2024 Outlook: A Good Year for Investors
January 8, 2024
Global financial markets ended 2023 on a positive note, delivering a second consecutive month of exceptional gains in December, ending a volatile year.
Most of the gains occurred in the last couple of months of the year, during which market participants became increasingly optimistic about the likelihood of a soft landing. This shift in market narrative prompted an aggressive rally in both equities as well as fixed income markets into year-end.
Bonds made large gains on the back of increased expectations of Fed rate cuts in 2024. The November U.S. inflation data, which showed the headline deflator declining on a month-on-month basis for the first time since 2020, reinforced investor expectations of policy easing.
Meanwhile, solid economic data is boosting investors’ confidence that the economy will pull off a soft landing. This led to the most risky assets participating in last month’s rally. Commodities also rallied while the U.S. dollar weakened.
After the pandemic-induced sell-off in March 2020, the unprecedented fiscal and monetary stimulus gave the U.S. a rocket-like rebound across the board. In late 2021, the rocket ran out of gas and started falling back to earth. Monetary policy flipped from super easy to the fastest tightening in history, starting in March 2022. And what went up came back down in an almost perfect sequence. Equity markets had a major correction – one that we normally experience in times of recession, namely a 30% correction in the S&P 500 Index.
At the same time, we had a major bear market in global fixed income, with the 30-year US Treasury bond losing 50% of its value between November 2021 and October 2023 before regaining some of the losses in the last two months.
The Chinese and Hong Kong stock markets also experienced a 50% bear market over the past two years. However, this is overshadowed by the big gains in the U.S. market in 2023, with the S&P 500 Index up 26%. Nevertheless, it is noteworthy that the S&P 500 ended the year basically at the same level at which it ended 2021.
This means no gains for the U.S. market in two years and also disguises the fact that there was massive dispersion in returns. Large-cap tech stocks performed much better than the rest of the market. The so-called ‘Magnificent Seven’ (Alphabet, Amazon, Apple, Meta Platforms, Microsoft, NVIDIA, and Tesla) strongly outperformed. This means that many stocks are still below their 2021 price levels.
The same goes for most of the rest of the world’s equity markets. Given the fact that the economy and corporate earnings have grown in the past two years, we think there is more upside in global equity markets. How much more will depend on several factors, including geopolitical risk, but mostly on how the Fed will play its cards. If the Fed will cut interest rates materially before the U.S. economy falls into recession, it would support higher equity market valuations globally.
The last few years have been extraordinarily complex for identifying the correct economic trends. The reason is that many analysts have been looking at developments through the lens of standard business cycle analysis. It has been anything but.
Was Inflation Transitory After All?
What we have lived through since 2020 has not been a normal business cycle. There was a macro-economic earthquake. Since late 2021, economic and financial forces have been trying to get things back on the rails.
The complexity and unfamiliarity of the post-pandemic macro-environment have led to a remarkable dispersion among analysts’ macroeconomic projections for 2024, from recession to soft landing to no landing.
The establishment view holds that inflation can only fall meaningfully if there is a recession. But inflation is falling faster than the Fed has acknowledged and is already back to target when properly measured. There are compelling reasons to believe that it will keep falling and will fall below the Fed’s target rate in 2024.
Meanwhile wage inflation is slowing but price inflation has fallen faster. Thus, real wage growth has finally become positive. Personal spending and income growth have realigned. Jobless claims data show little sign of a sudden wave of layoffs, but it is getting harder to land a job. The system is close to back on track.
The stage is being set for some big cuts in rates. Timing is everything but if the Fed plays it right, 2024 might indeed be another positive year for risk assets.
Looking forward there are different scenarios that could play out this year:
Soft Landing: (quick disinflation, soft economic landing): Inflation comes down faster than the consensus believes. Growth slows to a below-trend pace in 2024. Unemployment rises a little, but real GDP does not contract. A temporary contraction in corporate profits is possible but would not be meaningful.
However, the FOMC is forced to ease policy as inflation approaches the 2% target in order to avoid a sharp rise in short-term real interest rates. The Fed begins cutting rates around May of 2024. The Fed Funds Rate eventually bottoms at the end of 2025 at about 2.5%, a lower level than the market is currently discounting. This is likely a positive scenario for equity markets.
Mild Recession: (quick disinflation, mild decline in real GDP): The economy suffers a contraction this year in line with previous mild recessions (early 1990s and 2000s). This places even more downward pressure on inflation, which falls below the Fed’s 2% target sometime in 2024. The Fed slashes short-term rates beginning in the second quarter. Whether the impact for equity markets will be positive or negative will depend on how deep the recession is and how quickly the Fed reacts.
