What History Tells Us About an Economic ‘Soft Landing’
Will the U.S. economy avoid a recession in 2024, which by extension would deem the Federal Reserve’s rate hike campaign a success?
That’s what every investor wants to know.
Before I offer my take on these questions, I think it’s worthwhile to look back in history for past examples of Fed-engineered ‘soft landings,’ and also to assess how the equity markets responded. One could argue that the U.S. economy was heading for a soft landing in 2020 on the heels of interest rate hikes in 2019. The labor market was strong, and economic output was steady. But then the pandemic happened.1
The next historical example of a soft landing requires us to look back to the mid-1990s, which underscores another historical fact: soft landings aren’t all that common.
In 1994, Alan Greenspan’s Federal Reserve raised rates six times (adding a seventh hike in early 1995), as he was worried about an overheating economy driving inflation higher. Greenspan’s Fed doubled the benchmark Fed funds rate from 3.05% to 6.05% over that period, and the S&P 500 endured a volatile stretch in 1994. Stocks were up a paltry +1.33% that year (with dividends reinvested), while experiencing a -9% intra-year decline along the way.
Many readers likely remember what happened next, however. Greenspan’s Fed stopped raising rates in 1995 and even implemented some modest cuts (which, to note, is what we’re expecting in 2024). The economy and stock market did very well in the years that followed. U.S. GDP growth ‘bottomed out’ at 2.2% in Q4 1995, and the S&P 500 rallied +37.20% that year, +22.68% in 1996, +33.10% in 1997, +28.34% in 1998, and +20.89% in 1999.2
The chart below shows the benchmark Fed funds rate during the 1990s decade. Readers can see the period of rate hikes in 1994 that corresponded to a challenging year for stocks, and also the slightly falling – but largely steady – rates that followed for the remaining years of the decade.
Federal Funds Effective Rate, 1990 – 2000
In my view, the stock market’s rally late last year was a nod to the distinct possibility that the economy could keep growing modestly, but positively, in 2024 as the Federal Reserve positions for rate cuts – much like we saw in 1995. With inflation currently running at about 3% year-over-year, there’s not much justification to keep the fed funds rate at 5% to 5.25%. That feels overly restrictive, and the Fed has acknowledged as much.
Even though the Fed was raising rates last year, I think there’s a good comparison between 1995 and 2023. In both years, the economy continued growing despite rapidly rising rates, and the stock market posted strong returns in anticipation that rates would stop going up. The real question is, will 2024 look like 1996?
To be fair, soaring worker productivity in the dawn of the internet age was a key to the 1990s economic boom. The year-over-year change in labor productivity rose from 0.5% in Q1 1994 to 3.7% by Q1 1998, a massive leap. I’m not sure we’ll see a similar jump in the coming year(s), but I do think there are some supply-side factors working in the U.S. economy’s favor.
There has been massive investment in high-tech infrastructure and factories, and artificial intelligence could super-charge many companies’ ability to offer goods and services at scale with fewer workers.
Bottom Line for Investors
In 1996, real GDP growth was volatile from quarter to quarter but rose 2.5% for the year, and the S&P 500 climbed +22.68%. I won’t be so bold as to call for a similar outcome in 2024, but the idea of modest GDP growth with solid double-digit gains in stocks does not seem out of the realm of possibility.
In fact, I think it’s more likely than unlikely.
Disclosure
2 NYC. January 2023. https://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/histretSP.html
3 Fred Economic Data. January 2, 2024. https://fred.stlouisfed.org/series/DFF#
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