Investment outlook for 2024: Soft landing, recession, or rally?
Investment outlook for 2024: Soft landing, recession, or rally?
- Overall, we see a broadly favourable outlook for risk assets in 2024.
- Rate cuts by the Federal Reserve will support financial markets despite global growth slowing.
- Continue to hold more longer-dated bonds, as such bonds usually outperform before a rate cut.
- Any short-term technical correction is an opportunity to dip-buy into quality companies that can withstand the shock of a US recession.
Expectations of potential policy easing by the Federal Reserve was the final boost that markets needed to end 2023 on a spectacular note. US equities were the main beneficiaries of investors’ exuberance, although bonds did not fare too badly either.
The gains are remarkable, considering 2023 started with a financial crisis and predictions for a recession in the US. On a broader scale, geopolitics also hampered investment sentiment. These should serve as a timely reminder for investors to remain nimble to external shocks and position investment portfolios to tap investment opportunities throughout the year. Our market outlook can serve as a guide to make the process less challenging.
Overall, we see a broadly favourable outlook for risk assets in 2024, as rate cuts will support financial markets despite global growth slowing for the third year in a row.
Central banks and policy pivots
Markets may have run ahead of themselves on expectations of a rate cut by the Federal Reserve (Fed). For the data dependent Fed, November’s jobs report showed the US labour market remains firm, while core inflation was well above the central bank’s 2% goal. These gave officials cause to keep the fed funds rate at the 5.25-5.50% range in December 2023.
However, overall data is trending down. Third-quarter personal consumption data came in softer than anticipated, and slightly more US workers applied for unemployment benefits in December. The numbers support the market narrative of a cooling economy that could see interest rate cuts from the Fed.
Despite this, the prospects of early rate cuts in 2024 are slim. The Fed is likely to keep its tightening bias in case inflation remains sticky. We can expect the Federal Reserve to start cutting interest rates only if core inflation falls below 3%, and this could happen by June. It may start reducing interest rates by 25bps per quarter (from June onwards) as the lagged effect of tighter financial conditions work through the economy and consumer resilience.
Consumer spending accounts for about two-thirds of US gross domestic product. There is a possibility that the Fed could succeed in engineering a slowdown in the economy sufficiently enough to conquer high inflation. However, as fiscal policy turns less stimulatory, the US may not be able to avoid a recession. History shows all but five of the Fed tightening cycles since 1950 have ended in a recession.
The US economy may experience a mild recession (~50% likelihood) for two quarters in mid-2024. We expect the negative impact of a mild recession in the US to be more than offset by the positive effects of lower rates on valuations and duration. A mild recession could dent corporate earnings, but earnings growth is likely to be broadly supported in nominal terms.
In a soft-landing scenario (~30% likelihood), the US economy could avoid a recession, while a hard landing (~20% likelihood) could occur if core inflation remains above 3% in 2024, preventing the Fed from cutting rates even as US activity slows. This could result in a deeper recession than our base case.
Elsewhere, we anticipate the Eurozone and UK will only emerge slowly from recession in 2024 while China and Japan are set to slow too in 2024 as exporters face weaker growth, and thus reduced demand abroad.
Falling inflation should allow the European Central Bank (ECB) to start cutting interest rates from its current record level of 4.00% from June 2024 and the Bank of England (BoE) from 5.25% in the second half of next year. But GDP growth will still be only around 0.5% in 2023 and 2024 for both economies.
We think the Bank of Japan (BoJ) will only pivot in April 2024. This is dependent on the annual wage negotiations between enterprise unions and the employers that occur over February and March. If salaries are seen as rising fast enough to let inflation settle around the BoJ’s 2% target, only then can we expect the BoJ to raise its deposit rate to 0.00%. Meanwhile, the dovish stance will keep benefiting Japan’s equities throughout 2024, supported by constructive corporate reforms.
2024: A US presidential election year
We may get some volatility around the time Americans head to the polls in November, but the focus will eventually return to fundamentals as uncertainty fades.
The S&P 500 index during election cycles has demonstrated instances where markets have not only weathered political transitions, but have also shown resilience and provided favourable returns despite the uncertainty. Interestingly, biotech, industrial, and healthcare sectors tend to be favoured under the Democrats, while pharmaceuticals and airlines tend to outperform when Republicans are elected.
How to position your portfolio for 2024
Our conclusion is that the market outlook for 2024 is broadly favourable. An eventual pivot in the Fed’s monetary policy stance in the 2H2024 will benefit risk assets and offer investment opportunities.
1H2024: Market volatility will remain elevated due to uncertainty. It remains uncertain when rates will be cut and by how much. Investors may have been too aggressive in pricing in rate cuts as early as 1Q2024. Disappointment could be in store for bondholders if the cuts do not materialise as expected, leading to a spike in yields. Thus, remain defensive and continue to hold high quality investment grade bonds. More opportunistic investors can consider longer-dated bonds and ride through the volatility in 1H2024 to position for the expected rate cuts in 2H2024.
Continue to be cautious in equities as markets pare back their rate cut expectations. Take advantage of any short-term technical correction in the US to dip-buy into quality companies that can withstand the shock of a recession and benefit once the recovery broadens beyond the Magnificent-7 stocks. Invest into defensive value sectors, such as Healthcare, Consumer Staples and Utilities but keep some exposure to quality growth sectors like Technology.
2H2024: The Fed is expected to begin rate cuts and the resulting lower interest rates will be conducive for bonds, particularly Developed Market Investment Grade bonds and US Treasuries and equities. Equities will likely accelerate and begin to outperform bonds. While the Magnificent-7 stocks would likely be the first to rise, the remaining 493 stocks in the S&P are expected to catch up as the recovery broadens, giving an opportunity for investors to benefit from rotating into the broader US equity market.
A US soft landing scenario will be positive for high yield bonds and more constructive for equities than in the mild recession scenario. Significant market volatility accompanying a hard landing scenario will likely result in downward pressure on both stocks and bonds, like what we saw in 2022, while defensive portfolios will outperform.
Managing expectations against reality
Market movements may not always materialise according to expectations. There are many moving parts on the investment horizon, and any one of it could result in a negative surprise. Hence, investors should not be complacent, but be mindful to invest gradually over the year, rather than attempt to time the market. This would ensure their assets are prudently allocated to insulate portfolios from downturns in any asset or market.
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