Why We Think the U.S. Economy Will Face a Slowdown in 2024
Views You Can Use: After helping keep a recession at bay last year, consumers may be running out of steam.
Key Takeaways
While recession doesn’t seem as likely as it once did, we believe the economy is still on track for a sharp slowdown.
The consumer spending spree that fueled surprisingly robust economic growth in 2023 may lose its gusto in 2024.
As economic growth fades, we think investors should consider higher-quality and more defensive securities and strategies.
Consumers are essential to economic growth, accounting for nearly 70% of the nation’s gross domestic product (GDP). Ongoing consumer spending and robust government expenditures kept the U.S. economy recession-proof in 2023. But recent data and historical trends suggest the consumer spending spree may sputter in 2024, ultimately slowing the economy.
Consumer Spending Showed Signs of Cooling
Holiday retail sales provide an important gauge of how much consumers are spending and what they’re buying. In 2023, total sales increased 3.1% compared with 2022.1 This final tally was lower than consensus predictions of 3.7% and considerably lower than in 2022 when year-over-year holiday sales were up 7.8%.
Although 2023 holiday spending increased from 2022, consumers focused more on practical items, including food and clothing, and less on higher-priced electronics and jewelry. For example, grocery and apparel spending was up 2.1% and 2.4%, respectively, while spending on electronics and jewelry was down 0.4% and 2%, respectively.
Surge Typically Occurs Before an Economic Downturn
Consumer spending has grown in the two quarters before every recessionary period since the 1960s.2 Consumer consumption was also the main driver of GDP growth during each two-quarter interval.
In the eight pre-recessionary periods spanning 1960 to 2009, the economy expanded by an average of 1.4%. Everyday spending made up about 1.1% of this growth, while private fixed investment contributed 0.3%. Private fixed investment refers to spending by individuals and businesses on durable goods and capital assets expected to provide long-term benefits, including equipment and buildings.
Today’s economic cycle generally tracks historical trends, but there’s a noteworthy difference. Private investment has stayed strong, thanks largely to a robust housing market. Unlike in the past, when housing tended to slow down economic growth, today’s housing market has actually contributed to GDP.
Consumers Face Mounting Headwinds
We believe several factors will weigh on consumer spending over the next several months:
Depleted savings. In general, consumers have depleted any excess savings accumulated during the pandemic. Today’s personal savings rate stands at pre-COVID levels, and forecasters expect the savings rate to remain flat through 2024.3
Weakening employment. Services industry employment gauges dropped sharply in December, slipping nearly 4 percentage points into negative territory and the lowest level since August 2020. Employment gauges in the manufacturing sector have steadily declined since March 2022 and remained negative at the end of 2023.
Sharply higher prices. Three years of above-trend inflation broadly pushed consumer prices up more than 17% through December.4 Meanwhile, auto loan and mortgage loan rates have hovered at or near multiyear highs, while prices for cars and homes have climbed. In addition, the student loan repayment freeze expired last year, meaning higher monthly payment obligations for 27 million federal student loan holders.5
Monetary policy lag. The economy hasn’t yet felt the full impact of the Federal Reserve’s (Fed’s) aggressive rate-hike campaign. Between March 2022 and July 2023, the Fed lifted interest rates by 5.25 percentage points. It can take up to 18 months for the economy to absorb the effects of each rate hike. We expect the remaining impact to unfold within the next several months, putting additional pressure on consumers.
Economy Should Weaken by Midyear
We believe these financial burdens will affect consumer spending and eventually stifle GDP. For these reasons, we put the odds of a slowdown (recession or below-trend growth) sharply higher than stagflation or a “Goldilocks” scenario.
Slowdown: We expect growth to slow to a below-trend pace (flat to slightly positive) that persists for several quarters. We also believe a recession is still possible, though not as likely as anemic growth. We expect the Fed to start cutting rates once the slowdown is evident.
Stagflation: We believe a backdrop of high inflation, Fed tightening and sluggish economic growth is unlikely.
Goldilocks: A scenario in which inflation drops to 2% or lower, the Fed quickly eases and the economy thrives is a longshot in our view.
What Does a Slowdown Mean for Investors?
As the economy slows, U.S. Treasury yields likely will fall. We also expect credit spreads to widen. We still expect core inflation (excludes food and energy prices) to remain higher than the Fed’s 2% target due to:
Continued pressure on the services component of the Consumer Price Index (CPI), mainly from rising wages and elevated shelter (rent and owner’s equivalent rent) costs.
The ongoing repositioning and rerouting of global supply chains and the onshoring of production.
Still-high energy and agricultural (food) prices caused by geopolitical tensions and deglobalization trends.
Slowdown: Potential Investment Implications
Fixed Income
In a slowdown, investors should consider:
Increasing duration exposure. Diversified strategies with longer durations may potentially offer performance advantages as rates decline.
Staying high in credit quality. In addition to delivering diversification to investor portfolios, a modest allocation to high-quality investment-grade credit may now provide more attractive yields. However, we believe credit selection is critical to avoid weaker, economically sensitive issuers.
Maintaining inflation protection. We believe inflation strategies still appear attractive, given that inflation expectations remain higher than average.
Equities and Real Assets
In a slowdown, investors should consider:
Emphasizing quality stocks. Quality companies with higher profitability and healthy balance sheets may offer attractive potential. Investors tend to favor quality companies in more defensive sectors, such as utilities, health care and consumer staples. Additionally, we think dividend-paying stocks look attractive for the stability of income they generally provide.
Looking to sustainable growth. Companies with dependable, sustainable earnings growth have tended to outperform during economic slowdowns. Economically sensitive value sectors, such as financials, industrials and energy, have tended to lag alongside lowered growth expectations.
