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3 Risks to the U.S. Economy in 2024

Aug 9, 2023

The economy’s resilience is keeping investors bullish on U.S. stocks. It may be time to prepare for a less favorable scenario.

Author
Lisa Shalett
Lisa Shalett

Key Takeaways

  • Historically high stock valuations reflect investors’ bullish outlook on the U.S. economy.
  • However, favorable trends in consumer spending, financial liquidity and fiscal policy could recede next year.
  • Investors should remain cautious about high equity valuations and prepare for interest rates to stay higher for a while.

Throughout 2023, the U.S. economy has stayed resilient in the face of rapid monetary policy tightening, with solid consumer demand and an unflinching labor market. This has stoked investor confidence and helped the S&P 500 Index regain almost all of its 2022 losses. But are these conditions sustainable?

 

Equity investors seem to think so. Today’s historically high stock valuations reflect a bullishness that leaves little room for any risk to the prospect of a “soft landing,” in which economic growth slows and inflation cools without a recession. In this optimistic scenario, market pricing suggests the Fed will cut interest rates by at least 125 basis points in 2024 while corporate profit growth reaccelerates. In other words, equity investors are not anticipating a recession or an earnings slump – just a new bull market.

 

However, we believe risks to this scenario remain. The factors driving the continued resilience of the economy in 2023 may be exactly what undermines growth in 2024 as certain favorable economic trends start to unwind.  

  1. 1
    Robust consumer spending may decline.

    Households built up sizable cash piles during the pandemic thanks in part to government stimulus, but those reserves are dwindling. Economists now estimate household savings to be around $350 billion, which could run out by the first quarter of 2024. This coincides with the reinstatement of student loan payments, which may dampen spending, and an aggressive build-up of credit card balances, with interest costs that have soared to historical highs of more than 20%.

  2. 2
    Cash could be in short supply.

    Although the Federal Reserve has increased rates over the last year in an effort to tame inflation, financial conditions have remained relatively loose, with companies generally able to raise the capital they need. But as the U.S. Treasury restocks its cash reserves, it is likely to issue as much as $1 trillion in debt by the end of 2023’s third quarter. This would drain liquidity from the financial system, making it harder for companies and consumers to borrow. In addition, the Bank of Japan’s recent move to allow the country’s interest rates to rise more freely could drive significant new investment in Japanese government securities and divert potential buyers of U.S. Treasuries, further draining liquidity in the U.S. 

  3. 3
    Fiscal spending could decelerate.

    Government spending has been a key driver of economic growth recently. However, major spending programs, such as the CHIPS and Science Act and the Infrastructure Investment and Jobs Act, are heavily front-loaded, meaning the economic benefits of such fiscal largesse may recede in 2024. What’s more, the recent downgrade of U.S. government debt by rating agency Fitch suggests future government spending and debt proposals may face greater scrutiny.

With these risks, not to mention the potential for interest rates to stay higher for longer given economic strength, investors should remain cautious. In particular, be alert to high equity valuations and consider trimming exposure to the most highly valued stocks. Instead, seek out those with “growth at a reasonable price” or value-style attributes that seem likely to achieve earnings targets.

 

This article is based on Lisa Shalett’s Global Investment Committee Weekly report from August 7, 2023, “Is the 2024 Bull Case Priced?” Ask your Morgan Stanley Financial Advisor for a copy. Listen to the audiocast based on this report.

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Index Definitions

S&P 500 Index: The Standard & Poor's (S&P) 500 Index tracks the performance of 500 widely held, large-capitalization US stocks.

Risk Considerations

Equity securities may fluctuate in response to news on companies, industries, market conditions and general economic environment.

The value of fixed income securities will fluctuate and, upon a sale, may be worth more or less than their original cost or maturity value. Bonds are subject to interest rate risk, call risk, reinvestment risk, liquidity risk, and credit risk of the issuer.

High yield bonds (bonds rated below investment grade) may have speculative characteristics and present significant risks beyond those of other securities, including greater credit risk, price volatility, and limited liquidity in the secondary market. High yield bonds should comprise only a limited portion of a balanced portfolio.

Companies paying dividends can reduce or cut payouts at any time.

Asset allocation and diversification do not assure a profit or protect against loss in declining financial markets.

Investing in small- to medium-sized companies entails special risks, such as limited product lines, markets and financial resources, and greater volatility than securities of larger, more established companies.

Because of their narrow focus, sector investments tend to be more volatile than investments that diversify across many sectors and companies. Technology stocks may be especially volatile. Risks applicable to companies in the energy and natural resources sectors include commodity pricing risk, supply and demand risk, depletion risk and exploration risk. Health care sector stocks are subject to government regulation, as well as government approval of products and services, which can significantly impact price and availability, and which can also be significantly affected by rapid obsolescence and patent expirations.

The indices are unmanaged. An investor cannot invest directly in an index. They are shown for illustrative purposes only and do not represent the performance of any specific investment.

The indices selected by Morgan Stanley Wealth Management to measure performance are representative of broad asset classes.  Morgan Stanley Wealth Management retains the right to change representative indices at any time.

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