• Markets are embracing a lower rate outlook – Markets have now started looking beyond the ‘higher-for-longer’ theme, and are factoring in the next phase of the cycle, which almost certainly embodies lower interest rates. If major central banks start signalling the next move in rates is down, government bonds and investment grade credit should deliver strong returns.
• A powerful force is emerging – Despite the arguably positive backdrop unfolding this year from a macro perspective, politics will likely take centre stage, with 2024 being the “biggest election year in human history”, according to UBS.
• This year’s elections may impact the geo-political landscape – Not only are there risks around fiscal stimulus, Federal Reserve policy, and bond yields, any increase in the probability of a shift in the US’ electoral status quo could have meaningful impacts on geo-political events, such as global trade wars, the US’ ongoing support for Ukraine’s military efforts, and tensions with China and the South China Sea.
• A year to buy the dips, but not chase the rallies – As equities defied expectations in 2023 with double-digit returns, this makes a repeat performance in 2024 a relatively high hurdle. This means it could be a year of mediocre, but positive, returns for equities.
• Staying the course in fixed income may be key – With a higher resting pulse for inflation limiting the prospect of zero-policy rates returning, the ongoing yield from fixed income is likely to remain the opportunity.
• Tactical positioning within asset classes may outperform – A focus on quality and tactical opportunism may prove more rewarding than traditional asset class positioning.
Markets have quickly embraced our call to look beyond ‘higher for longer’ and focus on a path to lower rates in 2024. This has led to an aggressive fall in global bond yields in late 2023. With rising risks of a soft landing for growth, equities have also had a positive start to the year. Yet, as we discuss in this month’s Core offerings, despite this more positive macro backdrop, investors will likely need to navigate an alternative powerful force in 2024, namely politics. With more than half the world’s population going to the polls in 2024—including in the US, UK and India—politics could well be the factor that drives geo-political volatility. This month, we are closing our modest overweight in emerging market equities and our modest underweight in US equities, while trimming our bond overweight.
The worlds’ central banks may well still be focused on holding their policy rates ‘higher for longer’—maybe into H2 2024—to ensure they walk the last mile of the inflation journey and safeguard an inflation outlook consistent with their inflation targets. In and of itself, securing a future where inflation is relatively low (even if not as low as during ‘the great moderation’) and avoiding turning dovish too soon should be viewed as an important driver of a positive market backdrop for investors over the next few years.
However, since early December 2023, when we penned our 2024 outlook, The path ahead points to lower rates, markets have embraced our challenge to look beyond the ‘higher-for-longer’ theme. They have moved quickly over the past couple of months to factor in the next phase of the cycle, which almost certainly embodies lower interest rates. Arguably, bond markets moved too far too fast as 2023 came to end, underpinning one of the most aggressive falls in 10-year bond yields in history. US Treasuries fell from a peak of 5.02% in late October to 3.78% in mid-December (see chart below). Credit spreads also tightened.
Given this reflected a significant share of our forecasted fall in bond yields for all of 2024, we trimmed our overweight to government bonds in late December, ensuring we captured some of this tactical outperformance. Fixed income, nonetheless, had a strong finish to 2023, with benchmarks alone delivering about 6% in November and December.
In their defense, markets were responding to a number of data developments in late November and December that accelerated confidence in our ‘path to lower rates’ thesis for 2024. Most importantly, core inflation is falling further, annualising in the three months to December at 2.0% in the US (from 4.2% mid-year), at -0.8% in Europe (from 5.5% mid-year), and 3.2% in the UK from (6.9% mid-year). In Australia, the monthly inflation indicator fell to 4.3% in November from 5.4% for Q3 (see chart on following page).
Furthermore, the tone of central banks also shifted in late 2023 to more clearly flag that policy rates had peaked, signalling rate cuts were likely in H2 2024. But, for policymakers, the aggressive market pricing that emerged – six rate cuts in the US from March this year – has led to more ‘moderate’ messaging re-emerging from central banks, and US Treasuries have partially reversed course in early 2024 to around 4.05%.
For equities, they may well have also been pre-emptively harvesting some of our expected positive returns that we flagged for H2 2024. The combination of falling inflation and still surprisingly resilient growth (at least in the US and Australia but less so in the UK, Europe and China where activity has disappointed), has led markets to lower the probability of a hard economic landing in 2024. Together with rising hopes of lower interest rates ahead—easing one of the valuation headwinds—this has driven a positive backdrop for equities (despite early-year wobbles as market interest rates reversed some of their late 2023 rally).
