Good morning, VettaFi Voices! We are a week out from the VettaFi 2024 Market Outlook Symposium on December 14, which will feature a range of ETF industry leaders discussing their expectations for different areas of the financial markets and the economy in 2024. But speaking to our own in-house experts, what do you expect for next year? What’s in your outlook?
Rate Cuts Ahead?
Jane Edmondson, VettaFi head of thematic strategy: What we need to see next year to keep financial markets going is continued evidence we are winning the war on inflation and avoiding recession. That would be the “Goldilocks” scenario. And the market is already pricing in Fed interest rate cuts next year. That would spur a rally in areas of the market that rely on credit such as small-cap and biotech should that occur.
The question is, how long is “higher for longer”? And when will we meet the Fed’s 2% target for inflation? Can we get there without too much damage to the economy?
Todd Rosenbluth, VettaFi head of research: The Market Outlook Symposium is going to feature Jeremy Siegel and then have asset management experts to cover fixed income, international equities, alternatives, and more. For example, in alternatives, we are going to be talking to Bitwise about crypto and Calamos about convertible bonds. We have the manager behind a BNY Mellon international equity ETF offering best ideas for 2024. I’m really excited.
Jane mentioned rate cuts. We have already heard from advisors that they plan to take on more duration risk. In the prior symposium, nearly 70% said they are more comfortable taking on interest rate risk. I think ETFs like the SPDR Portfolio Intermediate Term Treasury ETF (SPTI ) and the PIMCO Active Bond ETF (BOND ) will be a good replacement for the popular ETFs from 2023 like the SPDR Bloomberg 1-3 Month T-Bill ETF (BIL ) and the PIMCO Enhanced Short Maturity Active ETF (MINT ).
A Macro Outlook
Jen Nash, VettaFi economic and market research analyst: I’m excited for next week’s Market Outlook Symposium and to hear about expectations for 2024. The major economic stories that I see taking center stage for 2024 will be similar to what was talked about for a lot of this year — but with a slightly different spin.
First off: inflation. At the end of last year, inflation was already starting to decline from the mid-2022 highs but remained extremely elevated. For 2024, I think we can expect to see inflation continue to decline but at a slower rate. Overall, my expectation is that inflation (as measured by core PCE aka the Fed’s preferred inflation gauge) will remain above the Fed’s 2% target rate for 2024.
Next: recession or soft landing? At the end of the last year, the consensus was that we were headed toward a recession in 2023. It’s December, and said recession has yet to be declared. Now at the end of 2023, a handful of experts are saying that we are headed toward a soft landing in 2024. I think a lot of 2024 conversations will revolve around this debate.
My opinion is that we are headed toward a recession in 2024, but probably a shallow and short-lived one. Also a big topic of conversation for much of this year that will continue in 2024 is the Fed’s rate decisions. I believe the Fed is done raising rates, and a lot of the recent data, including this week’s employment reports, support that. This time around, the question is, when will they begin to cut rates? At the time of writing this, the CME Fed Watch has a 54% probability of the first rate cut coming in March 2024.
Dividends & Clean Energy in the Spotlight?
Rosenbluth: If rates [are cut and] keep coming down, then I think dividend ETFs like the ALPS Sector Dividend Dogs ETF (SDOG ) will be more relevant. Equally weighted across the sectors, SDOG owns the five highest-dividend-yielding stocks. This fund and peers like the iShares Core High Dividend ETF (HDV ) and the Vanguard High Dividend Yield Index ETF (VYM ) are likely to return to favor.
Also, I think value ETFs will regain traction. The Vanguard Growth ETF (VUG ) is outperforming the Vanguard Growth ETF (VTV) 40% to 4% for the year. That spread will not persist.
Edmondson: If we do indeed see rate cuts, is it coming from a place of victory relative to inflation, or because the Fed sees signs of economic weakness? There are a slew of inflation ETF plays, where we could see some rotation out of those ETFs along with the extension of duration, as Todd mentioned, to lock in higher rates.
