Solving for 2024: 10 key themes to navigate the markets

Macro: From supporting the consumer to supporting the industry

#1 - Growing challengers for the consumer

The resilience of the many economies during 2023, particularly that of the U.S. and others that are more services- than manufacturing led, owed much to low unemployment and the excess savings that consumers built through the pandemic. Those excess savings, which were already skewed to wealthier consumers rather than those on middle and lower incomes, are running dry—and we think inflation will likely remain above targets, rates will remain high, housing costs will remain at multi-decade highs and job markets will soften in 2024. Expect a weaker consumer to be at the heart of next year’s economic slowdown.

#2 - Stickier inflation and slower growth may not be so bad for investors

Current projections for 2024 suggest the persistence of above-target inflation and higher rates even as real growth declines. Still, we are a long way from the stagflation extremes of the 1970s, and these conditions mean relatively high nominal growth compared with much of the past decade. This could be tricky for long-dated bonds and interest rate-sensitive equities, but more neutral for quality companies—those with strong balance sheets to shelter against the rising cost of capital, and the ability to sustain margins in a low real-growth environment.

#3 - More fiscal policy dispersion (and debt sustainability questions)

A renewed rise in yields and the return of term premia in both the U.S. (where growth has been resilient) and Europe (where growth has faltered) suggests growing concern about debt sustainability. After three years of near-universal agreement on deficit spending to protect workers and consumers from the impact of the pandemic, debate is likely to open up on the impact of tight monetary policy and expansionary fiscal policy on deficits, and the right balance of entitlement spending, defence and security spending, industrial-policy and energy-transition spending, and interest costs. Some countries will continue to expand fiscal policy (likely reorienting it to finance industrial policy), some will choose to reassert fiscal discipline, and some will have discipline forced upon them by newly hawkish bond markets. A packed election calendar worldwide will likely complicate the decision-making.

#4 - The “awkward age” for ESG

As sustainable investing and environmental, social and governance (ESG) regulation becomes more prescriptive yet increasingly fragmented, investors themselves are becoming more pragmatic and solutions-oriented. These are tensions typical of the graduation from the simplicities of childhood to the complexities of adolescence. ESG and Sustainability will remain a key regulatory focus, but confused by diverging regional approaches. However, investors on the ground will become clearer on the difference between investing for sustainable or impact outcomes on the one hand, and incorporating financially material ESG factors into investment analysis on the other. This will favour asset managers that observe these distinctions internally, bring solutions rather than labels to clients, and have made the necessary investments in personnel and data to genuinely integrate ESG factors into their research and engagement capabilities.

EQUITIES: EXHAUSTED BETA

#5 - Earnings quality and business resilience comes to the fore

In 2022, equity markets were driven mainly by rising real rates: longer-duration growth stocks were crushed. Through much of 2023, there was a lot of sideways drift, with one huge exception: a small number of mega-cap technology stocks benefitted from excess liquidity, a “buy the 2022 losers” momentum reversal, and exuberant sentiment around the potential of artificial intelligence. In 2024, we think the earnings headwinds that began in 2023 will continue to blow. Greater recognition of rising global macroeconomic uncertainties and draining liquidity will refocus attention on valuations, earnings quality and the broader resilience of business fundamentals to slowing growth. Large performance dispersion will likely follow, not just within and across sectors, but potentially also between active and passive management.

#6 - Laggards find (relative) favour

We have seen wide dispersion in the optimism being priced into regions (favouring developed over emerging markets), countries (India over China), styles (growth versus value) sectors (technology preferred to financials) and size (large caps over small caps). We believe markets with a greater degree of pessimism priced in are likely to perform better than those priced for perfection, should growth disappoint or the cost of capital continue to rise. The lurching back and forth between these investment categories that we have seen in 2022 and 2023 could be set to continue.

FIXED INCOME: THE LONG AND GRINDING ROAD

#7 - Supply and demand outweighs fundamentals

Marginal changes in spreads and yields will continue to owe more to supply-and-demand technicals than fundamentals, much like they have in 2023. Modest issuance and keen appetite for higher yields kept credit spreads tight and range-bound through much of 2023. Rising supply of government bonds is impacting risk free yields, and the shape of yield curves. Similarly, high cash yields created strong technical demand for cash and short maturity investments, which is beginning to push the most attractive point for relative value out into intermediate maturities. These technical factors are unlikely to change significantly in 2024.

#8 - A slow rise in idiosyncratic defaults, but elevated tail risk

As higher rates bite into the real economy, credit defaults are beginning to rise and will be a feature of 2024’s credit landscape. We expect credit stresses to be idiosyncratic: companies with longer-dated fixed-rate debt and high-yielding cash on stronger balance sheets, and the ability to sustain and grow margins, are unlikely to experience substantial spread-widening. We also expect the default rate to be low relative to past cycles. But there are caveats. A significant amount of corporate lending has moved into private markets since 2008, and deteriorating credit metrics stretch broadly across real estate and consumer debt, so a low visible corporate default rate may not tell the whole story. And systemic tail risk will be high, given the scale and rapidity of the tightening cycle—as we saw in the mini-banking crisis in 2023.

ALTERNATIVES: DISRUPTION BRINGS OPPORTUNITY

#9 - Where capital is constrained, capital providers can be rewarded

Even though fundraising is down, there is still a lot of dry powder in private markets, just not in all the right places. Exit bottlenecks mean that private equity firms are seeking to squeeze more growth out of their best existing companies, while also providing liquidity for investors that need it. That has led to a rise in demand for investor capital, not for new deals, but for secondaries, co-investments, private credit and capital solutions such as preferred or structured equity. We think these will continue to be the most attractive corners of private markets through 2024.

#10 - Real estate divides into the haves and have-nots

Real estate owners and operators face historic increases in the cost of capital, structural changes in demand for office, industrial, residential and retail properties, and growing geographic dispersion of economic well-being. This will divide owners into the strong and the weak, and compound the advantages and disadvantages. Those experienced players with strong performance and robust balance sheets will be able to continue to cement their market leadership positions. In addition, we think haves, have-nots and volatility will combine to create opportunity in the real estate credit markets

Behind the scenes access

As 2023 ended, the leaders of our investment platforms gathered to talk about the evolution of the investment environment over the past 12 months and the key themes in a roundtable discussion. You can find the discussion here.