2024 Market Outlook
Economies were more resilient than expected in 2023, especially in the US, thanks to resolute consumer and government incentivised expenditure programmes. However, the rapid increase in interest rates is likely to slow economic activity in 2024 and inflation will continue to fall. There is reason still to be more sceptical of a soft landing than consensus.
While the short-term outlook appears challenging economically, as we move through the cycle it sets us up nicely for the recovery and expansion phases, which typically support attractive investment returns. For committed long term investors the outlook appears reasonable, albeit with some inevitable twists and turns along the way. Staying diversified and remaining disciplined continue to be key.
Key Considerations
Global GDP growth is expected to slow to below trend.
Bank lending activity will remain subdued, with lending standards staying high as they err on the side of caution to protect balance sheet strength.
Disinflation will continue, but at a slower pace. Decline in rent and service sector prices will catch up with weakness in goods prices. The Fed and ECB look likely to meet their inflation targets later in 2024; the BoE path looks longer.
Liquidity will continue to be withdrawn as central bank quantitative tightening persists
The Fed message of ‘higher for longer’ will pivot to ‘lower and faster’, as growth becomes the primary focus and the presidential election approaches. The BoE is expected to be later in cutting interest rates, but then move faster.
Over 40% of the global population goes to the polls in 2024 heightening scope for policy change.
High yield credit spreads are at risk of widening as defaults rise.
Long term government bond yields will fall as growth slows, but the yield curve will steepen as the short end comes in, leading to a bull steepening
Money supply growth is unlikely to materially improve until the latter part of the year acting as a constraint on economic activity. Things will improve late 2024, offering upside into 2025
Labour market tightness will ease as outstanding vacancies shrink, participation rates rise & unemployment nudges higher.
Elevated budget deficits leave little room for election give aways and fiscal profligacy – markets expected to think dimly of parties taking this approach.
Consensus earnings forecasts look vulnerable to disappointment. Downgrades are expected as sales volumes remain sluggish and margins unsustainably high.
Consensus expectations of recession failed to materialise in 2023, despite persistent monetary tightening by central banks. The consumer was the mainstay of economic growth and resilience, as labour market strength supported nominal wages. Fiscal expansion, notably in the US, stimulated investment activity which more than offset the slowing effects of higher interest rates. It is uncertain how sustainable these economic drivers will be.
Cumulative savings appear low by historical standards, budget deficits are bloated for this stage of an economic cycle, and the impact of monetary tightening has yet to fully work its way through the system. This points to a more challenged macroeconomic outlook for 2024, although consensus expectations of a ‘soft landing’ are widespread.
The economy is not the market though, so we need to consider broader variables to understand the likely direction of markets including liquidity, valuation and sentiment. Here, there are signs that things may be poised to improve, or at least get less bad. Often in markets less or more is of greater importance than high or low. Patience and commitment will be required - it is expected to be a bumpy journey.
Move over inflation – growth will become the core focus
Disinflation is well advanced across most major economies, with interest rates comfortably above GDP growth and higher than core inflation. This restrictive stance by central banks is deliberately designed to slow economic activity and create some slack so that inflation expectations are lowered and price stability targets met.
It would be bold to declare the war against inflation over, but the battle appears to have been won, with long term inflation expectations rolling over. This led the Fed to talk about the timing of rate cuts in its post December meeting press conference, as they shift their focus to limiting risks of recession and supporting growth.
As we move into an election year, it’s not surprising that growth will become the primary point of focus. This is gaining greater attention because strength in the labour market is cooling and the electorates’ focus is shifting from cost of living concerns to worries about job security.
As growth slows, unemployment rises, temporary worker demand falls, quits rates decline, wage pressures ease and job vacancies contract. And this is all before new year corporate budget restraints take effect. These cracks have scope to become chasms, and rather like the path to bankruptcy, can start slowly and unfold rapidly.
Soft Landing or Wile E. Coyote?
Despite interest rates rising at the fastest pace since the 1980s, economies in 2023 have been far more resilient than we expected. However, the consensus assumption of a soft landing may yet prove to be optimistic. History has demonstrated that it's notoriously difficult for central banks to achieve, despite their best intentions. Already in 2023 there have been a number of ‘rolling recessions’ (a term borrowed from Charles Schwab) in housing, manufacturing and even services.
Source: Charles Schwab, Bloomberg, The Conference Board
The full effect has yet to be truly felt, because when corporates and household’s current lending terms expire, they’ll need to refinance at much higher rates. For many this means a 50%+ increase on what they're currently paying. This will lead to a squeeze on disposable incomes and corporate growth plans. For example, the average US 30-year fixed rate mortgage has risen from around 3.7% in Q1 2022 to 7.79% at the end of October 2023, while the cost of bank debt for small caps has climbed from around 6.5% to 9.6% over the same period. The subsequent dampening effect on consumption and investment isn't hard to imagine. Combine this with greater incentives to replenish the depleted savings pots used to make ends meet during the cost of living crisis, it’s hard not to conclude the prospect of an imminent slowdown.
The economy is not the market, and the market not the economy
Fortunately, the importance of relativity in investing means that challenge brings opportunity. Markets have begun to discount lower interest rates in anticipation of a weaker near-term outlook. This has led to an easing of financial conditions, which should help to abate some of the financial squeeze.
This may be a deliberate ploy by the Fed to get the market to do some of the easing without lowering base rates themselves. However, since the 1960s the Fed has cut rates by an average of 450bps to support and stimulate economic activity. Even if we halve that assumption, the 150bps of rate cuts currently discounted in the market for 2024 has scope for further positive surprise if a slowdown becomes a recession. Replacing the ‘higher for longer’ with ‘lower and faster’ is something markets will keenly embrace.
This bodes well for fixed interest, where yields are meaningfully more attractive than the depressed levels post pandemic and the Global Financial Crisis. They also offer scope for capital protection and appreciation if interest rates come off as we expect they will.
Furthermore, negative correlations between fixed interest and equities may begin to reassert themselves as slower growth forces equity analysts to downgrade their earnings forecasts.
Living beyond your means
Debt and its sustainability is one area that does look challenging. With Debt:GDP ratios commonly around or in excess of 100%, there are growing concerns about the ability to service that debt. The US budget deficit expanded to $1.7trillion in fiscal year 2023, representing 6.3% of GDP. This is at a time when the unemployment rate was close to a record low. If a slowdown leads to a rise in unemployment, pressure on the fiscal deficit will grow. This is a worry that we will continue to monitor, but we expect the market will continue to function effectively, albeit with a higher term premium to compensate investors for the additional risk.
Source: Charles Schwab, Bloomberg, Bureau of Labor Statistics, as of 31/10/2023
The headwinds of inflation are expected to moderate through 2024, with central bank and investor focus shifting towards growth and its sustainability. Variable macroeconomic data will keep central bankers talking tough, but we believe we are past the peak in interest rates, with cuts expected in 2024 and into 2025.
Humility, patience and perseverance are key to any successful investment strategy. Continue to expect the unexpected, maintain diversification, and commit for the long term - the data shows that investors tend to do well.
Disclaimer: This communication is designed for informational purposes only and is not intended as investment advice. These investments are not suitable for everyone, and you should obtain expert advice from a professional financial adviser. Please note that the content is based on the author’s opinion at the time of writing/publish date. Our views and opinions regarding certain investment themes and topics can alter over time as the macroeconomic background changes and other industry news is made publicly available, this is not intended as investment advice.
Past performance is not a reliable indicator of future performance. The value of investments and the income derived from them can fall as well as rise, and investors may get back less than they invested.