential shifts in Federal Reserve policy, and fluctuating commodity prices underscore the need for a cautious approach to bond market investing. As yields continue to fall, HDA will remain vigilant, adjusting its fixed-income portfolio as necessary.

REAL ESTATE: LOWER INTEREST RATES TO BOOST ACTIVITY

Higher interest rates over the past few years have sidelined many buyers, leading to sluggish mortgage activity and low inventory levels. However, lower rates are expected to stimulate commercial transactions, prompting buyers and sellers who have been waiting for better conditions to reenter the market. This may lead to more transactions, but a backlog of inventory suggests that prices will remain stable as increased supply balances out demand.

The residential market is anticipated to follow a similar trend. Lower interest rates should boost transaction volume as buyers and sellers take advantage of improved affordability. While the fourth quarter is typically the slowest period, the rate cuts could incentivize homeowners to sell and attract buyers seeking better affordability. If more homes come onto the market, we may see a modest surge in activity, but prices are expected to remain stable.

SUMMARY AND CONCLUSION

The U.S. economy remains resilient, buoyed by solid consumer spending, a strong labor market, and interest rate reductions from the Federal Reserve. HDA expects continued growth in the stock market, supported by technology and innovation-driven sectors, while bond yields become less attractive as rates fall. Real estate activity is anticipated to pick up, particularly in light of lower interest rates, although price stability remains a key factor. HDA will continue to monitor economic developments closely and adjust its strategies to ensure clients’ portfolios are well-positioned for future growth.

CLIENT REFERRALS

As always, we are grateful for the new business referrals we continue to receive from our clients. If you know someone who may benefit from this investment newsletter, please contact Doreen at (310) 553-5551 or dferritto@hdainvest.com.

Harold A. Davidson, DBA Craig E. Farkas, CFP Vick Khoboyan
President Vice President Senior Portfolio Manager

“‘Economic Outlook & Investment Perspective’ is designed to serve as a regular forum for the discussion of pertinent
economic and market issues that are of concern to individual investors. However, this newsletter is not, and under
no circumstances is to be construed as giving financial or investment advice and/or as an offer to sell any
securities. Harold Davidson & Associates, Inc. and its officers and employees may have an interest in some or all
of the investments, industries or securities, mentioned herein. The information set forth herein has been derived
from sources believed to be reliable, but is not guaranteed as to accuracy and does not purport to be a complete
analysis of the investment, industry or security involved.”