The 5 biggest themes for investors in 2024

A new year may have brought some optimism into the market, but it’s fair to say some of the water cooler conversations haven’t changed. Some of it is speculative, like pondering the RBA’s next move and whether rate hikes are close to an end. Others are more pessimistic, like the dire state of housing affordability and supply.

Same old stories – or are they?

Inflation is finally starting to ease – though the same is unlikely to be said of Australia’s skyrocketing house prices. Consumer spending has dropped off and companies are likely to see this hit their bottom lines.

As the broker puts it: “The other side of the cycle is becoming clearer but the base from which to start is less evident at this juncture.”

While last year was an unexpected story of growth, fuelled by the AI boom, we’re finally seeing the long-awaited economic slowdown and caution is the name of the game.

Morgan Stanley points to five key themes for investors to consider in 2024 and perhaps there’s more change afoot than investors might think.

These themes include:

1. Are earnings about to trough? 
2. A tale of two halves in the consumer market
3. The housing market
4. Capital markets – ending the drought?
5. Small/mid caps v large caps

Theme 1: Are earnings about to trough? 

In the last week, Dominos (ASX: DMP) released its earnings forecasts, disappointing the market and shares fell sharply accordingly. It likely won’t be the only company to disappoint in the upcoming reporting season.

We’re finally seeing a slowdown in consumer spending. While Black Friday saw a surge in spending, the consensus was that it simply shifted Christmas spend earlier. Retail spending dropped 2.7% in December according to the Australian Bureau of Statistics, with household goods and department stores hardest hit. But it’s also worth noting that turnover fell for restaurants, cafes and takeaway food too.

It's not hard to see how this might affect the bottom line for many ASX-listed companies. 

“As it sits today, FY24e earnings have been downgraded by c. 12% over the last 12 months and now reflect something more normal in our view if the global soft landing scenario is found,” said analysts Chris Nicol, Antony Conte and Chris Read in Morgan Stanley’s Investment Primer 2024.

The analysts are concerned that investors are too willing to look beyond 2024 in the hope of better returns in 2025.

What to keep in mind

“Our view is that trading conditions and the economic growth profile are in the midst of a key adjustment phase, the base is being formed for earnings but not found. As such, we retain a degree of concentration and caution into this results season,” Nicol, Conte and Read said.

Or to put it simply, earnings could be reaching lows and start to adjust across the next year. Take care with your investments in what could be a rocky adjustment ride.

Theme 2: A tale of two halves in the consumer market

Consumer spending was more resilient than expected across 2023, meaning many companies in the discretionary sector held up. But consumer spending finally started to drop off in late 2023, as mentioned earlier, and this should start to hit companies across the year.

On the flip side, Morgan Stanley tips improved household income trends, supported by tax cuts and a lack of further rate hikes. It also suggests the savings rate may rise modestly.

Migration was a significant tailwind in 2023, but Morgan Stanley argues it will be smaller in 2024 and ease to around 330,000 as pent-up demand from COVID-19 slows – still above pre-COVID rates but less than the 500,000 rate across 2023.

The household savings rate fell to 1.1% in the third quarter of 2023, a sharp fall from the 25% peak in the COVID pandemic and the lowest savings rate since the GFC.

“While consumer sentiment is at recessionary levels, relatively few workers are worried about losing their jobs – something that we think has also supported the savings drawdown over the past few years,” said Morgan Stanley analysts.

Morgan Stanley tips a broadly steady savings rate over the next few quarters, with a step up in the second half of the year courtesy of rate cuts.

What to keep in mind

Morgan Stanley says the key risk is to the labour market – a faster correction would be a double hit to both household spending and saving.

Aside from that, consumers are looking beyond this year for company prospects.

“So key to sustaining the recent rises in share prices for many consumer-facing names will be second-half financial year 2024 momentum and also margin delivery. Our view remains that thrifting behaviour that started to emerge last year will continue to build whilst financial conditions stay restrictive,” said analysts.

Consumers are starting to save again and consumer-facing brands are going to have to push hard with tight margins leading into 2025.

Theme 3: The housing market

The market has been focused on a potential upswing in property prices, as hopes rise for rate cuts and expectations of a soft landing.

