ECONOMICECONOMIC&&MARKET
MARKETOUTLOOKOUTLOOK SEPTEMBERDECEMBER 2023

Choose yourown adventure
Assessing investors’ economic
and market path ahead
Executive summary• While the key economic debates facing investors havenot changed since last year, much in the economy has.
Investors should take note.
• Recession is a matter of when, not how, the cycle
plays out. And though many investors have expressedthat this cycle feels slower than others, based on historical
Fed hiking cycles we are right on time. Tighter policy isstraining many economic sectors already. Profit margins,
the consumer sector, and the labor market are next.
• Regardless of investors’ economic view for the year
ahead, the changes already seen support allocation
adjustments for the year ahead.

Global Market Strategy
at New York Life Investments
Our team of market strategists connects macroeconomics
to asset allocation. Leveraging proprietary researchalongside the breadth and depth of the New York Life
Investments platform, we provide actionable insight into
market-driving events, structural themes, and portfolio
construction to empower investment decision-making.

Lauren Goodwin

Julia Hermann

Michael LoGalbo

Chief Market Strategist

Multi-asset Strategist

Multi-asset Strategist

Introduction
In reading the economic and market outlooks for 2024, investors could beforgiven for feeling “déjà vu all over again.” The very same debates crisscrossing
investment outlooks for 2023 — the Fed’s aggressive interest rate hikes, market
volatility, concerns about recession — are little changed.
But for the investment landscape, much has changed.
The impact of the Fed’s hiking cycle has taken a meaningful toll on interest ratesensitive, liquidity-sensitive, manufacturing, and services sectors, following thetypical path from policy tightening to recession. The factors still going strong —the consumer and the labor market — are historically lagging indicators and tell
us very little about the path of the economy ahead.
Investors would also be reasonable to say that this economic cycle feels long.
Comments about “the most telegraphed recession” can be heard from every
corner of the proverbial marketplace.
In fact, we’re right on time. The Fed is now at the tail end of the most aggressive
monetary policy tightening cycle ever. But a faster pace of hikes doesn’tnecessarily mean that those impacts are felt more quickly in the economy.
Historically, interest rate hikes have taken roughly 12 to 18 months to impact
the economy, and 18 to 24 months to impact the labor market. That experienceis holding today.
And so the evolution of data makes us feel confident: an economic slowdown
is already happening, and a recession is on the way. But alongside our sober
economic outlook, we must acknowledge what the past four years haveconsistently shown us: the market has surprises up its sleeve. It’s nice tobe right, but better to be prepared.
In this piece, we defend our long-held view that recession is inevitable byillustrating where the economy has changed, where it hasn’t, and why thatmakes us feel confident about where it’s headed. We then share a playbook
for our most likely scenario — alongside concrete allocation ideas for key risks.

What has changed?
While the key economic debates facing investors have not changed, much in the economy has. Since the
Fed started raising interest rates in March 2022, overall U.S. financing costs have become prohibitively
expensive. Most recently, the U.S. 10-year Treasury yield pushed to 15-year highs. These tighter financial
conditions have had their intended effect, with inflation cooling meaningfully, though not yet durably. Interest
rate-sensitive sectors such as housing and manufacturing have clearly reacted, the first data to falter in thestandard pattern of an economic slowdown.

Ten-year yield took a towering turn

The cost climb has cooledFirst Fed hikeFirst Fed hike
9

4.5

8

Inflation

Y/y (%)

Yield (%)

4
3.5
3

7
6
5

U.S. 10-year yield

4

2.5

3

2

2
1.5
Jan
2022

May
Sep
March 2022

Jan
2023

May

Sep

Jan
2022

Housing hopes have hollowed

58

80

56

Index

Index

Jan
2023

May

Sep

First Fed hike

90

70

NAHB index

54

Manufacturing PMI

52

50

50

40

48

30

46
May
Sep
March 2022

Sep

Production prowess has plummeted

First Fed hike

60

May
March 2022

May

Sep

May
Sep
March 2022

May

Sep

Sources for 10-year yield chart: New York Life Investments, U.S. Department of Treasury, Macrobond, December 2023. Sources for inflation
chart: New York Life Investments, U.S. Bureau of Labor Statistics (BLS), Macrobond, December 2023. Inflation is represented by the Consumer
Price Index. Sources for NAHB chart: New York Life Investments, National Association of Home Builders, Macrobond, December 2023.
Sources for PMI chart: New York Life Investments, Institute for Supply Management (ISM), Macrobond, December 2023. Definitions can befound at the end of this piece.

