Twelve months ago, 85% of economists and market analysts expected the US and global economy to fall into a recession and investors were voting with their feet – equity fund outflows in 2023 ended up being both protracted and significant.

Yet a recession did not transpire and equity markets delivered a decent set of positive returns for investors, especially in the US.

Today, the market is leaning more towards an expectation of lower inflation, no recession and significant interest rate cuts. This is a goldilocks-like scenario that is far from guaranteed, and there are early signs already in 2024 that investors may be stepping back from this narrative.

Documenting a market outlook is always a humbling experience and we don’t claim to hold a crystal ball in our market assessments. The experiences of 2023 are a good example how difficult it is to make precise macro forecasts.

See also: Baroness Dambisa Moyo: Why traditional multi-asset portfolios may lose their shine

The investment arena may appear daunting given these macro-economic uncertainties, but we are seeing many exciting investment opportunities which warrant capital in a multi-asset portfolio. Within equities, overall market multiples appear reasonable – running not too hot, and not too cold – with all major countries better placed than they were a few years ago from a valuation standpoint.

US equities should continue to play an important role in portfolios, although the concentrated rise in the Magnificent Seven has created opportunities to add selected value, which looks especially interesting in smaller, value-oriented companies.

One long-term risk is the lack of earnings growth. Last year we saw stock prices rising in the United States due to multiple expansion, rather than due to earnings uplifts.

One potential reason for the expansion of multiples this year was a belief that central banks would quickly and aggressively pivot to rate cuts. However, markets are currently pricing in five interest rate cuts in 2024, which appears quite optimistic to us.

Financial services, squarely a cyclical value-leaning sector, leaps out as inexpensive with low expectations. Rising rates and the 2023 US banking crisis led the sector to underperform. We believe much of the risk here has been discounted and that US banks are worth a look.

Outside of the US, the broad opportunity in emerging markets has grown more significant during 2023 as those stocks have lagged their developed-market peers.

Much of the performance drag can be attributed to Chinese stocks as investors weighed looming geopolitical and secular growth concerns. The aggregate sentiment toward emerging markets remains bearish in absolute (compared with its own history) and relative terms (compared with developed markets). As a result, we are happy to allocate capital to emerging markets, with a focus on Asia.

See also: Head to head: Will the year of the dragon herald better times for China?

Fixed income is perhaps even more interesting than equities given the level of starting yields – which historically are highly correlated with returns – are near the highest levels since the global financial crisis. Real yields also remain elevated as inflation continues to abate.

An interesting feature of the yield curve is that the inversion remains pronounced and therefore yields on short-dated bonds exceed those of long-dated debt.

For investors with a more cautious mindset or shorter time horizon, we see short-dated bonds having appeal. However, if we do see inflation risks continue to recede, it may not be possible to lock in today’s long-term rates in the future. For investors with longer horizons, we would suggest exposure across the maturity profile and our portfolios’ duration is longer than it has been for many years.

We believe there is no need to stretch for yield. We prefer investment grade risk to high yield, with the latter offering investors relatively tight credit spreads when compared to historical averages. Corporate fundamentals look solid, and near-term refinancing risk is low, but we prefer allocating risk to other parts of the investment universe.

Mark Preskett is senior portfolio manager at Morningstar

This article was written for our sister title Portfolio Adviser

The economist and author tells our sister title Portfolio Adviser there is a “tug of war” debate as to whether rates will return to near-zero levels as inflation falls, then revert to a ‘new normal’ of 2% or lower; or whether the past two decades of ultra-low interest rates were an anomaly, and that they are set to return to a more normalised range of 3-5%.

Depending on which scenario comes to the fore, she says there will be significant ramifications on which asset classes will outperform, and which will struggle, over the medium-to-long term.

“Anything where the opportunity to generate returns is based on a low rate is going to suffer. So, anything that relies on leverage or on taking outsized bets – I believe venture capital falls into this space, for example,” she says. “This is why I don’t think the Targeted Absolute Return sector is winning right now, either.

