2024 Market outlook: Predictably unpredictable


19 Dec 2023

With much to ponder when assessing the outlook for equity and debt markets, Andrew Holt searches for the bulls and the bears.


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With much to ponder when assessing the outlook for equity and debt markets, Andrew Holt searches for the bulls and the bears.

The only predictable thing about the markets is their unpredictability. This, it appears, is not going to change in 2024. In fact, the many economic and geopolitical factors shaping the investment outlook could even intensify.

But given the many events potentially shaping the markets, what trends can we spot emerging, particularly in equities and debt, during 2024?

Given the fractured nature of many markets it is inevitable that we are struggling to reach consensus on equities. Linda Bakhshian, deputy chief investment officer of equities and multi asset at Macquarie Asset Management, sums up the position. “It is no surprise that as we look towards 2024, opinions about a bearish or bullish equity market outlook are divided,” she says.

“In our view, growth on the supply side of the global economy is likely to slow due to de-globalisation, increasing geopolitical tensions, shifting demographics, and more constrained monetary and fiscal policies,” Bakhshian adds.

These could cause many headwinds. “Volatility and uncertainty are likely to be the hallmark of 2024 for equity investors, as we navigate challenges – including inflation and geopolitical tensions – and its impact on economic growth, company earnings and valuation of the global equity markets,” Bakhshian says.

Quality focus

For long-term investors, it would be prudent “to look through the short-term macro-economic debates and cyclical volatility”, Bakhshian says.

This means positioning portfolios in “high-quality securities, with strong balance sheets, cashflows and management teams that are likely to weather through various market conditions, while positioning for future profitability and growth.”

Further to this environment, surging yields and stealth stagnation may not be friendly conditions for broad equity exposures, says Wei Li, global chief investment strategist at the Blackrock Investment Institute. But this is not all bad news.

“Valuation dispersion within sectors has moved meaningfully higher relative to the past creating new opportunities,” Li says. “Benefiting from this requires getting more granular, eyeing opportunities on horizons shorter than our six to 12-month tactical view and tilting to more active strategies that aim to deliver above-benchmark results,” she adds.

Given the uncertain economic outlook and a preference for long-term quality, listed real assets remain attractive to Bakhshian, who is focused on listed infrastructure equities and real estate investment trusts, which stand out from a “valuation” perspective.

Selectivity and again, quality within each area is key, Bakhshian says. “However, both have come under market pressure and providing long-term investors opportunity for high relative yields and inflation protection,” she adds. “Both areas also have high exposure to secular trends, such as the energy transition, digitisation and trade restrictions globally are driving on-shoring and re-shoring of manufacturing.”

Bulls and bears

There is always a bullish and bearish case to be made for equities, says Tapan Datta, partner in global asset allocation at Aon Retirement Solutions. “Investors have to ultimately take a view on which side of the argument they find more credible,” he adds.

Exploring this further, the bullish case is that economic conditions will remain broadly stable in 2024, and that declining inflation will allow interest rates to fall back, removing the headwinds equities have been facing.

The bearish case is that the combination of much higher interest rates for a prolonged period, alongside likely recessionary economic conditions that dent corporate earnings will lead to another round of market falls in 2024, of the sort we saw in the first half of 2022.

Both are plausible. The consensus is there is no consensus. But Datta says: “Investors should also remember that there are more intermediate scenarios – the one we like sees equities challenged by economic and interest rate conditions, but not necessarily inducing a large bear market.”

With that, which scenario appears more credible? “A bear market scenario would suggest that investors start to sell into market recoveries and look to have lower than target positions in their portfolios and vice versa for a bullish case which would suggest building overweights,” Datta adds.

In his preferred scenario, he says: “A mild underweight to target or strategic positions would appear reasonable, but not a wholesale run to the hills for cover.”

Real rates

But the volatile macro-economic environment is always shifting the investment sands, even if it is sometimes only slightly. Fabiana Fedeli, chief investment officer of equities, multi asset and sustainability at M&G Investments, observes that given real rates are now in what can be deemed positive territory, even in the US, the equity risk premia have risen, putting pressure on equity markets.

“This could continue into 2024, and, while we still see pockets of future positive performance in equities, we are more cautious on the overall equity market in the near term,” she says. Fedeli also notes an important observation in terms of quality investments.

“It’s important to stay high on the quality scale, invest in companies with strong moats, pricing power, balance sheets and cashflow generation,” she says. “We continue to favour structural long-term themes that should prevail, independent of near-term volatility, infrastructure, the low-carbon ecosystem and innovation, including AI.”