Sticky Inflation and Recession: (sticky inflation, initially resilient economy, then deep recession): The economy remains resilient to the tightening in monetary conditions over the next six months, while wage and price inflation level off at rates that are inconsistent with the Fed’s inflation target. The FOMC responds by lifting the Fed funds rate by another 50 basis points in first half of 2024 and holding it near 6% for the rest of the year. Risky credit spreads widen sharply as investors anticipate a harder economic landing, which unfolds in late 2024/early 2025. The Fed eventually eases, but only hesitantly due to stubbornly high inflation. This scenario will not be a positive outcome for risk assets. However, we think the first or second scenario are much more likely to happen in 2024.
Roaring 20’s Again?
The surprise could be how well the U.S. economy will continue to re-emerge from the Covid-19 pandemic crisis. In fact, the current inflation problem may well give way to a possible deflationary boom this decade. There are similarities between now and the early 1920s. Back then, the world just came out of the First World War (WWI), the 1918 Spanish Flu pandemic and a brief recession in 1920/21. This dark period was followed by booming business activities, soaring stock prices and a spurt of rapid productivity growth.
Like the roaring 1920s, which started off with unprecedented supply-side destruction and soaring inflation, the Covid-19 pandemic crisis also devastated the capacity of the world economy to produce goods and services, wreaking havoc on global supply chains and causing inflation to soar. Now, like then, serious economic destruction might have set the stage for a strong recovery that could last some time to come.
The economic response to the post-pandemic economic recovery has conjured up images of a rapid supply-side recovery. So far, inflation has fallen sharply but overall demand has stayed strong, the unemployment rate continues to be low, and real wages have begun to rise again. In the third quarter, U.S. GDP soared at a 5.2% annualized rate with sharply lower inflation. All of this suggests that it is the supply-side expansion that has been driving economic growth in the U.S. This is similar to the post-WWI economic boom.
2024: A Good Year For Investors
After nearly 3 years and a 50% peak-to-trough hit in long-term Treasury total returns, normalization of interest rates argues for a meaningful rebound for fixed income. The substantial gains made since mid-October are likely part of a trend that is not yet over.
Fiscal policy has played a big role in creating the impression that the economy is less sensitive to rates than before. The contribution to growth from fiscal policy since early 2022 has been significantly higher than pre-pandemic. If anything, the influence of fiscal policy is probably understated, owing to the unique nature of the fiscal packages released by the Biden administration. But there are signs that the fiscal lift is beginning to fade. So, it will be important how the Fed will react to this change.
Timing is everything, but in theory timely cuts by the Fed as inflation drops could set the economy up for acceleration by the end of the year.
This could make it another strong year for investors in general if monetary policymakers become believers in low inflation and start to react by cutting rates.
Outside of geopolitical upheavals, the known risk of recession associated with the Fed keeping rates higher for too long, and the unknown unknowns, the greatest economic threats to the U.S. may be fiscal policy and the upcoming U.S. Presidential election.
The current U.S. budget deficit is unsustainable given the level of interest rates relative to the growth rate of the economy. The debt arithmetic could, however, change a lot next year depending how much rates drop. Yet there is nothing on the horizon to suggest any material change in government spending or borrowing needs, nor do either of the two contenders for President in 2024 provide much hope for fiscal remediation. Trump likes to cut taxes and Biden likes to spend money.
- Magnificent Seven
- China & Emerging Markets
- The U.S. Dollar
- Digital Assets
- Portfolio Positioning
Fed easing in response to either a mild economic contraction or a “perfect landing”, both of which would involve further disinflation, could lead to a continued Magnificent Seven rally. These long-duration technology plays would directly benefit if both short-term and long-term real interest rates are headed lower. In addition, they will gain indirectly from an unwinding of the Fed-induced dollar overshoot. Every Magnificent Seven company, except Amazon, has a higher foreign revenue share than the 41% overall average for the S&P 500.
Another sector that has the potential to do well this year is energy and especially the more conventional energy companies. We expect that geopolitical uncertainty can push up energy prices, but more importantly we expect that demand will exceed supply. Current valuations of conventional energy stocks remain attractive.
China & Emerging Markets
2023 was another negative year for the Chinese equity market and although other emerging markets performed better, as a group they underperformed developed markets. This is a structural trend that has been going on for several years already. Can this trend reverse in 2024? To answer this question, we first need to make sure that we separate economic growth from equity markets. Good economic growth does not mean strong equity markets as China has shown in the past 12 years.