“Of course, there is a debate as to whether we will return to a low rate environment, in which case these opportunities could become interesting again. But given what happened to markets in 2022, 2023 was a case of going back to basics and asking: ‘in a higher cost-of-capital environment, where will the genuine returns come from?’”

Over the last three full years, equity and corporate bond market returns have varied widely. In 2021, the MSCI All-Country World index achieved a total return of 19.6% while the Bloomberg Global Aggregate Corporate Bond index fell 2%. Then in 2022, global equities suffered with the MSCI ACWI falling by more than 8%, while global corporates also lost more than 6%. Both asset classes achieved positive returns last year at 15.3% and 5.5% respectively, according to data from FE Fundinfo.

These returns coincide with varying moves from developed market central banks in a bid to curb rising inflation. When central banks embarked on interest rate rises at the end of 2021, bonds suffered while economic uncertainty weighed on equities. Rate hikes continued throughout the course of 2023, with inflation beginning to fall by varying degrees across the US, the UK and Europe.

“In 2023 there was a lot of discussion about value investing returning to the fore,” Baroness Moyo says. “If we consider the businesses which can survive over the long term and generate real returns above the cost of capital, these types of businesses certainly do look interesting. Which is why what happened in 2023 was odd, because the performance of growth stocks such as the Magnificent Seven was an anomaly in terms of the mood music of markets, given the interest rate moves we had seen.

“In short, it has been too easy to make good returns in bog standard, traditional multi-asset portfolios. You didn’t have to go into long/short portfolios, or venture capital, or anything that required a lot of leverage to make returns. And in fact, it is those areas which have now become higher risk. So, for now, I would argue that it is still very difficult to make the case for people to allocate capital to absolute return strategies.”

See also: Morningstar: Are basic allocation strategies still relevant?

The economist says that, while investors started 2023 “excited about credit”, given interest rate expectations, they are now beginning to hold off and question longer-term themes, given continued economic uncertainty.

AI and decarbonisation

“I would argue that there are two huge key themes. One is AI; hence the Magnificent Seven breaking out of that value anomaly last year. The second one is decarbonisation,” Baroness Moyo – who is also co-principle at the Versaca Investments family office – says.

“The last time we had a catalytic move in the economy on a structural basis was the 1980s, when we saw tech investment opportunities. This is the next one.”

These two themes spell a “real fundamental shift” in how economies will work in the future and therefore which assets will perform well, the economist says, although she adds that the cost of capital “obviously matters” in terms of how people will play these markets.

In addition to historically higher rates, Baroness Moyo says geopolitics have become more volatile – at a time when markets are pricing in interest rate cuts.

“I don’t think anyone over the last year would have accounted for two wars, the announcement of 11 countries joining Brics, swing states – real issues that could now be re-inflationary,” she warns.

“US inflation still stands at 3.1%. Germany is in a recession and Europe is weak, which could signal that rate cuts could be on the docket.

“Geopolitics could be incredibly disruptive, and could mean we live a ‘higher for longer’ environment and that is set to continue.”

Finding dislocations

Alongside moving out of leveraged plays, this uncertain backdrop has also led Baroness Moyo to play equities more “opportunistically”, holding out for market dislocations in favoured sectors such as healthcare, or more attractively-valued companies set to benefit from AI.

“We are mostly looking at AI on a ‘wait-and-see’ basis for the reasons that I mentioned. But if we start to see real productivity gains and genuine possibility for disruption from AI, I think it will be an opportunity.

“What does this mean for us? It means a skew towards taking money out of equities and putting it into cash or bonds, and waiting for opportunities in these much more structured bets such as AI.

“If it is true that, over the next 20 to 30 years there will be a fundamental shift in how the world operates, we want to be a part of that. So, the best thing to do is to dip in and take some money out of markets where we could be losing and put it into bonds, which are earning us 5.5-6%, until there is more clarity around how best to play the AI space.”

That being said, Baroness Moyo has “taken a nibble” at some less widely-held stocks she believes are attractively valued such as US healthcare provider HCA and cloud-based software company Salesforce.

