Investment outlook for 2024

Overview

The new uncertain and potentially volatile macro environment, with rates set to be higher for longer, poses both opportunities and challenges in 2024. These include:

• A sluggish global economy with the US economy at a high risk of tumbling into a recession during the year
• Interest rates to be cut by a small amount in response to more normalised inflation prints and economic weakness
• Volatile equity markets both on the upside and downside – this could be particularly poignant if rates are cut or if earnings disappoint
• A stronger year for longer duration fixed income

Equities

In 2022, the S&P 500 collapsed close to 20% in the midst of the Fed’s decision to rapidly raise interest rates. Yet, contrary to widespread expectations, equity markets have advanced valiantly in 2023, with the Dow reaching a record high in December 2023.

What’s interesting regarding equity returns this year is that they’ve been driven by the Magnificent Seven (Apple, Microsoft, Alphabet, Amazon, Nvidia, Tesla, and Meta). In fact, if you strip the Magnificent Seven out of the MSCI ACWI Index, the return is actually flat for 2023.

The outlook for US equity earnings growth hasn’t been as strong as investors hoped. Equity concentration in the S&P 500 is now at levels not seen since the 1970s. The rise in stocks this year has been driven by a cluster of behemoth tech stocks with the likes of NVIDIA and Tesla spearheading the rally.

These circumstances aren’t the most bullish of signals, this has been seen before ahead of previous economic slowdowns, whilst slowing inflation may scupper pricing power. This, combined with a consumer with diminished savings and weaker purchasing power suggests that corporate margins and equity valuations could be in for a tough period in 2024.

Regarding the UK, economic data is likely to slip further as the full impact of much higher interest rates increasingly seeps into the economy. This could be marginally offset by an improvement in real wages as inflation has declined. Yet, the risk is teetering UK labour markets, if the impact of higher rates squeeze corporate profit margins.

Since Brexit, the UK equity market has – to an extent – been unloved by investors, but opportunities on a valuation basis have arisen. The FTSE 100 Index’s defensive qualities could hold it in a good position, given the volatile backdrop that’s expected for the global economy and global equities in 2024. This blue-chip equity index has relatively large exposure to defensive sectors (eg health care and consumer staples). UK equity valuations appear somewhat enticing, with almost every sector trading at an abnormally high discount relative to historic averages.

Bonds

Following a cataclysmic 2022 for bond investors, fixed income markets have staged somewhat of a rebound this year, albeit with a generous dose of volatility for investors to deal with.

Long-term interest rates are forecasted to decline, with developed market central banks believed to be finished with their hiking cycle. As interest rates decline, investors won’t only earn the currently high interest rates, but will also benefit from additional price appreciation on bonds with longer maturities.

Cash doesn’t benefit from falling rates like bonds can. With inflation continuing to normalise, the Fed’s next move could likely be a cut in rates. As rates fall, bond prices rise and provide investors with returns from price appreciation in addition to coupon income. However, to capture the potential upside of price appreciation, investors would need to own duration, which is a measure of a bond’s sensitivity to changes in interest rates. As the duration of cash is close to zero, it doesn’t perform well when rates are cut.

As a result of interest rates in much of the developed world peaking and scope for rates to be cut next year, we’ve added duration across our managed portfolios. We’ve done this in the form of buying longer dated UK Gilts and US Treasuries, which we see as major beneficiaries to rates being cut.

Areas of the bond market which we’ve limited our exposure to (for the time being) are corporate credit, investment grade, and especially high yield. We entered 2023 overweight to investment grade credit. But since then, credit spreads have tightened and are now in a range which certainly isn’t cheap. This means that we‘re not being rewarded with substantial yield over that of governments bonds, despite taking additional credit risk.

Credit spreads could face further pressure and widen as the economy weakens. Also, the market may price in an expectation for additional downgrades and defaults, leading to wider spreads and credit falling in value.

Alternatives

Gold

In 2023, gold reached record highs, driven by geopolitical strife and economic uncertainty. We maintained a chunky allocation in our managed portfolios toward the precious metal coming into 2024. Demand for gold could remain elevated via safe-haven demand and the ever-evolving outlook for US interest rates. Historically, real yields of US Treasuries and the price of gold have tended to be negatively correlated. Unlike bonds, gold doesn’t pay coupons. This means that when real yields are high, investors may be more inclined to move their money into assets such as bonds. As real yields are set to be driven lower next year if we see economic weakness and dovish central banks, we could see further strength for gold.

Real estate

Another area of interest is listed real estate. Rate hikes have been felt very intensely in the real estate sector. Higher interest rates have meant a higher cost of borrowing for real estate investment trusts (REITs), which has been a performance hindrance for 2 years. With the Fed signalling a potential pause on rate hikes, the time for a resurgence in REITs may finally be near. REITs have typically experienced return underperformance during Fed tightening cycles, they’ve outperformed both private real estate and equities in post-rate hike periods. With the interest rates likely to have peaked, this could bode well for 2024 REIT performance.

Megatrends

Megatrends are another way to manoeuvre portfolios and they typically transcend traditional asset classes. They stand out as outstanding drivers of corporate profits on their own, and could offer potential opportunities that may be uncorrelated to traditional macroeconomic cycles. The standout one for us coming into 2024 is artificial intelligence (AI).

Artificial intelligence

Advances in computing software and hardware has led to a surge in AI investment and chatter since late 2022. AI developments have the potential to be exponential as innovation continues to lead to further and more sophisticated advancements. AI and its general uptake and development has the potential to smooth inefficiencies, increase profit margins, and grow broader earnings over time.

AI is starting to be rolled out in healthcare to analyse data and spot patterns. Factories are becoming increasingly automated, while it also has the potential to reform agricultural practices, making food systems massively more efficient. The possibility for disruption that AI can bring to industries is virtually limitless. Almost all industries could benefit from AI taking over repetitive tasks that humans perform, whilst also adding insights delivered by analyses of big data sets.

Governments around the world continue to invest in supercomputers that rely on the capabilities of AI to process great magnitudes of data. The UK has recently entered this tech arms race with the latest budget, promising a billion pounds to help develop exascale supercomputers. These computers have more than one thousand times the power and ability of today’s most advanced computers and are pivotal to the enhancement and uptake of AI.

We have exposure to the AI megatrend through large-cap US equities in our managed portfolios. Although it’s important to note that one should be cognisant of the high valuations of equities with broad exposure to the AI megatrend.