To date, the strength in the residential market has been driven by low supply and high levels of migration, in turn, forcing prices upward. It was also exacerbated by low supply in the rental market.

Morgan Stanley argues that 2024 will not necessarily see similar rises.

The rationale for this comes from weaker indicators for the housing market, such as the sharp deterioration in Mortgage Serviceability and weakness in building approvals. Lower levels of migration should see pressures on supply ease to an extent. The broker is not anticipating rate cuts until 2025 - meaning it is not expecting improvements in mortgage serviceability.

Morgan Stanley also notes that historical data suggests that in previous tightening periods (1994, 2000, 2008 and 2010), building approvals, housing loan approvals and housing sales all declined significantly in the latter part of the tightening cycle – continuing to decline at a slower pace once rates hold. 

Housing prices also typically perform worst in rate hold periods. If we follow that pattern and assume that rate hikes are potentially done, in theory, we should still see that continuing decline in housing indicators and prices for a period.

What to keep in mind

“We think this trajectory is consistent with our House Price forecast for flat nominal prices in 2024 (and therefore a real price decline of ~3%),” said analysts.

That is – don’t bank on big price increases in housing to generate a return.

Morgan Stanley is not expecting much to ease in the rental market – it predicts CPI rents to grow at around 10% through 2024.

In addition, those watching for a construction pick-up shouldn’t get their hopes up, with the broker forecasting a 12% decline in housing starts for the year to June 2024.

Theme 4: Capital Markets: Will the drought break?

Corporate market activity boomed during the COVID-19 pandemic, only to soften as lockdowns lifted in 2022. There’s effectively been a ‘drought’ in terms of M&A and other corporate activity, with analysts noting that “2023 brought the lowest completed M&A volumes in a decade and the lowest relative to nominal US GDP in at least three decades.”

However, 2024 could spell a brighter outlook. Markets are pricing for aggressive easing, and businesses may be more inclined to act with lower costs of funding compared to what we’ve seen in the last few years.

“Pent up demand following two years of extraordinarily weak M&A activity should drive up activity levels as CEO confidence builds. Structural drivers of M&A will support deal activity this cycle,” said analysts.

What to keep in mind

Some of the sectors most likely to see M&A activity in the coming year have historically had significant activity – and continue to see high demand. Materials companies are seeing significant activity, with Morgan Stanley identifying targets such as Lynas Rare Earths (ASX: LYC), Chalice Mining (ASX: CHN), Core Lithium (ASX: CXO) or Liontown (ASX: LTR) (which received bids from Albemarle (NYSE: ALB) before mining magnate Gina Reinhart acquired a large stake as a blocker).

Healthcare is an obvious area for M&A activity, with large pharmaceutical companies looking to bolster their businesses in trending areas like immunology or radiology. Some examples in this area include Mesoblast Ltd (ASX: MSB) and Mayne Pharma Group (ASX: MYX).

Morgan Stanley also sees some potential for targets in equity real estate investment, energy and financials.

Theme 5: Small/mid caps v large caps

Large caps continued to dominate small and mid caps in 2023 – though there was some uplift in December for small caps. Investors are starting to focus more on the small and mid-cap end of the market, hoping for a pivot in performance.

Small-cap performance would be assisted by: a soft landing, easing interest rates (which typically benefit small caps), a rising dollar, a positive outlook for commodities, lower bond yields, a surge in M&A activity, stronger volumes from retail investors and rises in gold prices.

What to keep in mind

Some market indicators would favour better performance in small and mid caps in 2024, but stock selection will be critical.

Some stocks that Morgan Stanley believes look well positioned in the small-cap side include: Siteminder Ltd (ASX: SDR), Audinate Group (ASX: AD8), McMillan Shakespeare Limited (ASX: MMS), Hansen Technologies (ASX: HSN), Healthco REIT (ASX: HCW) and Tyro Payments (ASX: TYR).

A final word

Australia is in a period of slowdown – but it’s not all bad news. Morgan Stanley tips that tax cuts mid-year should offer some early monetary easing for Australians.

“Our bias is to proceed with some caution, particularly given the still-to-be seen full effects from tightening,” said analysts.

We could be reaching the trough – and on the whole, analysts seem to agree that 2025 could be a better year for earnings, but we aren’t there yet so where investors buy, they should do so carefully.