In 2023, the macroeconomic situation evolved more positively than expected. Recession risk receded towards the end of the year, which was broadly positive, especially for equities. For those running diversified portfolios, however, it was challenging to compete with the impressive performance of the S&P 500, which was driven by narrow leadership. For fixed income investors the highest level of yields in 10 to 15 years were seen, after years of low rates, though there was considerable volatility due to the global economy outperforming expectations.
Now, as we start 2024, Square Mile’s CIO, Mark Harries, was joined by Hugh Gimber, Global Market Strategist at J.P. Morgan Asset Management and James Ashley, Head of Market Strategy at Goldman Sachs Asset Management to explore factors affecting consumers and investors, the best opportunities for making money this year, where risks are and the outlook for 60/40 portfolios.
You can also listen to the full podcast episode here.
The future for consumers
2023 was a challenging time for the consumer. Inflation was running rampant, wages did not keep up, and therefore, there was a squeeze on negative real incomes.
In 2024, that squeeze should ease. Utility prices are beginning to come down, and inflation should generally begin to level off. However, even moderation of inflation still results in an elevated price level, so the consumer will continue to face a number of headwinds, though not as intensely as they've experienced for the past few years.
Comparing the US consumer to the UK consumer results in an interesting viewpoint too. The US consumer had a much stronger year in 2023 than those the other side of the Atlantic, whereby UK and European consumers have been more cautious. They have had more of their incomes going into savings in comparison to the US, where consumers have been a lot more confident in spending. That might start to converge this year as UK and European consumers move away from the energy crisis, while the US consumer could potentially start to lose some steam.
Data dependent markets
Markets are incredibly data dependent at the moment because central banks are. Policy makers do not yet know whether or not inflation is definitively heading back to 2%, so currently, the path for interest rates is a lot less clear. Central banks cannot, therefore, offer forward guidance as they did in 2022 when they identified they were behind the curve as inflation increased, so were able to announce decisively that interest rates would go up and also go up again in the future.
Uncertainty by central banks has led to a range of estimates for growth this year, which is the widest since the global financial crisis, with the single exception of 2020. It is the same for consensus on interest rates. There is not a clear singularity on where the market believes the US 10-year will be at the end of 2024. Clarity will come when central banks provide some degree of guidance about when they will pivot to rates coming down, due to inflation moderating.
Opportunities in 2024
2024 has plenty of opportunities across both equities and bonds, as well as in alternatives, private markets, and real estate. In terms of regions, Japan and India look exciting, while in the US, moving down in market cap offers investment potential. In fixed income markets, there is now the potential to deliver returns in a way that has not been seen for a generation. Fixed income is no longer just about risk mitigation; it now has some return-generating capacity as well.
Furthermore, some of the best opportunities lie beneath the index level today. It is unlikely there will be the same very concentrated returns from markets as seen in 2023 where, for example, close to 90% of returns came from just seven stocks in the S&P 500. This has resulted in a wide dispersion in terms of valuations. The top ten largest stocks in the S&P 500 are on close to 30 times forward earnings. The rest of that market is on 18 times. This kind of dispersion is seen across sectors, across styles, and within regions as well. For instance, there are discounts available in Europe compared to the US, which make for compelling opportunities and potential for some of these very wide valuation gaps to close.
A big year for elections
2024 is a year of elections, which will undoubtedly provide many surprises, which is why positioning portfolios based on an assumed election outcome can be risky. Instead, what's happening in the economy matters more for markets than what is happening at the polls. Looking back through some of the recent election years, in 2000, returns were all about the tech bubble, and had nothing to do with what was happening with the US election. Or, in 2008, the financial crisis was the dominant factor and then 2020, more recently, was a Covid year – again, not a year where the election dominated.
Given that every election cycle is different, forecasting is extremely complex. So, while it is important to remember that 2024 will be a year of political uncertainty, it should not dominate portfolio positioning decisions. Instead, it is better to be reactive when more detailed information is available - such as election winners and their specific policy impacts.
The traditional 60/40 portfolio in 2024
The big benefit of a 60/40 portfolio is that there are periods where stocks and bonds will go in different directions, resulting in diversification between the two. Over the past couple of years, however, that has not been the case as the problem for markets has been inflation rather than growth, so there has been a simultaneous decline in stock and bond prices together.
Looking forward, the outlook for the 60/40 is positive because inflation is coming down. So, if there is a growth shock this year and stocks did come under more pressure, there is room for central banks to cut rates and therefore bonds to appreciate quite strongly in that scenario. While this may not be a base case for many investors, the opportunities for diversification in some of those tail risk scenarios now makes using a 60/40 balanced portfolio between stocks and bonds more appealing.
Furthermore, the 60/40 portfolio should have a good year in 2024 thanks to the wider range of opportunities across the board, but it is vital not to become over enthusiastic. There are still headwinds due to the high valuations of certain stocks, as well as being realistic about the magnitude of what is already priced into fixed income markets and how tight spreads are in the corporate bond space.
Finally, when trying to build a balanced portfolio today, there is still an inflation risk. While the 60/40 can help to mitigate that, it is important not to lose sight of some of the alternative asset classes as well that are much better placed to hedge against inflation, so core bonds can be used to hedge against the growth risk.
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