Choose your own adventure. Assessing investors’ economic and market path ahead

2What hasn’t changed?
Proponents of an economic soft landing point to the factors that haven’t been as visibly affected by higher
interest rates — the labor market and the consumer. Historically speaking, these factors lag monetary policy
the most, so it is no surprise the labor market is still tight and corporate profits are flat.

Unemployment upsurge unobserved

Payroll positions persist
First Fed hike

9

Percent

8

Median recession increase (+3.4%)
7
6
5

Unemployment

No. of payrolls, thousands

First Fed hike

1,000
800

400
200
0
-200
-400

4

Payrolls (nonfarm, private)monthly change

600

Peak recession payroll decrease (-435,000)

-600
3
Jan
2022

May
Sep
March 2022

Jan
2023

May

Sep

Jan
2022

Corporate profit consistency

1,200

Basis points

USD, trillions

May

Sep

0.9
0.8

2020 peak

1,000

Corporate profits after tax

1.0

2016 peak
800
600
400

Average recession decrease (-27%)

High yield credit spread
200

0.6
0.5
Jan
2022

Jan
2023

First Fed hike

1.2

0.7

Sep

Credit spread stagnation

First Fed hike

1.0

May
March 2022

0
May
Sep
March 2022

Jan
2023

May

Sep

Jan
2022

May
Sep
March 2022

Jan
2023

May

Sep

Sources for unemployment chart: New York Life Investments, U.S. Bureau of Labor Statistics (BLS), Macrobond, December 2023. Sources
for payroll chart: New York Life Investments, U.S. Bureau of Labor Statistics (BLS), Macrobond, December 2023. Sources for corporate
profits chart: New York Life Investments, U.S. Bureau of Economic Analysis (BEA), Macrobond, December 2023. Corporate profits after tax arepresented without inventory valuation adjustments and capital consumption adjustments. Sources for credit spread chart: New York Life
Investments, Bloomberg, Macrobond, December 2023. High yield spread is represented by the option-adjusted spread (weighted by market
value) of the U.S. Dollar High Yield All Cash Bonds sector. Past performance is not a guarantee of future results.

Choose your own adventure. Assessing investors’ economic and market path ahead

3What are we tracking?
There are gaps between where consumer, corporate, and labor market data are today, and where we expect
them to be in a recession scenario. In the meantime, what are the signposts? What does the glide into
recession look like?

How will we know we’re in the final countdown to recession?

05

04

03

Company expectations
slow…

Proﬁt margins fall…

Consumers begin to adjust
spending on big ticket
items…

 Negative corporate forward• Loan restructurings increase• New home sales volume falls(existing home sales volume
has already fallen)

guidance accelerates• Securitized commercial realestate: special servicing rises

 Earnings expectations
downgrades• Remodeling plans halt

• Banks increase loan loss
provisioning• Auto sales fall (new and used)• Beginnings of defaults for smaller,
more cyclical companies• Quits rate decreases (workers
not leaving jobs willingly)• Temporary help payrolls rise

The U.S. banking system is starting to provision more for loan
losses, but not yet to recession levels
80
70
60

FDIC income
statement
provision
for loan &lease losses

USD, billions

50
40
30
20
10
0
-10

23
20

20
20

20
17

20
14

20
11

08
20

05

9
19
9

20

6
19
9

02

3
19
9

20

0
19
9

19
87

19
8

4

-20

Recession
Sources: New York Life Investments, Federal Deposit Insurance Corporation (FDIC), Macrobond,Bloomberg Finance LP, December 2023. Deﬁnitions can be found at the end of this document.