As part of this, Fedeli says it isn’t time to take a broad market investment approach. “As companies deal with a high interest rate and positive real rate environment, weak demand, and relentless innovation, there will continue to be winners and losers,” she adds.

Muted market

Wylie Tollette, chief investment officer at Franklin Templeton Investment Solutions, sees equity returns providing slightly “more muted return opportunities” over the next three-to-five years as the improved returns coming from fixed income now provide an attractive alternative for many investors.

That said, Tollette believes that opportunities can be found. “We find some of the more appealing opportunities in global emerging markets and in the US,” he says.

Globally, he notes the picture “remains mixed” with European companies facing “greater threats from weak economic activity” and developed Asian economies impacted by weak Chinese growth.

Focusing in on investor expectations, Michael Field, European equity market strategist at Morningstar Research, says: “Investors have a firm eye on 2024, optimistically hoping that stronger equity markets, combined with lower headline inflation, might mean better real returns.”

Although he notes 2024 will be a tough year for business, with interest rates still at record levels and many firms struggling to service their debt. As such, it is likely that business insolvencies, which rose by almost a fifth in August, compared to the same month in 2022, will continue to increase in the new year.

“For investors, this means a focus on higher quality debt, where there is a higher chance of being repaid at the end of the term, would likely be a more prudent strategy than chasing debt instruments with the highest yield,” Field says.

He makes the point that European equity market valuations are not cheap, currently seeing a single-digit upside to the Morningstar fair value estimate. “Given the weak economic backdrop, this is a time when even the most bullish of investors are not shouting from the rooftops about how attractive the market is,” Field says.

But he also sees plenty of opportunities within European equities. “Sectors like utilities and pharma are now showing opportunities that did not exist six months ago,” he says. “The opportunity in the former is driven by higher bond yields, and the latter driven by investors’ lack of appreciation for the extent of innovation in the industry,” Field says.

We should forget about the type of inflation regime we have seen in our working lifetime.

Mitesh Sheth, Newton Investment Management

Reasons to be cautious

Making sense of the market would be difficult without assessing the impact of global events. Luca Paolini, chief strategist at Pictet Asset Management, says the conflict in the Middle East threatens to further destabilise the global economy and financial markets. “A reason to be cautious – we remain neutral stocks and overweight bonds.”

The conflict has come at a point when economies in developed and emerging markets are looking vulnerable, Paolini says. Increasing geopolitical tensions, market volatility and weak earnings have therefore dampened investor sentiment.

This brings the argument back to the reoccurring theme of quality. “With developed market economies slowing down, we continue to prefer quality stocks – companies with high profitability, good earnings visibility and low leverage – and defensive stocks, and retain our overweight in consumer staples and the Swiss market,” Paolini says.

Despite the gloomy economic outlook, he maintains an overweight stance on emerging economies. “These markets have better growth prospects than developed markets. We retain our increased exposure to energy, a defensive move in the light of heightened geopolitical tensions,” he says.

But that gloomy outlook persists, given that the spectre of a recession still hangs over the market outlook. “Equities may face volatility from uncertainty around timing and depth of any potential recession, if and when it comes, and the fact that bonds have become a worthwhile yield alternative again,” Bakhshian says. Hence, she believes investors should continue to be selective and “tilt towards high quality investments”.

Going global

The range of equity opportunities globally is fascinating. Bakhshian adds that looking at the recessions of 2002 and 2008, US small-caps outperformed large-caps in the early phases and, interestingly, the recovery, driven by more favourable starting valuations and pricing in recession risks, started earlier and more significantly.

“Currently, price-to-earnings ratios for US small-cap stocks are at levels typically seen during a recession, while large caps are more highly priced, driven primarily by mega cap growth stocks,” she says.

Elsewhere in the global equity market, Bakhshian cites China as continuing to be the dominant driver within emerging markets. “Given the recent economic uncertainty and property market crisis, investors have been more cautious towards China,” she says. Yet Bakhshian’s view is we could be approaching the end of this apprehension.

And on other geographical areas, she adds: “Europe’s valuations appear attractive and index concentration is low compared to the US, although both regions will have earnings risk if economic conditions deteriorate significantly,” she adds.

Blackrock is big on Japan. “We turned overweight Japanese equities on potential earnings beats and shareholder-friendly reforms. We also tap into the AI theme in developed market stocks,” Li says.

Tollette expects the Japanese market to deliver earnings growth of just over 8% through this year and next, the highest of any region globally: a nice number indeed.