As 2024 gets underway, our core views remain unchanged. The global economy is slowing, and inflation is moving gradually lower. Reflecting this, we continue to expect H1 2024 to favour fixed income returns over equity returns. If major central banks start signalling the next move in rates is down, as we expect in H1 2024, government bonds and investment grade credit should deliver strong returns. Moreover, with only a moderate easing cycle ahead, this should still present the opportunity to add defensive yield to portfolios.
For equities, we continue to believe the opportunity to turn more bullish equities may emerge in H2 2024. Slowing growth through H1 has the potential to challenge currently bullish corporate earnings expectations, which at 11% for the US, appear on the optimistic side (in tandem with current bullish rate cut expectations). Reflecting this, as we transition H1, for now we remain neutral equities, noting an increasingly constructive backdrop.
Nonetheless, this month we have made some adjustments to our tactical positioning ‘within’ asset classes. This reflects the more reflationary environment that is emerging.
We believe these two changes better set our tactical positioning in an environment where US economic growth might remain more resilient than expected amid easing financial conditions and as political considerations ramp up in the lead-up to the US Presidential elections. Indeed, were the global economy to face growth or geo-political challenges in the year ahead, the US equity market may prove defensive in a risk-off environment.
Yet, despite the arguably positive backdrop unfolding in 2024 from a macro perspective, markets will also likely have to navigate an alternative powerful force, namely politics. In 2024, politics takes centre stage, and not just in the US with the Presidential election. 2024, according to UBS, is the “biggest election year in human history”, with more than half the world’s population going to the polls in more than 70 elections globally. This includes India, the UK, Indonesia, and the European Parliament.
While some will argue such events rarely impact markets in a sustainable way, there is potentially a greater risk that this year’s elections will reach beyond just domestic politics, instead impacting the geo-political landscape. Sure, the US election in late 2024 may be expected to impact outcomes more particularly during 2025. But while the potential for former President Trump to receive the Republican nomination may be seen as a positive for supporters of president Joe Biden, the prospect of former President Trump being re-elected is increasingly likely to be priced to varying degrees in markets through 2024.
In addition to risks around fiscal stimulus, US Federal Reserve (Fed) policy, and bond yields, any increase in the probability of a shift in the US’ electoral status quo could have meaningful impacts on geo-politics events, such as global trade wars (rising protectionism), the US’ ongoing support for Ukraine’s military efforts, as well as tensions with China and the South China Sea. The carry-through to supply chains and inflation could start to meaningfully impact markets. Elections elsewhere could also have the potential to impact returns in different regions.
US elections: Former President Trump increasingly looks likely to receive the Republican nomination, while President Biden is the presumptive Democratic nominee. Markets are thus likely to soon start focusing on a 2020 rematch and any implications for US domestic and foreign policy. A Biden victory is arguably a known status quo, though the extent of any victory (and a likely split Congress) may impact his ability to pursue his priorities.
In contrast, there is much less visibility over what a Trump victory could look like, though greater clarity may emerge in coming months. Investor concerns have highlighted issues, such as a potential US withdrawal from Ukraine or the North Atlantic Treaty Organization (NATO), as well as whether Trump would follow through with plans to put a 10% tariff on all imports to the US (to fund tax cuts) and spark global retaliation. On the other hand, some commentators have posited that a second Trump Administration could still take on traditional Republican characteristics, emphasising tax cuts and deregulation. Similar to a Biden victory, the outcome of Congressional elections may constrain his policy options.
In an increasingly divisive political environment, some have claimed that ‘establishment’ concerns over a Trump presidency could prompt the Fed to take a more proactive role in supporting the economy in 2024. Similarly, Chris Patten, the last Governor of Hong Kong, recently claimed a new Trump presidency would put “the fate of liberal democracy in the hands of a demagogue who undermines its most basic principles.”
Taiwan elections: In January, the year of elections kicked off in Taiwan. The ruling pro-independence (from China) Democratic Progressive Party (DPP) was re-elected. According to the Observatory Group, “from Beijing's perspective, the result of Taiwan’s election is acceptable”. No party won a majority, and DPP won with a much narrower margin than in 2020. There is also now scope for the pro-China parties to control the legislative agenda. This was a positive development for regional calm, and increases the likelihood that “the geo-political tensions across the Taiwan Strait will likely be kept under control”…for now.
