Whilst believing that the global economy continues to slow, I expect healthy asset returns during 2024. This may seem paradoxical, but largely driven by the belief that major central banks will ease policy during the course of the year.
First, the bad news. I think that high interest rates and the recent bout of inflation have caused a deterioration in economic performance. Europe is already on the brink of recession and I worry US consumers have already depleted their savings.
Hence, I fear that global growth remains on a downward path. That is often associated with poor returns on riskier asset categories. However, the good news is that weak growth is helping to lower inflation and that, as a consequence, central banks are likely to soon start reducing interest rates.
Indeed, the Chairman of the US Federal Reserve said as much after the December policy meeting.
The right bond mix
That potentially opens the door to better asset performance, especially as developed world interest rates and bond yields are higher than for much of the post-GFC period. This gives not only more attractive income on bonds than for some time, it also gives the possibility of capital returns as interest rates decline.
Yield curves usually steepen when central banks ease, meaning that short rates fall more than longer rates. However, longer maturity bonds usually outperform shorter dated instruments due to the beneficial effects of duration.
My embrace of risk is further accentuated by the overall regional split which favours Europe and emerging markets.
Hence, I prefer longer maturities to shorter maturities. One consequence of this is that I expect better returns on a range of fixed income assets than on cash, so I have reduced cash to zero within my ‘Model Asset Allocation’.
Across fixed income assets, my favourite category is investment grade credit, which is maximum weighted within my Model Asset Allocation (I prefer it to government bonds as my defensive selection).
In particular, I like emerging market (EM) investment grade credit due to what I believe is an attractive spread versus the one in the developed world.
I also like high yield credit, though the narrowness of spreads in the US and a potential rise in defaults temper my enthusiasm. (I am overweight but not as much as for investment grade credit).
I would normally prefer high yield credit to bank loans at this stage of the interest rate cycle (bank loans have virtually zero duration). But I find bank loan yields to be particularly attractive at the moment and am also overweight this asset category.
Though I find government bonds to be more attractive than for some time, I remain slightly underweight versus my neutral position, again finding EM to be the most attractive region.
Though riskier assets may benefit as interest rates decline, they may also suffer as economies weaken. In particular, industrial commodities are struggling as the global economy slows, as illustrated by the gradually weakening oil price, despite OPEC+ attempts to restrict supply.
Short-term volatility
Hence, I wouldn’t be surprised to see short term volatility in assets such as commodities, equities and real estate, though I would expect more consistent performance as economies reaccelerate in the second-half of 2024 (aided by lower inflation and falling interest rates).
Looking across the year as a whole, I have added to my equity allocation but remain underweight (largely because extreme concentration makes me wary of capitalisation-weighted exposure to the US market). Across equity regions, I prefer EM (especially China) and Europe.
Otherwise, within equities I expect outperformance by stocks and sectors that have been most impacted by the rise in interest rates and the deceleration of economies. This leads me to size (small caps) and value among factors and sectors such as real estate. (I am overweight real estate (REITS) within the overall Model Asset Allocation).
I would also expect banks to outperform as yield curves steepen, especially in the US and the UK where asset-liability mismatches are a bigger part of the banking model.
I have deployed the cash reserves within my model asset allocation and adopted a more aggressive approach by adding to a range of assets. My embrace of risk is further accentuated by the overall regional split which favours Europe and emerging markets.
