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February 2024 Market & Economic Outlook and Commentary



InfraCap Management, New York ~ The team at Infrastructure Capital Advisors has completed our new report providing key insights on current market conditions and economic outlook for this month and the coming months. See this month's full report below but be sure to JOIN our Monthly Market & Economic Outlook Webinar scheduled for Thursday, February 8th at 1:30 pm ET where Jay Hatfield, CEO/CIO and portfolio manager will provide even more recent updates and insights to this report and the changing market and economy. Not registered for the webinar already? Click here to register. Also, by registering, we will send you a webinar playback video link if you are unable to join live.


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Monthly Economic Outlook Commentary

Summary of Recent Research & Critical Insights Outlook:

A. The First Half of 2024 to be Dominated by a Global Roll Down (Base Effects) of Inflation.

  • We forecast that US PCE Core for January released next month will roll down to 2.6% (.51% rolling off from 2023), and February will likely further roll down to approximately 2.4%.

  • The roll down to below 2.5% in February sets the stage for a Fed rate cut, although we expect the Fed to be conservative after the “transitory” debacle.

  • The Fed’s statement and Powell’s presser validated our view that rate cuts are coming but not likely until May or June.

    • Of the Fed starts cutting in June and cuts every subsequent 2024 meeting that would result in 5 total cuts, which is our base case- 70% probability.

    • We estimate a 30% probability of a May 1st rate cut.

    • We believe that there is a less than a 10% probability of a March rate cut vs. the market at 47%. It is important to note that the Fed has a bias toward being conservative as it believes in the “expectations” theory of inflation and due to their “transitory” inflation call.

B. 2024 is likely to be defined by a huge wave of global central bank rate cuts driven by a dramatic rolldown of global inflation in the first half of the year.

We currently project 5-6 ECB cuts and only 5 Fed cuts. These rate cuts and associated increases in the Global Monetary Base (www.infracapfunds.com ) are likely to propel the market to at least 5,500 by year-end 2024 and drive 10-year treasury rates into the 3-3.5% range. We believe that interest-sensitive sectors will outperform in 2024 as these rate cuts occur. In our view, the sectors that benefit the most from that are:

  • The financial sector, broadly defined, includes preferred stocks, financials and REITS.

  • Within the financial sector, global investment banks, such as GS and MS, are likely to lead the sector as investment banking is very likely to boom in 2024 due to low volatility, lower rates, and rising stock prices.

  • Small-cap stocks are very cheap, particularly in the value sector, which has significant concentration in interest rate-sensitive sectors such as REITs, financials and utilities.

C. Euro Zone has stalled and likely to enter a recession

Our biggest contrarian call is that the Euro Zone has stalled and is likely to enter a recession with Euro Zone GDP Growth coming in at 0% for the fourth quarter and with last quarter’s GDP down .4%.

The ECB is far too optimistic about 2024 GDP growth with an estimate of positive .8% based on a projected resurgence in consumer spending, and the ECB is way too pessimistic about inflation with Y/Y likely to decline well below 2% (See Below). It is important to note that 45% of European mortgages are floating with the recent ECB rate increases yet to fully impact the consumer.

  • Euro Zone PMI’s continue to be very weak with January Composite coming in at 47.9, indicating a contraction.

  • We forecast that Euro Zone inflation will continue to decelerate rapidly:

    • For the last 8 months headline inflation has only risen .8% so over the next 4 months 2.1% of the 2.9% y/y increase will roll off, resulting in a year-over-year increase as low as 1.6% and a CPI Core at or very close to the ECB target of 2% after the April release setting up an ECB rate cut on June 6th.

    • Declining inflation and the potential onset of a recession in the Euro Zone, particularly in already declining Germany, will force the ECB to cut rates in the first half of 2024. If the ECB cuts 25bp at every policy meeting, there would be only 5 cuts in 2024 but they may be forced to cut by 50bp due to the likely recession.

    • Germany is already in a recession with a negative 1.2% change in GDP for the fourth quarter and a .4% decline over the last year with retail sales plunging, down 2.5% in November and negative 2.0% year over year. Construction spending, a critical leading indicator of recessions, is plummeting with the construction PMI well below 40 and housing prices down 10% over the last year.

D. Why Our Optimistic View has Differed from the Fed and Most Strategists:

  • The Global Money Supply Matters

  • Most strategists believe corporate earnings growth is dependent on margin expansion and high nominal GDP growth.