Choose your own adventure. Assessing investors’ economic and market path ahead4

After a full year of revenue pressure, companies are finally seeing their earnings and profit margins decline.
Typically, this is accompanied by a stronger corporate and investor awareness that risks are rising and theeconomy is becoming more fragile. Consumers adjust their spending accordingly until the labor market finallycracks. Equity and credit markets tend to react only when unemployment claims rise and earnings are revised
downward—when recession is already upon us.

00

01

02

Recession

Consumer conﬁdence ispressured and households
make holistic changes tospending…

Labor market ﬁnallycracks…

• Negative substitute companies
with lower price points see
revenue gains• Layoffs rampant/seen
across industries• Credit cards: balances anddelinquency rates rise acrossage and income groups• Uninsured unemployment
claims rise

The labor market still looks strong, but can deteriorate rapidly
National unemployment, current period of yield curve inversion vs. past six
inversions (ex-2019)

Index (start of inversion = 100)

130
125
120
115
110
105
100
95

0

6

12

18

24

30

36

Months since inversion start
Six historical inversions

Current inversion

Sources: New York Life Investments, Bureau of Labor Statistics (BLS), Macrobond, December 2023.

Choose your own adventure. Assessing investors’ economic and market path ahead

5What does this mean for asset allocation?
Amid all this data, inflation remains, in our view, the single most important determinant of financial conditions
and therefore market behavior ahead. Using this as a starting point, investors can determine the likelihood of
success for their many allocation choices.
Our base case perspective — that economic growth will slow in a recession — would bring inflation lower andallow the Fed to cut rates next year. For those assigning a higher likelihood to other outcomes, we provide
concrete allocation ideas.

What comes next? Choose your own adventure

Key question:

Yes

Does inflation
come down?

Why?

CrisisAll we needed
was time!

Proceed straight
to Goldilocks

Why?

Labor market
cracks anddemand slows

Economic
activity
re-accelerates

The Fed cuts
rates too soon

External shock(i.e. oil supply
shock)

Companies
hoard laboreven asgrowth slows

Overheating

Stagﬂation

Not so fast!
A surge in economic
activity and inﬂation likely
means the Fed raises
rates further. Pleaseproceed to recession.

Tread carefully…
Sticky inﬂation and low
growth create a unique setof factors for investors —at least for a time. But withno incentive to cut rates,
the long and variable lagsof Fed policy could still
result in a mild recession.

Proceed straightto recession

Don’t ﬁght the Fed!
After a period ofmarket defensiveness,
policy support prompts
a return to “Goldilocks”
market conditions

Goldilocks

No

Recession

See your allocation on the next page

Choose your own adventure. Assessing investors’ economic and market path ahead

62024 scenarios:
Recession

Goldilocks

Overheating

Stagflation

60% likelihood

5% likelihood

15% likelihood

20% likelihood

The lagged impact of Fed
policy makes the U.S.
consumer, small business, corporate, andbanking systems evenmore fragile.

Pandemic-era government support —including low rates, fiscal
stimulus, and balance
sheet expansion —keeps businesses andconsumers afloat.
Today’s “higher for
longer” rates mean thatthe economy andinflation slow back tonormal pace without
recession — but thistakes time.

An energy-related orother external shock
results in a highly
inflationary near-term
scenario, forcing central
banks to respond withhigher interest rates.
Global consumers are
already weakened byseveral quarters of higher
rates and costs. Tacticalinvestors can benefit
from short-term
inflationary allocation.
Otherwise proceed to“recession.”

Excess household
and corporate savings,
including the hoardingof labor, keep the
economy afloat but
provide little inflation
relief. GDP data is
positive, supported bygovernment spending
figures, but “felt”
economic activity andthe job market weaken,
particularly for small
businesses and thosehouseholds with lesssavings and income tokeep up.

Fed can likely cut rates
modestly by H2 2024.
Market dysfunction may
bring a pause of QT.

The bar for Fed cutsin 2024 is high.

Fed may be forced tohike further.

Rates are stable athigher levels.