I am excited about the positive implication for thematics that have suffered this year in a high-rate environment such as clean energy. And lower input prices could be a boon for EV-related themes, re-spurring demand there. Lower interest rates would make EVs more affordable.
Rosenbluth: I’d love to hear how clean energy can do better in a lower-rate environment
Edmondson: Areas of the market like solar have been hard hit by high rates because they try to finance projects. In clean energy, ETF plays that could benefit would be names like the First Trust Global Wind Energy ETF (FAN ) and the Invesco Solar ETF (TAN ), and broader based funds like the iShares Global Clean Energy ETF (ICLN ) and the First Trust NASDAQ Clean Edge Green Energy Index Fund (QCLN ).
Other Clean Energy Challenges
Stacey Morris, VettaFi head of energy research: Lower rates should be incrementally positive for clean energy, but rates haven’t been the only problem this year. Wind has been particularly challenged with inflation, supply chain issues, and even problems with design for key components. Several offshore wind projects have been canceled in the U.S. and overseas.
In solar, there have been inventory overhangs as sales have fallen with higher rates. I agree that lower rates would help, but it may not be a silver bullet.
Edmondson: In the EV supply chain, ETFs like the Amplify Lithium & Battery Technology ETF (BATT ) and the Global X Lithium & Battery Tech ETF (LIT ) could benefit, along with the pure plays on EVs like the Global X Autonomous & Electric Vehicles ETF (DRIV ) and the KraneShares Electric Vehicles & Future Mobility Index ETF (KARS ).
Carbon credit ETFs like the KraneShares Global Carbon Strategy ETF (KRBN ) could also see a resurgence. The energy transition is not cheap. It’s very capital intensive, so lower credit costs would be extremely helpful.
I mentioned biotech. Being as biotech names lack revenue during the drug development phase, they are also very credit sensitive. The ALPS Medical Breakthroughs ETF (SBIO ) is an ETF that would benefit, as funding medical breakthroughs is not cheap either.
Other funds such as the iShares Biotechnology ETF (IBB ), the VanEck Biotech ETF (BBH ), the Global X Genomics & Biotechnology ETF (GNOM ), the WisdomTree BioRevolution Fund (WDNA ), and of course the ARK Genomic Revolution ETF (ARKG ) also stand to benefit from lower rates.
Outlook on Housing
Nash: My housing market expectation for 2024 is that mortgage rates will slowly decline. That said, housing supply will remain limited. Current homeowners will still be reluctant to give up the low rates they previously locked in. However, I expect to see an increase in housing starts, building permits, and new-construction homes to help offset the limited existing inventory. This could impact homebuilder ETFs such as the Invesco Building & Construction ETF (PKB ), the iShares U.S. Home Construction ETF (ITB ), and the SPDR S&P Homebuilders ETF (XHB ).
Rosenbluth: I saw that BlackRock in its 2024 outlook said “a dovish Federal Reserve surprising markets with rate cuts earlier than expected could spur a cyclically driven rally. Under those circumstances, we could see small-caps, which currently sit at cheap valuations and underweight allocations, outperform the broader market.” The iShares Core S&P Small-Cap ETF (IJR ) and the iShares Russell 2000 ETF (IWM ) are two of their small-cap ETFs.
Edmondson: Yes, I agree, Todd, that small-cap ETFs would indeed be the beneficiary of rate cuts. They have underperformed the market for two consecutive years now relative to large-caps, and relative valuations do look cheap. This also advocates for equally weighted exposure to the broad market index to capture a greater weight to small- and midcap names. RSP is the Invesco S&P 500 Equal Weight ETF (RSP ).
Rosenbluth: Money has indeed been pouring into RSP this year as advisors seek more dispersion. A market that is not dominated by the Magnificent Seven would be welcome. But smallish large-caps are still large-caps.