    • More than 100% of earnings growth comes from the reinvestment of retained earnings and depreciation and not margin expansion or GDP growth. If businesses do not continue to invest, earnings will stagnate and eventually decline. This dynamic of retained earnings investment driving earnings growth is required by law with regulated utilities but also holds with almost all businesses.

    • Normal US earnings growth is approximately 10% which is driven by a 70% earnings retention and a 15% after-tax return on investment.

    • Historical stock price returns are close to 10% and driven almost exclusively by earnings growth.

    • If strategists don’t believe consensus aggregate earnings estimates they should specify which companies are going to miss and why. The Dow can be used as a proxy for the S&P as it is 30% of the market cap of the S&P, is 95% correlated with the S&P, and has an earnings multiple within one point of the S&P 500.

E. The US Economy Will Continue to Be Resilient in 2024:

  • 11 out of the last 12 recessions were precipitated by a collapse in the housing sector. We have been forecasting for the last two years that the US economy would not go into a recession due to the shortage of housing in the US. We are projecting solid growth in GDP of 2% in 2024 with some headwinds from tight Fed policy causing the economy to grow below the trend growth rate of 3%.

  • A decline in personal consumption has never caused a US recession. Consumer spending is 95% driven by employment and wages. Consumer spending only declines when the decline in investment spending on housing and other durables leads to mass layoffs, which causes consumers to reduce spending.

    • The average post-WWII recession had over a 10% decline in investment but personal consumption was on average flat.

 

Monthly Economic Outlook Commentary

Bond Market Outlook:

We project that 2024 will be the Year of Global Rate Cuts.  The futures market in all major economies imply an unprecedented number and magnitude of rate cuts.  The global rate cuts are likely to drive the 10-year Treasury rate into the 3-3.5% range. 

 

  • ECB implied rate cuts are currently approximately 5 (131BP)

    • Euro Zone GDP Now implying a 0.8% recession in Q4

    •  CPI data in the Euro Zone is likely to cool dramatically over the next 4 months due to base effects.

    •  Every OECD country except Japan is projected to cut rates with the average cut well over 1%.

    •  The US has 5 rate cuts priced in which was partially validated by the Fed dot plot implying 3 rate cuts.  The Fed pivot marks the first time since the Pandemic started that the Fed has responded appropriately to real time data.

    •  The Fed is likely to be slower to cut than most central banks as the US economy is stronger than most and the Fed still believes in the Urban Myth that 70s inflation was caused by starts and stops in monetary tightening while ignoring the 1200% rise in energy prices as the key culprit.

    • Smaller central banks such as Hungary and Chile are already cutting rates.

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Monthly Bond Market Outlook and Commentary

Stock Market Outlook:

We are bullish on the market for 2024 and have established our target on the S&P of 5,500 based on 20.5x the 2025 EPS consensus estimate of $270, which assumes a 10-year treasury rate of 3.5% to justify the 20.5x multiple. We believe that central banks will ease in 2024, led by the ECB as Europe has already entered a recession. We project that lower long term global interest rates, a resilient US economy, and the ongoing AI boom will drive the S&P to our target by year-end 2024.

  • The Stock Market May Stall Out at the 5,000 level Until the Fed Actually Cuts Rates:

    • The Fed is likely to be conservative about the timing of interest rate cuts after the “transitory” debacle.

    • The 10-year is likely to stabilize in the 4% area until rate cuts are implemented and the global monetary base starts to expand.

    • We are through with the bulk of important earnings reports, which were a positive catalyst.

  • Many forecasters are too bearish about the consensus implied earnings growth rate of 10% as they fail to recognize that all aggregate earnings growth comes from the reinvestment of retained earnings and depreciation and is not driven by margin expansion or dependent on high GDP growth. The normal S&P earnings growth rate is over 10% as a 70% of earnings are retained and reinvested at approximately at 15% after tax rate.

    • Corporate savings represents almost 75% of gross domestic savings in the US.

  • We expect the US economy to be resilient in 2024 with the shortage of homes in the US causing the housing sector to hold up. Housing crashes are almost always the key driver of recessions.

  • We expect that in a falling interest rate environment, financial related sectors, including preferred stocks, bank stocks and REITs as financial related stocks are well below fair value due to rising rates and a volatile stock market in 2023. These asset classes are likely to outperform in 2024 on a risk adjusted basis as global interest rates decline.