Datta also likes this trend. “Japan and emerging markets have a bit more going for them in relative terms compared to either the US or Europe, similar to the way defensives should be favoured over cyclicals at the margin, as rates pressures ease with a slowing economic activity scenario playing out.”

The bonds picture

So what is the picture for bonds? Blackrock likes them, at least those issued across the Atlantic. “We like short-dated US government bonds and have also turned more positive on UK and euro area bonds where yields have spiked far above their pre- pandemic levels,” Li says. “We also like emerging market hard currency debt.”

Although she is steering clear of long-term US bonds even after their surge. “We think term premium – the compensation investors demand for the risk of holding long-term bonds – will rise further, pushing yields higher, as markets price in persistent inflation, higher-for-longer rates and high debt loads,” Li says.

The recent history for bonds has been challenging, with periodic sell-offs, adding to a generally difficult last couple of years. “At the margin, the outlook for debt – in expected ‘total-return’ terms – has shown significant improvements given the sharp rises in yields through much of 2023, which suggests that after inflation return prospects for fixed income, and cash has improved,” Datta says.

However, he cites two risks in debt markets that investors need to bear in mind.

First, the battle over inflation is not yet conclusively won. There is still some possibility that after some welcome falls this year, progress in returning inflation to central bank targets stalls, or, in the US case, reverses if the economy re-accelerates, forcing more rate hikes from the Fed.

Lurking risk

Though this still represents a lurking risk for bond yields, Datta believes in the slowdown narrative, so rates should not come under renewed pressure.

The other risk comes from credit markets, where weaker economic conditions and the large rise in debt servicing and refinancing costs brings credit losses – defaults in lower grade bonds and downgrades in investment grade credit.

“In other words, debt markets are not fully out of the woods,” Datta says. “That said, the bigger price adjustments in debt markets and high cash rates make it harder to like equities. Equities have some of the lowest relative attractions versus bonds in the past two decades at current valuations,” he adds.

Tollette says the higher starting level for base yields now offers a much more appealing entry point for bonds. “They are no longer return-free risk as they were for much of the recent decade and again offer a competitive alternative to equities.

“In the medium term, yields will likely fall back a little, offering modest capital gains for longer-duration bonds,” he says.

Enticing yield

Emma Wall, head of investment analysis and research at Hargreaves Lansdown, says gilt funds are topping the popularity table for investors. “Enticing yields are offering investors with a five-year view the chance of a real return over inflation,” she says. This is because after a decade languishing at near-zero rates, government bonds offer an exciting opportunity for income seekers.

“This environment looks set to stay,” Wall says. “Higher for longer rhetoric has been repeated by the Federal Reserve and the Bank of England, though chances of another hike by either central bank have dwindled.”

This means a return to a more traditional portfolio. “Investors should therefore ensure they have a balanced portfolio, with assets for growth, income and income growth – that is, well-covered dividends, in their portfolio,” Wall adds.

But like many forms of investment at the moment, the bond picture is not always easy to assess. Jeffrey Cleveland, chief economist at investment boutique Payden & Rygel, says the bond market seems to imagine the world in only two states. “One where central banks are hiking and the other where they must be cutting, if they are not hiking,” he says.

Cleveland says he can imagine a third state, one where central banks do nothing, that is to remain ‘on hold’ for the next six months. “The US Fed, for example, spent much of the mid-1990s in just such a state, as well as a long stretch from 2008 to 2016 spent at zero,” he says.

Sovereign exposures

There are some unexpected – or possibly actually expected – attractions in fixed income. Fedeli finds the long end of the developed sovereign bond markets – including 10 and 30-year government debt issued by the US, the UK and Germany – more attractive following the recent price sell off.

“It is always difficult to find the perfect entry point in the midst of market volatility,” Fedeli says. That said, she adds: “With the Fed closer to the end of its hiking cycle, historically this has been a precursor of peak rates at the long end of the curve. The long end of the curve also serves as an ‘insurance’ should a macro-economic slowdown ahead be more significant than the market expects.”

Investors should also consider another scenario, one in which central banks, after a pause period, do not cut, but instead hike again. This is slightly contrarian, as policymakers have clearly indicated the next move is lower. Yet Fed chair Jerome Powell has said the Fed maintains its hiking bias.

“Many bond traders think lower inflation soon is a foregone conclusion, but we are more sceptical,” Cleveland says. “Central bankers will want more than a bond trader’s hunch that the inflation dragon has been slayed before changing course.”

More to the point, it will not be the hopes of bond traders and policymakers that ultimately determine interest rate moves in 2024 – it will be the cold, hard facts of economic reality. “At least with regard to the US, GDP and employment growth are still above trend, and core inflation more than double the central bank’s target,” Cleveland says.