Treading carefully in the commodities market. As consumer and industrial demand wanes, commodities typically lose their luster. However, we believe gold may continue to shine amid falling interest rates and heightened economic and market uncertainty.
Limiting exposure to real estate stocks. Real estate investment trusts (REITs) have tended to lag as poor economic conditions weigh on residential and commercial real estate markets.
What Does Stagflation Mean for Investors?
In our view, stagflation would push the 10-year Treasury yield higher amid significant volatility as below-trend growth and high inflation collide. We also believe the two-year Treasury yield would increase as the Fed continues to tighten financial conditions. Meanwhile, credit spreads may widen amid weaker economic growth, particularly in the high-yield sector.
Stagflation: Potential Investment Implications
Fixed Income
If stagflation takes hold, investors should consider:
Maintaining inflation protection. We believe inflation-protection securities, particularly with short durations, are attractive as rates rise and inflation remains elevated.
Focusing on quality credits. Higher-quality short-duration strategies may offer benefits if yield outweighs the effects of spread widening. We believe a focus on credit quality will be important, given the pressures on corporate fundamentals from inflation, rising rates and muted growth.
Equities and Real Assets
If stagflation takes hold, investors should consider:
Focusing on traditional value sectors. The energy and basic materials sectors typically have benefited from higher commodity prices. Utilities generally have provided dependable cash flows and dividends during economic slowdowns despite higher inflation and interest rates.
Favoring quality stocks. In this challenging environment, we believe higher-quality companies with less debt, higher profit margins and reliable cash flows from operations should hold up better. We expect the market to reward firms with pricing power and unique competitive advantages.
Gauging commodities. Historically, commodities have provided high average returns during periods of elevated and rising inflation. However, we believe astute management is required because geopolitics and supply chain issues may heavily influence performance.
Limiting exposure to real estate. REITs may underperform their long-term averages as mortgage rates rise and the housing market slows.
What Does a Goldilocks Scenario Mean for Investors?
If inflation quickly drops to target or below-target levels and the Fed eases monetary policy, Treasury market volatility likely will subside. We would expect Treasury yields and mortgage rates to decline, credit spreads to tighten and the economy to expand at trend or above-trend rates.
Goldilocks: Potential Investment Implications
Fixed Income
In a Goldilocks economy, investors should consider:
Evaluating higher-risk bonds. We believe credit-sensitive securities may offer outperformance potential, particularly high-yield bonds and bank loans, which historically have benefited during economic expansions.
Focusing on nimble duration management. Modest growth, lower inflation and a Fed pivot suggest active duration management may be warranted as markets and rates adjust to the changing backdrop.
Reduce inflation exposure. As inflation subsides, we believe nominal Treasuries may offer better performance potential than Treasury inflation-protected securities (TIPS).
Equities and Real Assets
In a Goldilocks economy, investors should consider:
Looking to growth stocks. Pro-cyclical, growth-oriented sectors historically have outperformed in lower-rate, strong-demand environments. This has been particularly evident in the information technology and communication services sectors, where revenues rely on capital expenditures and advertising spending.
Assessing cyclical sectors, small-caps. Economically sensitive holdings like banks and consumer discretionary and industrial stocks tend to benefit from increased economic activity. Investors typically focus less on fundamentals, such as quality cash flows, in favor of market beta, at least initially. Small-cap stocks could also offer appeal.
Allocating to REITs. We expect REITs to outperform as the housing market recovers. Additionally, lower interest rates typically boost the attractiveness of REIT yields.
Limiting exposure to certain commodities. We believe industrial metals and other pro-cyclical commodities may outperform as economic activity and demand pick up. However, softer inflation correlates with lower prices for energy and food.
Bottom Line: Consider the Impacts of a Slowing Economy and Inflation on Portfolio Allocations
Even in our base-case slowdown scenario, we believe inflation will remain challenging. In our view, inflation ultimately will settle higher than the Fed’s target.
Persistent, higher-than-normal inflation can erode investors’ spending power over time. That’s why we believe inflation-protection strategies should be core components in fixed-income allocations.
Elsewhere, we believe investors should consider tactical allocations to interest rate and credit sensitivity, given the uncertain growth outlook. Remaining nimble may be the best tactic among credit-sensitive securities, offering opportunities to potentially capture yield advantages across various economic scenarios.
We believe focusing on quality in equities and real assets will be crucial over the next several months. In our view, companies that can pass on costs to consumers should be able to protect margins from wage and input cost inflation.
More broadly, emphasizing quality should also help investors navigate a flat or recessionary economy. In general, quality companies — those with healthy balance sheets, higher profitability and more stable cash flows — tend to offer attractive performance potential in economic downturns.
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Mastercard, “Mastercard Spending Pulse: U.S. Retail Sales Grew +3.1% This Holiday Season,” News Release, December 26, 2023.
Federal Reserve Bank of Dallas, data from 7/1/1960–12/31/2023.
FactSet.
Consumer Price Index, data from 1/1/2021–12/31/2023.
TransUnion, “Implications of the End of Pandemic-Era Student Loan Forbearance,” July 2023. Data as of 5/31/2023.
Past performance is no guarantee of future results. Investment returns will fluctuate and it is possible to lose money.
The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.
Investments in fixed income securities are subject to the risks associated with debt securities including credit, price and interest rate risk.
In certain interest rate environments, such as when real interest rates are rising faster than nominal interest rates, inflation-protected securities with similar durations may experience greater losses than other fixed income securities. Interest payments on inflation-protected debt securities will fluctuate as the principal and/or interest is adjusted for inflation and can be unpredictable.
Generally, as interest rates rise, the value of the bonds held in the fund will decline. The opposite is true when interest rates decline.
Diversification does not assure a profit nor does it protect against loss of principal.