Equity• Profitable growthacross market cap• Large caps
• Defensive sectors• Infrastructure equity• Value• Small caps
• Cyclical sectors• Energy companies• Alternative energy• Balanced allocation
across growth andvalue equity styles;
focused on companies
with pricing power• Convertible bonds

Fixedincome• Add duration as 10Y
and long rates movelower
• IG corporate credit• 10Y moves higher/
stable: wait to add
duration• Increase credit
allocation: floating
rate, HY
• Emerging market debt

• Neutral duration;
10Y spikes
temporarily• TIPS• Rates stable• Barbell credit
allocation: IG and
HY pairing

Alternatives• Hedge funds• Real estate equity• Private credit• Commodities• Precious metals• Real estate equity• Precious metals• Real estate debt

Scenario
Neutral• Infrastructure bond

Cause

Refinancing activity islimited, leaving the
economy under thepressure of high interest
rates for an extended
period. Even if economic
activity is resilient at
first, market risks —including cost of
credit — continue torise, eventually resulting
in a traditional recession.

Allocation

Fed reaction• Quality, which looks different in this cycle• Careful credit analysis and security selection

Opinions of New York Life Investments, December 2023. For illustrative purposes only.

Choose your own adventure. Assessing investors’ economic and market path ahead

7

What it means to be “scenario neutral”
2023 proved to investors that sitting it out is not the answer, even when renowned investors
and expert economists are calling for an imminent recession. Those who turned strictly towardtraditional defensive investing techniques in the past year — overweighting cash, investment gradebonds, and value equities — saw their purchasing power erode in the money market, participatedin the greatest Treasury rout in 150 years, and missed out on the spectacular, though temporary,AI-driven equity rally.
Investors face the same conundrum for 2024, and as we have illustrated, macro pressures have
only mounted. Outrunning these pressures — and especially inflation — for the sake of capitalpreservation and appreciation requires taking selective and prudent risks. But how can we go
about this when everything feels risky?
We encourage a holistic approach to this question: focus on real returns, and consider how theimmediate cycle can be used to rebalance towards longer-term goals.
Real returns. For more than a year, we've said that defensive allocations should look different
when inflation is material. In other words: “safe” allocations are not, in fact, safe if they do notpreserve capital. Consider real, total returns: to what extent does the income profile of an asset
class provide a buffer against price movements?
The money market provides an interesting case in point. Historically, and until very recently, themoney market has not outpaced inflation. With the Fed nearing the end of its hiking cycle, we
expect it’s time for investors to dip their toes back into bonds. And if the money market doesn’t
outpace inflation on average, it may not be “safer” than active high yield credit strategies that aremanaged with a keen eye on credit risk.
Looking through the cycle. Investors know that standard diversified allocations are constructed
to weather all portions of an economic cycle, but what about the next? The structural view can beincorporated at the asset class level by considering the long-term trends at play, from energy
rebalancing to digital infrastructure, domestic manufacturing, and access to natural resources.
This also extends to investment themes and strategies. For us, these include:• cross-asset quality;• active management in more volatile and flows-dependent asset classes (such as municipal
bonds, or the smaller potential beneficiaries of AI); and• allocation to alternative asset classes including private credit, private real estate, andcommodities.
Above all, we remind investors that for all the uncertainty and volatility, this time is not different.

Choose your own adventure. Assessing investors’ economic and market path ahead8Definitions
Consumer Price Index (CPI) is a measure of the averagechange over time in the prices paid by urban consumers fora market basket of consumer goods and services.
Loan loss provisions, also known as valuation allowances,
are an expense set aside as an allowance for potential
uncollected loans and loan payments.
The NAHB/Wells Fargo Housing Market Index is an
economic indicator that gauges home builder sentiment in
the United States for single-family home sales andexpectations for the next six months.
The Manufacturing Purchasing Managers’ Index (PMI)from the Institute for Supply Management (ISM) is an indicatorof economic health for the manufacturing sector and isbased on surveys of private sector companies regarding
new orders, inventory levels, production, supplier deliveries,and employment.

Choose your own adventure. Assessing investors’ economic and market path ahead

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