Look for quality

If the threat of rate hikes is indeed done, interest rate volatility should decline. Government bonds will undoubtedly benefit, but so will everything from high-yield corporates and agency mortgage-backed securities, hurt by higher rates and higher rate volatility, to emerging market debt. In a soft landing, the US dollar should soften providing global relief.

Franklin Templeton has therefore, Tollette says, retained a preference for high-quality government bonds, but also see investment-grade corporate bonds as appealing. “Corporate bond spreads have increased recently but may not fully reflect the anticipated increase from low default rates, reducing the appeal of lower-rated sectors such as high yield,” Tollette says.

A point shared by Sriram Reddy, managing director of credit at Man GLG. “Given elevated yields in fixed income – which remain at over decade highs – investors should be encouraged by the attractive opportunity set to generate attractive risk-adjusted returns.”

That said, given the uncertainty that still remains in the market, Reddy says it is the time for investors to be selective. “Monetary policy remains tight and is likely to remain so for the foreseeable future. Coupled with reduced credit availability, we expect that corporate profitability is going to be squeezed,” he adds.

Under the surface

Against this backdrop, Reddy sees some opportunities in credit markets, but believes that an active approach is crucial to source opportunities that may already be pricing in recessionary risks. “The reason for this is that when we consider broad corporate indices on aggregate they seem to be pricing in a soft landing type outcome, yet, when looking below the surface we see a barbell of some expensive names and some that look cheaper and are already pricing in recessionary type outcomes.”

He sees value in owning duration, something that will chime with many institutional investors. “Both for the potential portfolio diversification benefits and the potential total return in investment grade credit,” Reddy says.

He also sees “selective opportunities in high yield and emerging market corporates where the valuations look appealing, particularly compared to equity markets”. Additionally, Reddy adds: “The significant amount of income that investors can generate can potentially protect against significant drawdowns over the medium term, even if spreads widen from here.”

US spreads

Pointing in another direction, Matthew Dunleavy, client portfolio manager of fixed income at Principal Asset Management, says that US credit spreads have proven resistant to widening during 2023. “Part of the reason for that has to do with the appetite investors have shown for yield. As yield has become the backbone of bond investing, corporate debt buyers are capitalising on it,” he says.

Dunleavy foresees that trend continuing to play out, especially amid a higher-for-longer rate environment. “In fact, the longer rates remain elevated, the sharper the focus and larger the appetite of yield buyers, which, in turn, begets bond buying,” Dunleavy says. “With spreads at the tighter end of their recent range, spreads are likely to start to drift wider as signs of a more material economic slowdown becomes evident.”

In this environment, Dunleavy adds that high-quality fixed income will continue in all likeliness to deliver attractive returns on a risk-adjusted basis, as the Fed maintains its higher-for-longer rate stance. “Most fixed income asset classes should fare well, supported by attractive yields and resilient fundamentals,” he says.

Moreover, he believes the market environment for investment-grade investors should remain “enticing” heading into 2024, as higher yields are creating a technical tailwind for the investment-grade market and should bolster spreads.

In addition, high-quality, short-duration consumer asset- backed securities also remain a “compelling opportunity” for investors, while regulatory changes and rate stability driven by a pause in the Fed hiking cycle should produce “increased bank demand for mortgage-backed securities” over the longer term.

Furthermore, despite an anticipated economic slowdown, at least in some markets, Dunleavy does not believe investors should shy away from high-yield credit. “Some areas of the high-yield market present an advantageous long-term risk- reward profile due to strong corporate fundamentals and a receptive primary market,” he says.

Goodbye Goldilocks

But other more fundamental factors are at play that will impact the market outlook. Mitesh Sheth, chief investment officer of multi asset at Newton Investment Management, highlights that investors are facing a new era. “We have had 15 years of a goldilocks market, where interest rates and inflation were low and the world was characterised by globalisation.”

But this is changing and inevitably, will have an impact on the economic and investment fronts. “We should forget about the type of inflation regime we have seen in our working lifetime,” Sheth says. “We expect higher structural inflation and more volatile inflation [going forward].

“It is why there is much disagreement between economists and investors,” he adds. “That is because if you look through all of this, our view is that equity markets should be lower. We are expecting a selloff in equities from here.

“Our view is that in the medium term, all asset classes that have benefited from this environment are all likely to be over-valued and we will see some type of correction,” he adds. Therefore, the unpredictable may well give way to a truly new form of challenge.


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