    • The S&P 500 High Dividend Index is trading at only 11X 2024 Earnings and yields over 5%.

      • We launched our InfraCap Small Cap Income fund (SCAP) on NYSE in Q4 2023 and we believe that small cap value stocks are undervalued trading at only 14.2X 2024 earnings vs. a historical average 0f 17x.

      • We believe that investors should consider investing in fixed-to-floating rate preferred such as SCE J – currently yielding 6.15% but converts to a 9.45% yield in September of 2025 (noting this is held in the registered investment company we manage, the Virtus InfraCap US Preferred Stock ETF, PFFA).

    • In our view, Financials and REITs are undervalued and we believe MS, AB and BXP as companies likely to benefit from lower rates in 2024. (noting this is held in the registered investment companies (InfraCap Equity Income ETF (ICAP) and InfraCap Small Cap Income ETF (SCAP), and private accounts.


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Monthly Stock Market Outlook Commentary

Fed and ECB Outlook:

We expect CPI/PPI to continue to print cool as the over 15% plunge in gasoline prices since the beginning of October will gradually bleed into core. There is a 5% bleed through of energy prices to core. The most obvious examples are airline fares and food prices as both have a 40% energy cost component.

  • Energy represents almost 9% of lower income household expenses, which means a 20% drop in energy costs will boost consumer spending and ensure that the US does not enter a recession.

  • The Fed does not understand the energy bleed through effect which is why it has developed a whole body of urban mythology about the inflation of the 70’s when actually 90% of the problem was a catastrophic 1,200% (not a typo) increase in oil prices. The oil price explosion was exacerbated by draconian price caps on US production.

    • The Fed meeting will be critical for the market with all the focus on the SEP (dot plot). The last dot plot had 1 rate cut implied whereas the fed fund futures imply almost 5 rate cuts, setting up the potential for a disappointment given a Fed biased toward being hawkish given their focus on the discredited “expectations” theory of inflation.

  • The Bank of England has launched an inquiry led by Ben Bernanke to determine what went wrong with the central bank’s policy framework that led it to miss the surge in inflation.

    • The Fed should launch a similar inquiry and revise their policy framework as it raised rates 3 months after the BOE so was even more incompetent than the BOE.

  • The Fed should change its policy framework by targeting a 2-4% range of inflation and look at a variety of measures of inflation including both headline and core for PPI, CPI, PCE and CPI-R and be more attentive to leading indicators of inflation such as the money supply, housing prices, auto prices and energy/commodity prices.

  • Learn more about our investing strategy.

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Monthly Bond Market Outlook and Commentary

Commodity Outlook:

We maintain our $75-95 range estimate for oil in 2024 as continued production constraint from OPEC+ and steady demand growth support the price.

 

  • Middle east war providing only modest support to the oil market. 

  • We attribute the recent weakness to seasonal/weather factors partially offset by uncertainty created by Houthis attack on Red Sea shipping lanes.

    • December of 2023 was the warmest in 150 years.

  • China’s Economy is Way More Resilient Than Perceived which Benefits Commodities:

  •  China is the only major global economy that is loosening monetary policy.  China increased its monetary base over $140 billion in September representing a 2.9% increase vs. a $300 billion drop in the Global Monetary Base.

    • China is projected to grow by 5% this year.

    •  China saves 45% of GDP vs. less than 20% in the US, which results in much higher long-term growth as the critical driver of economic growth is savings and investment.

    •  The property crisis is a concern, but if it starts to generate contagion, the central government is likely to intervene.

    •  The China recovery story is bullish for global commodities and growth.

  • The utopian vision of an all-electric economy The utopian vision of an all-electric economy has now completely imploded as average consumers have limited interest in all electric autos, and renewables development falters due to nimby opposition to offshore wind and massive cost over runs.  Europe’s failed energy transition is likely to exacerbate a recession and lead to regime change in many countries.

  • The failed attempt to push an all-electric vision has hurt the environment as there was less focus on hybrid electric cars and using natural gas to supplant coal.

 
Monthly Bond Market Outlook and Commentary

QUICK TIP:

The key to national economic growth is competitive corporate tax rates as corporations are the key driver of economic growth and earnings growth is fueled by after tax corporate earnings. High corporate tax rates encourage corporations to relocate operations to lower tax countries and reduce after-tax corporate earnings.



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