The Marijuana Industry & Active Management
Heather Bell, VettaFi managing editor: I’ve been watching the marijuana industry, which is only natural as I’ve got at least five dispensaries in walking distance of my house (because Denver). The Secure And Fair Enforcement Regulation (SAFER) Banking Act, which will ease some of the banking restrictions around marijuana, could be a big boost to the industry if it passes.
But all marijuana ETFs are in negative territory right now, year to date, though the magnitude of their declines varies quite a bit. This, paired with lower interest rates (should cuts happen), could boost the industry out of its doldrums phase. I feel like there might be an opportunity there.
Personally, I think for a theme like marijuana, you’re probably better off going with active management. An index just seems too restrictive for an industry that currently resembles the Wild West.
Rosenbluth: The Amplify Seymour Cannabis ETF (CNBS ) is one of the active thematic ETFs.
Bell: It’s down almost 14% year to date, but if someone’s looking for an entry point…
Edmondson: I agree with the value of active management in this space. There are so many dimensions to understand beyond the company level.
Bell: Yes, it’s a complicated industry! Every state has different rules. And it’s such a new industry too.
Edmondson: The Banking Act would be helpful to operators, giving them access to traditional sources of capital and the banking system. In addition, because cannabis is legal in some states and not others, and because it is not legal at the federal level, there is no interstate commerce. That creates some weird supply/demand dynamics where you have some states like Oregon in surplus and others in shortage, which creates price dislocations.
I cannot predict when we are going to see federal approval, but ultimately, I think it will happen.
The Outlook for ESG
Bell: I think that’s inevitable!
I also think ESG will have a bit of a rebound. But will the current set of funds survive? I’m not sure.
James Comtois and Nicholas Peters-Golden just had that debate for the latest Bull vs. Bear column, and Nick really won me over with his arguments (sorry James!). Typical ESG methodologies have some modifications to make if they’re going to stay relevant, I think. But that’s a category that is not going away. And it’s certainly getting a boost in investor minds from all the weather events we’ve seen in recent years.
I do think ESG products will home in more on climate change, and that would benefit the ETFs and industries you and Stacey were discussing, Jane. The energy transition is going to continue to be a major topic. And I think the funds focused on related companies and commodities will benefit.
Edmondson: The dialog around ESG has definitely changed. And the expectations for ESG as an alpha driver have changed as well. But there is a market for quality ETF products that are objective and actionable that represent values and goals, like climate goals, that investors share. The bar has been raised for ESG, and ultimately, that is a good thing from a product and outcome perspective.
A few years ago, the industry fell into the same folly as the dot-com bubble. Many assumed that tacking ESG onto an ETF name would make it successful, just like adding “.com” to the company name. Regulators have clamped down on that behavior. However, I think the industry is now on watch that it needs to create more thoughtful and quantitatively driven products like the Adasina Social Justice All Cap Global ETF (JSTC ), which uses a whole matrix of inputs from both public and private sources to identify companies not aligned with its values. (edited)
There are other good ESG implementations out there as well that focus on data inputs and not subjectivity. The ESG ratings agencies are also being called to task to do better and be more consistent and transparent with their rating methodologies. I agree, Heather, that ESG in its new and improved form could see a resurgence.
Are there some other overlooked segments of the market that could see more interest in the coming year? I like a good comeback story.
Bell: From a sector perspective, healthcare and consumer staples in the S&P 500 are both in the red year to date. And the utilities sector is down almost 10%. Energy is down. Those are sectors that are basically providing the necessities of life. I mean, those have to stage a comeback, don’t they?
Energy Industry Outlook
Rosenbluth: I would love to hear Stacey Morris’ outlook on energy and whether MLPs behind AMLP can continue to do well into 2024. But if bond yields come back in the defensive sector, ETFs like XLY and XLP should do better. Bond proxies are less appealing when short-term bonds yield 5%.
Morris: It’s important to not throw midstream out with the energy bathwater. Yes, energy’s down about 4% YTD on a total-return basis, but the underlying index for the Alerian MLP ETF (AMLP ) is up over 24% through December 6 (ahead of the S&P 500 Index). And the underlying index for the broader Alerian Energy Infastructure ETF (ENFR ) is up over 14%.