Indian elections: Current Indian prime minister Narendra Modi is widely expected to secure a third term in the 2024 elections. Supporters of Modi claim he has lifted India to a global power, while others question his aggregation of power in the now second most populous country in the world, including India’s strategic alignment with less democratic nations.
Russia-Ukraine: The Ukrainian army is bogged down in a war of attrition with a far larger enemy, and the US and Europe are losing interest. Earlier expectations by some that a re-equipped Ukrainian army could repel Russia, trigger a coup in the Kremlin, and deliver a swift end to the war have not eventuated. Instead, the war is ongoing, and the US and Europe are losing interest, with the risk of a shift to a more insular US leadership potentially impacting meaningful developments through 2024 and 2025.
Israel’s war in Gaza: Israel’s efforts in the Gaza strip to destroy Hamas continue, and a shift in US leadership could impact the ‘moderating’ influence the US has been imparting, and increase the risk of escalation, most likely with Iran (and Hezbollah). This obviously bleeds over into another geo-political event, namely the aggression of the Houthis in the Red Sea, where the US has been willing to make efforts to free the significant trade route. Risks centre around Israel taking unilateral action against Iran, while the latter’s ability to control the Houthis could also escalate developments.
For now, and according to geo-political analysts at the Observatory Group, “while every theatre in the Middle East is ripe for escalation, several factors argue against Iran wanting to escalate the conflict with the US and Israel further than it already has”. On one front, the ‘public’ does not share the regime’s ideological goals. On another (equally but separately worrying front), Iran’s significant progress to produce weapons grade uranium means Iran would not want to risk US or Israel strikes on its nuclear infrastructure. Adding to the political angle, discussions are ongoing in terms of succession for 84-year-old Supreme Leader of Iran, Ali Khamenei, with little unity among the elites in regard to who should take over.
Red sea and shipping lanes: Increasingly regular attacks across December and January by Houthis militants in the Red Sea – where 30% of world container ships pass, including oil and gas – have raised concerns of a sharp slowing in global growth or an inflation shock that delays interest rate cuts. A US-led naval force is, for now, committed to secure the safety of super-tankers. However, as reported by Bloomberg, most vessels are now travelling around Africa, adding two weeks to logistic costs.
While the risk of recession is reduced, the risk of inflation has risen. For now, estimates from UBS suggest that while some shipping costs have risen over 100%, the impact on inflation is “very small”. Still, resolution significantly rests on de-escalation and the ongoing willingness of the US to play a role in the region.
Each investment cycle almost always has something unique to bring that challenges investors. At its extreme, it’s always ”different this time”. The current investment environment has seen the uniqueness of ”excess cash savings”, as well as supply-chain driven “disinflation”. Growth is slowing, but proving resilient, at the same time that inflation is falling fast enough to discourage central banks from overtightening. That’s a relatively constructive market backdrop for both fixed income (where we are overweight) and equities (where we are neutral).
It may be a year to buy the dips, but not chase the equity rallies. Equity markets have been quick to price positive macro developments. After a mild correction in early 2024, equities have arguably been focused on the prospect of lower rates and resilient growth. However, with equities having defied expectations in 2023 with double-digit returns, it makes a repeat performance in 2024 a relatively high hurdle. According to MST Marquee, this could be a year of “mediocre, but positive, returns” for equities.
Staying the course in fixed income may be key. The shift in tone from central banks has already led to a sharp rally in yields into early 2024. As with equities, significant capital gains may be hard to harvest, unless the “hard landing” scenario for the global economy comes back into frame. Yet, ignoring the defensive characteristics that fixed income can provide portfolios could be a mistake in 2024. Similarly, with “a higher resting pulse for inflation” (in the tomes of KKR) limiting the prospect of zero-policy rates returning, the ongoing yield from fixed income is likely to remain the opportunity.
Tactical positioning within asset classes may outperform. Volatility is a companion we may just need to befriend. As we wrote in our 2024 Outlook, “as the turning point to a new phase evolves, we expect market disruption and volatility to persist”. This suggests that a focus on quality and tactical opportunism may prove more rewarding than traditional asset class positioning. Within fixed income, this might look like subordinated tier 2 major bank paper. Within equities, it might look like under-owned sectors or small caps. Within alternatives, it might look like distressed real estate or hedge funds that can capture dispersion across assets and regions.
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