What Advisors Need to Know About Inflation, Recession, and the 2024 Economic Forecast

Economics often dominates the news with ominous headlines as everyone speculates about interest rates, inflation, and economic growth. This impacts markets directly. Asset prices change not just in response to economic change, but also in anticipation of it. Portfolio construction must account for economic change, both expected and unexpected.

Our U.S. economic outlook is optimistic about GDP growth and inflation for the next several years, relative to expectations. By planning ahead, investors can make the best decisions to make progress toward their long-term goals.

Here’s what financial advisors need to know about economic conditions and how to support clients in 2024.

For a full picture of the 2024 economy, download the outlook. If you’re a financial advisor, download the report here. If you’re an investor, please visit morningstar.com or consult your financial advisor.

While Morningstar economists expect real GDP growth to slow in 2024, our longer-term outlook is optimistic.

Our researchers predict the U.S. economy will feel the lagged effects of the Federal Reserve’s interest rate hikes. Consumers also seem cautious as household excess savings deplete.

However, our economists expect GDP growth to rebound over 2025 through 2027. Slowed growth and normalizing inflation could induce the Fed to cut rates aggressively in 2024. And after the lows of the COVID-19 pandemic, increased labor supply and productivity could also spur economic growth.

• Monitor economic developments. Ignore the hype and stay up to date with a trusted independent source. Economic outcomes can shift based on swing factors like geopolitical risk and technological innovations. Staying informed—and explaining to clients how you do so—can quiet their anxiety.
• Head off client inquiries with proactive outreach. Recessions can be stressful for investors. Create opportunities for clients to discuss their concerns over the phone or email.
• See market fluctuations as an opportunity to demonstrate your expertise. Advisors can provide investment research that shows their value as a resource. Make sure newsletters are easy to read to dissolve confusion instead of enhancing it.

While everyone talks about “higher for longer” interest rates, our economists predict that inflation will fall back to central bank targets in 2024 and remain low.

We expect inflation to return to the Fed’s 2% target in 2024 and stay there in the following years. The supply constraints that caused a surge in inflation in 2021-22 are now easing. This allowed inflation to fall dramatically in 2023 despite GDP growth. This process still has much room to run.

Against this backdrop, central banks could cut interest rates aggressively from mid-2024 into 2025. This is a potential positive but not a certainty.

• Revisit your asset mix. Under the threat of future inflation, investors might feel pressured to rebalance their portfolios. Short-term bonds may be positioned to guard against the risk that longer-term bonds face.
• Talk to retirees about long-term strategy. Given their fixed incomes, retirees might be worried about future inflation. Allocating more to inflation-linked bonds instead of nominal bonds can provide a hedge against inflation.
• Research inflation-fighting funds and portfolios. No asset class can perfectly prevent the negative impacts of inflation, which means diversity is key. Assess vehicles like a TIPS portfolio, commodities, emerging-market bonds, real estate, and gold. Some funds and managed portfolios can provide exposure to these diversified assets.
• Help investors balance inflation protection against risk tolerance. Cash likely won’t beat inflation over time, so taking risks is necessary for investment returns. That means some inflation-hedging vehicles won’t be appropriate for all clients.

Questions about potential recession risks and the inflation outlook will likely persist. While our U.S. base case involves a soft landing with no recession, we could see a wide range of potential outcomes.

To assess how the market is pricing economic expectations, segment stocks by cyclical, defensive, and sensitive factors and compare their relative valuations. If a recession were top of mind, we’d expect a steep discount in cyclical and sensitive stocks, but higher valuations within defensive stocks.

However, while we see valuation dispersion between cyclical and defensive stocks, in aggregate both are offering discounts while sensitive stocks are closest to fair value. This pricing is closer to a soft-landing expectation and suggests a recession could catch broad markets off guard. However, utilities, communication services, and financial services all seem to price in an economic deterioration.

• Revisit clients’ financial goals. Goals-based financial planning can help advisors set more relevant definitions of success than an arbitrary dollar amount. It can also clarify the value of advice in making progress toward those goals and personal guidance

• Map actions that investors can take to prepare for a recession. Are there places where they can reduce their monthly spending? Can they allocate a little more of each paycheck to emergency savings or paying down debt?

• Remind clients that the economy is cyclical. Recessions are common, temporary, and followed by economic recovery. The long-term view helps ensure investors take on the right amount of risk for their goals.

This outlook comes amid recent volatility and a wide range of possible outcomes. In the coming years, we anticipate a complex macroeconomic playing field, influenced by various global influences and resultant investment implications. From a portfolio management perspective, these fluctuations carry both risk and opportunity.

Scenario testing reveals key portfolio positions to support robustness. For Morningstar Investment Management’s best investment ideas, download the full outlook.