Not-so-magnificent Seven?

When it comes to the Magnificent Seven stocks – many of which have become synonymous with investing in AI such as Nvidia, Amazon and Alphabet – Baroness Moyo is less tempted and says valuations are “too rich”.

“I understand the whole euphoria; it’s the New Year, let’s all get excited. But the market has sold off a fair amount already, coming into the year.

“But when it comes to the Magnificent Seven, which are trading on high price-to-earnings multiples… We had a bad 2021, a mixed 2022 with a big skew to certain stocks. In 2023, my sense was that people were waiting and seeing. And now, I think people are waiting for that first rate cut, then they are going to bank as much of that return as possible.

“So if anything, I’m worried that markets are going to sell off. Not initially, but I think institutional investors could be waiting for a rate cut and a market rally, at which point they will bank their gains tactically.”

The other risk with the Magnificent Seven stocks, says Baroness Moyo, is that they account for a very significant proportion of the S&P 500. According to data from Yahoo Finance, this handful of companies accounts for 29% of the US index’s entire market cap.

“If I look at the Magnificent Seven versus the 493 remaining stocks in the index, and I had to take a bet on either a bigger rally among the Magnificent Seven, or a revenue catch-up from the 493 others, I am going to bet on the catch-up,” she reasons.

“Do I believe that tech is the future? Absolutely. But we are talking about a numbers game here. I am looking at multiples and margins, the ability to grow top-line revenue and the ability to cut costs.

“On that basis, I think it will be harder for those very efficient larger companies, which achieved enormous gains in 2023, to continue that growth. I think a lot of value has been squeezed out of the Magnificent Seven, and a lot of that value is now dependent on how they execute on AI.”

Value in energy

In contrast, Baroness Moyo says the energy sector offers attractive valuations. “Why? Because we’re consuming 100 million barrels of oil every day across 8 billion people. People need energy to live – whether that is from fossil fuels or from renewables. That is an area where I think there have been relatively bad returns, but there is real opportunity for upside.

“For me, value investing is about a compelling sector-based narrative that is based off of basic needs, such as food, energy and transportation. But these companies have to be well-run. You have to be able to look at the margins, the fundamental demand and what that might mean for long-term opportunities, in order to generate risk-adjusted returns above the cost of capital.”

For the economist, this could mean investing in companies which provide fossil fuels and are looking to embark on the transition to net zero, as well as those leading the charge on reducing our dependence on carbon.

See also: Canada Life’s Sriharan: The rules of engagement on asset allocation have changed

Zambia-born Moyo says: “When you have been raised in an environment – like I have – where electricity and water is not automatic, you have a very different understanding of how difficult it is to deliver energy and deliver water.

“In the west, there are a lot of people who have good intentions for us to move and transition into this new equilibrium, which is renewables-based. That’s fantastic. I don’t know anybody who is against that.

“However, we have to be sensible about what the costs of that journey are and how easy it is to execute. It’s 2024 and there are many countries around the world which cannot create energy on a sustainable basis. And I’m not just talking about desperately poor countries – this includes middle-income countries like South Africa. Even California has suffered from energy disruption.

“This, to me, is precisely the dislocation that presents investment opportunities. The vast scale of our energy requirements, the need to transition, and the requirement to find the best companies at actually providing this.”

Has Japan turned a corner?

On a regional, macroeconomic basis, Baroness Moyo is positive on the US and Japan. When asked whether Japan has become a consensus trade, given its recent stockmarket rally, Baroness Moyo says there are two key reasons the market has performed so well. “One is technology and the other is energy – the two big long-term trends driving markets. These are massive pivot points for the world, and I think people see Japan as very much at the coalface of that.”

But people have been predicting a “new dawn” for Japan for decades – since its economy slumped throughout the nineties. Is the recent recovery the real deal? The economist does indeed believe the country has “turned a corner”.