Looking ahead to 2024, I feel really good about midstream/MLPs being able to continue to execute on free cash flow generation and returning cash to shareholders through dividends and buybacks. That’s regardless of what we see with commodities. In short, I think the outlook for oil is a bit murky. OPEC+ will likely defend a floor, but there will be fewer upside drivers for oil.
Natural gas prices will likely get better into the end of 2024 and 2025, but gas tends to be more of an afterthought for sentiment. If we see continued commodity volatility, midstream/MLPs’ defensive characteristics from fee-based business models and generous yields (7.7% for MLPs, over 6% for broader midstream), that should be beneficial. Importantly, a handful of companies have already provided guidance for EBITDA and dividend growth next year that remains very healthy.
Rosenbluth: Wow — up over 20% for AMLP! That’s worth repeating. This is not an AI ETF.
Politics & Stability
Dave Nadig, VettaFi financial futurist: If we’re thinking 2024, it’s hard to avoid talking about geopolitics and the election (which is one of the reasons we’ve got Richard Haass from the Council on Foreign Relations and Amy Walter from the Cook Political Report headlining at Exchange this year).
Election cycles always end up with investors a bit confused about what outcomes are “good” for their portfolios and which are “bad.” But I don’t that that’s the most useful framing. What’s good for markets is usually stability and predictability.
As we parse headlines for the next 12 months, the question should probably be, “is this good or bad for stability of the status quo?” Because that’s what the Street always wants. Of course, lower interest rates are good for a rally as well. And I don’t think it’s unreasonable that we get some relief in the third quarter, as some are suggesting.
On ESG: It’s worth noting that many of the “boring” ESG funds that simply reweight or cull the big indexes are actually beating their non-ESG benchmarks over the last little while. As I’m writing this, the Xtrackers ESG S&P 500 ETF (SNPE ) is beating the plain old SPDR S&P 500 ETF Trust (SPY ) by 2% year to date — that’s no small feat. I suspect that the flows spigot will turn on a bit more next year. Plus, international investors never really stopped buying ESG. I do think the discussions will get much more nuanced, however. A clean energy ETF is simply not the same as a social justice ETF. It’s accurate to put them in different conversations.
Key Developments to Come
The big stuff I’ll be looking for:
1) Significant practical use cases of AI impacting S&P 500 company bottom lines. We’re close, but by Q3 next year, AI and robotics are going to be more in the headlines, with real-world impacts, than it is right now.
2) Significant global reaction to social media disinformation around the election. We’re already seeing this (largely in the EU). That said, I wouldn’t be surprised to see some high-profile lawsuits/enforcement actions being taken, whether it’s more TikTok bans at the state level or changes to FEC rules around advertising.
3) With a live bitcoin ETF (and probably a live ETH ETF by the third quarter) the discussion around the use cases for crypto — and more importantly, decentralized finance — will be back in the mix.
Edmondson: We have not fully addressed the elephant in ETF land: Will we see spot bitcoin ETF approval in 2024?
Bitcoin ETFs on the Way
Rosenbluth: Yes. We will have multiple products trading by the time we are together at Exchange in mid-February. Roxana Islam has more expertise with crypto. However, I’m expecting the Grayscale Bitcoin Trust (GBTC) conversion to occur and multiple products from ARK, Bitwise, BlackRock, etc., to be live. We will talk next week with Bitwise about it at the symposium.
Nadig: At this point, I’m with the “90%” camp on whether we get approvals in January.
Roxanna Islam, VettaFi head of sector & industry research: I think crypto will be an outlier. That’s a riskier area of the market that is seeing renewed interest already. I think that will only increase in early 2024 when spot bitcoin ETFs launch.
But besides crypto, I think there will be more focus on defensive sectors like consumer staples and healthcare in addition to large-cap stocks. The industrial sector is starting to show some recent strength. I think that will continue, especially with the rebound in housing starts/industrial shipping and increased focus on the defense industry.
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