The fact that Chinese President Xi Jinping acknowledged in his New Year’s speech the weakness in the Chinese economy could mark a turning point for Chinese equity markets in 2024.
The most critical issue is whether Beijing will increase stimulus measures to boost the economy and more importantly revive investor confidence.
The recent Biden-Xi summit was positive but the real indicator of whether geopolitical risk will fall is the Taiwanese election on January 13. War risk will decline if the ruling party loses, as China will try to make headway toward integrating Taiwan without the use of force.
Bond markets rebounded strongly in the last two months, with U.S. Treasury yields falling back to the same level at which we started 2023, despite the notably different economic outlook.
We are now close to the point where the yield curve begins a major pivot back to a more normal slope and on a timeline that is sooner and faster than implied by the money market curve.
So far, the Fed has thrown cold water on the idea of early rate cuts. But with inflation falling and nominal GDP growth slowing, the Fed’s stubbornness should help sustain and extend the recent gains in fixed-income total return. Ironically, the beginning of the end of the current rally in bonds may come when the Fed finally begins to cut rates.
For 2024 we expect decent returns on fixed income. Higher yields provide a good income base and yields are likely to fall slightly further in the near-term. Moreover if the global economy slows more than we currently expect, than bond yields can fall much more, driving the performance of fixed income portfolios.
Corporate bond spreads are rather tight at present and are not pricing in any recession risk at this juncture. Therefore, we are more positive on government bonds than corporate bonds. In particular, high yield corporate bonds seem expensive. We see better opportunities in private credit and Mortgage Backed Securities (MBS). MBS still have large relative spreads, which we think has the potential to come down in the coming year and low prepayment risks, leading to outperforming traditional high yield bonds.
The U.S. Dollar
The U.S. dollar has been relatively strong in the past few years, and despite the recent weakness the dollar remains overvalued against most major currencies. It is possible the dollar rebounds in the near term but unless we see a major global recession, we expect the dollar to weaken this year.
One major currency we believe has most upside is the Japanese Yen. Not only is the Yen more than 40% undervalued relative to its Purchasing Power Parity (PPP) exchange rate, but it is also poised to benefit from rate cuts by other central banks and the eventual dismantling of the BoJ’s Yield Curve Control framework.
A sharp drop in yields alongside the eruption of geopolitical tensions in the Middle East propped up the price of gold in the last quarter of the year. Yet, the rest of the commodity complex did not perform as well in 2023.
We think 2024 can be a better year for commodities. The tensions in the Middle East as well as sustained demand for energy will likely drive energy prices higher this year. At the same time, the continued energy transition and drive towards electric vehicles will drive up industrial metal prices as we still believe that demand will outstrip supply after years of underinvestment in new mines.
Gold was the best performing metal last year and we think gold prices can rise further as Central Banks around the world seem to be buying more gold again to diversify foreign currency reserves.
Bitcoin has significantly outperformed all asset classes in 2023 despite a series of negative news clouding the cryptocurrency space over the last 18 months. After rallying more than 160% in 2023, we believe there is more upside in 2024 and investors should consider adding bitcoin exposure to their portfolio allocation.
Firstly, demand-supply dynamics are expected to provide continued tailwinds. In addition, the next Bitcoin halving event is expected to take place in April 2024. Halving events cut in half the amount of tokens Bitcoin miners receive as a reward, limiting the rate of creation of new bitcoins and slowing supply growth. In the past 3 halving events since Bitcoin’s launch in 2009, significant rallies ensued, followed by new all-time highs each time.
The correlation between bitcoin and global equities appears to be decreasing, which means that adding digital assets to a portfolio could enhance diversification.
For most of 2023 we had positioned client portfolios for a rebound in the equity markets. In September we started adding long-dated U.S. Treasury exposure to core portfolios and added more duration in late October, which greatly profited from the rebound in Treasuries in November and December. We even replaced some equity exposure with long-dated Treasuries. The timing of this proved to fortuitous.
We also kept the overweight in the NASDAQ 100 and the Japanese equity market, both of which performed well. During Q4 we took some profit on these positions. We feel our core portfolios are currently well positioned to continue to perform well in 2024.
This material represents an assessment of the market and economic environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. Forward-looking statements are subject to certain risks and uncertainties. Actual results, performance, or achievements may differ materially from those expressed or implied. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor. Past performance does not guarantee future results.
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