2024: Growth challenges amid uncertainty

The year 2023 has been challenging, characterised by market fluctuations and constant shifts in risk appetite. While in 2023, the central debate revolved around the inflation cycle and whether it had peaked, in 2024, we expect the focus to be on the growth cycle and whether it has bottomed out. This indicates that market volatility will likely continue in 2024 as investors react to the latest economic news. Geopolitical factors, particularly the upcoming US presidential and congressional elections, will add further uncertainty to the mix.

Our macroeconomic base case predicts a soft landing for the global economy, avoiding a deep recession. Factors such as robust labour markets and manageable government debt levels in the developed world suggest a cyclical adjustment rather than a severe contraction like that of 2008-2009. However, markets may at some point factor in a bleaker outcome than our base case.

Growth will overtake inflation as the key driver

In 2023, the investment landscape reflected concerns over inflation, although there was strong economic growth. However, as we enter 2024, we anticipate a shift in focus from inflation to economic growth as the primary driver for investment decisions. Here are five predictions for 2024:

1. Growth will overtake yields as the main driver for risk assets: The sharp rise in inflation led to rising yields, which had a negative impact on the prices of risky investments such as shares. As inflation pressures are receding, markets may shift their attention to concerns about slowing economic growth. We believe that economic growth will become more crucial than yields for risk assets, particularly equities. A stronger-than-expected economic growth steered the US economy away from the anticipated recession in 2023. In 2024, we believe that economic growth will become more crucial than yields for risk assets, particularly equities. 

2. Opportunities in equities: In a low-growth environment, companies capable of sustaining growth will be among 2024's winners. Additionally, "bond proxy" or defensive stocks, which perform well when market participants anticipate a recession and the easing of monetary policy, may regain favour. Their attractive valuations make them compelling investments. 

   

3. Fixed income shifts attention to growth: Fixed-income markets faced challenges in 2023, especially as interest rates rose. However, as the focus moves from inflation to growth, we expect a move away from duration risks (also known as interest rate risks) to credit risks. Long-term government bonds remain appealing from both a diversification and a return perspective. And with yields still at attractive levels, short-term high-quality bonds present compelling opportunities. 
4. Geopolitics will stay in the spotlight: Geopolitical events have had a growing impact on financial markets in recent years. While their influence tends to be temporary, they remain significant. Brexit, the US-China trade conflict, and the Ukraine conflict continue to shape financial markets. The transition from a globalized to a multi-polar world introduces additional geopolitical uncertainties. 
5. Diversification in a shifting landscape: Diversification remains a prudent strategy in 2024. Adding uncorrelated assets to portfolios, especially those with different drivers than for traditional equities and bonds, will help investors to mitigate risks and seize opportunities in the constantly evolving investment landscape.

Equities dance on the knife-edge of economic growth

As we approach the close of 2023, we anticipate that the gravitational pull of higher interest rates will persist as a dominant force in the equity markets next year. The ongoing high but stable interest rates, coupled with gradually declining inflation, are expected to continue exerting a braking effect on economic growth. This scenario sets the stage for a cautious approach to equities:

1. Challenges to achieving profit growth: With easing inflation, economic growth slowdown, and weaker demand due to supply chain bottlenecks, achieving profit growth will become harder in 2024. Companies capable of withstanding these headwinds and achieving sales and earnings growth will be in the frame for potential share price gains. 
2. High valuation levels: Relative to fixed interest bonds, equities remain richly valued, with the equity risk premium hitting a 20-year low. This suggests that investors may find themselves inadequately compensated for taking on equity risks compared to bond risks.

In 2024, success in equity investments will hinge on two key drivers: earnings growth and changes in valuation multiples. We have identified two strategies offering potentially higher share prices:

1. Profit growth in a low-growth world: Economic growth is expected to remain sluggish, accompanied by declining inflation and pricing power. Companies that can navigate these challenges and achieve sales and earnings growth are well-positioned for share price gains.
2. Revaluation potential of "bond proxies": Stable and defensive equities, often considered "bond proxies" may see their valuations increase. Particularly if interest rates decline slightly, this positions them as attractive options for investors.

Fixed income has the potential for improved returns

The intense interest rate hiking cycle in 2023 translated into another year of disappointing returns for most fixed-income segments. 

In 2024, we expect central banks to become more supportive, and this will move attention from interest rate and duration risks to credit risks. The improved return potential in most bond segments is underpinned by several factors:

1. Peaked interest rates: A key driver for the improved outlook is anticipation that interest rates have peaked. We do not expect major central banks to raise rates further in 2024. Instead, they are likely to adopt a cautious and gradual approach to interest rate cuts. 
2. Normalization of yield curves: We think that the US dollar and euro yield curves will normalize in 2024, with term risks being compensated by a premium. Factors such as the sustainability of the US government budget may exert upward pressure on long-term rates, but the negative term premium is expected to dissipate. 
3. Shift to looking at credit risks: Credit risks are poised to take the spotlight in 2024, emphasizing the significance of individual bond selection. While opportunities persist in short-dated corporate bonds with strong credit metrics, caution is warranted for longer-dated corporate bonds, particularly at current valuation levels. 
4. Favour a "barbell approach": Short-dated investment-grade bonds present an attractive investment opportunity, and seven- to ten-year US government bonds may benefit if the economy cools more than anticipated. Investing at both ends of the maturity timeline is known as the barbell approach.

Shifting narratives move the EUR/USD rate

The euro declined in value against the US dollar during the summer of 2023, attributed to the underperformance of the eurozone economy, a slower-than-anticipated recovery in China, and the robust performance of the US economy, coupled with a widening real interest rate differential between the United States and other major regions.

However, for a sustained recovery of the euro, a catalyst for upward movement is required. The most likely scenario for this would be an economic slowdown in the US, which could adversely affect the strength of the dollar. Another aspect to consider is risk sentiment, as the dollar is considered a safe-harbour asset and benefits from deteriorating risk sentiment. Here are the potential scenarios:

1. A dovish Fed during an economic slowdown: If a mild recession occurs in the US, a revaluation of all asset classes could take place, leading to a decline in the value of the US  dollar. 
2. Impact of risk sentiment on the US dollar: While the dollar is viewed as a safe-harbour asset, a dovish stance by the Federal Reserve amid deteriorating risk sentiment could lead to an appreciation of the euro against the dollar later in 2024.

Navigating the shifting sands of geopolitics

Geopolitics has surged to the forefront as a primary concern on the markets that contributes to volatility. As 2024 approaches, politics and geopolitics cast longer shadows, particularly the US presidential and congressional elections in November 2024. The outcomes of these elections will not only impact domestic policies but also have far-reaching global repercussions, influencing events and decisions worldwide.

Geopolitical tensions such as Russia's invasion of Ukraine and more recent conflicts in the Middle East underscore the intricate nature of global geopolitics. Beyond high-profile events, we are also seeing a transition from an integrated, globalized world to a multi-polar, "slowbalized" world, with slowing growth in cross-border flows.

Recent geopolitical tensions have highlighted the fragility of supply chains. Resource security is now a top priority, prompting diversification efforts to reduce dependence on specific sources and transport routes, and accelerating action by companies to re-shore critical components in order to enhance resilience. The outcomes of such activities will affect both economies and corporate results.

As we embark on 2024, navigating the intricate web of geopolitics and understanding the implications for global markets will be essential for investors and policymakers alike. Now more than ever, intelligent diversification will remain crucial for portfolio success.