“It’s extremely difficult to run an economy, to get a slow economy moving, and to get businesses and companies to work efficiently. There is a whole potential system of errors – a lot of things have to go right, and we have seen in the past how quickly things can fall apart. Germany was a huge economy doing well, and look how quickly it has come off the rails,” she explains.

“Japan has a lot of things going right for it. It has strong levels of high education, it has a business sector which is sharp and knows how to innovate. It is difficult for a country to put these things in place.

“We have seen it in the UK – I often talk about how, 15 years ago, business was a big piece of the story. Business accounted for a large part of the UK economy; everyone was talking about the banks, Rolls Royce, Marks & Spencer. Today, that is less the case.”

Home market

Indeed, while the Topix has gained 9.2% over the last six months alone, according to FE Fundinfo data, the FTSE 100 has achieved less than one quarter of these gains over the same time frame, at just 1.3%. It has also achieved less than half of the gains of the MSCI All-Country World index over the last five and 10 years. Does the UK market present a value opportunity?

“I’m afraid it will still be a case of ‘wait and see’ for the UK. There is a lot of hope that this is the home of industrial revolution; that we can get back to business and back to clarity. But the business and markets have become so intertwined with politics that there is risk,” Baroness Moyo says.

See also: Facing the inflation dilemma head on

“It is at the point with politics where business has not been able to work without a political overhang creating costs from a regulatory perspective, and from a risk mitigation attitude when it comes to investing.

“In the US, if I talk about AI or the energy transition, the first question people will ask me is how much money they could make if they invest $1 – what return would this generate? When I have the same conversation in Europe, the first question is how to mitigate any risks coming from those themes.

“Our only way out of this is to find some kind of balance between these two attitudes. I’m worried that a lot of conversation in the UK is still very top down and government led, where people would rather kill off investing in certain areas, rather than use innovation to solve any issues.”

Emerging markets

Baroness Moyo is also reticent to invest in emerging market equities, arguing there are other areas where investors can generate “considerable returns, above the cost of capital, without the inherent risk”.

“I understand the arguments on paper. The macroeconomic arguments are very compelling. But as a practical matter, life is too short,” she says. “It sounds flippant, but it’s fundamentally true. Investors only have a certain number of years to make returns. That doesn’t mean they can’t ultimately achieve gains and compound those returns. But why take the risk by putting your capital in a market with slowing growth geopolitical risks and FX problems? It’s very hard.

“In my case, I only have 20 years to compound any returns. Why would I waste my time trying to work my money in an uncertain environment? Yes there could be some outside bets but I am willing to leave that money on the table.”

See also: Top five investment themes to look out for in India in 2024

She cites India as an example which is popular among investors. According to FE Fundinfo, the MSCI India index has returned 26.3% over the last year – more than double that of the MSCI ACWI.

“Lots of people say they are going to make billions by investing in India. Good luck to you, but I am willing to reduce my basis-point returns and not have to deal with the risk,” she reasons.

“Would I ever say India is never going to make it? No, it’s not my place to say that. But what I will say is it is extremely difficult to generate predictable returns in that kind of environment. There is a lot of red tape; it is definitely skewed towards locals winning over the foreign partner. It doesn’t have a great track record.

“People have to understand it’s not free money; there are other places you can invest and generate returns with relatively little risk.”

This article was written for our sister title Portfolio Adviser

In an environment of falling inflation but rising geopolitical risk, what should investors expect from global equities this year and where should it fit into their asset allocation plans?

In this head to head, Alison Savas (pictured right) of Antipodes looks at the factors that drove performance in 2023 and explains her cautiousness to begin 2024, while Rathbones’ David Coombs (pictured left)  explains why his equity portfolios will continue to be dominated by the US in coming months.

Alison Savas, investment director, Antipodes Partners

Global equities had a strong 2023 driven by the seven largest tech stocks for most of the year, until the back end saw an increase in breadth.

The 2023 laggards have begun to lead the market on the view that inflation has been vanquished, meaning rates will fall while economic growth and employment can remain intact. This is one possible outcome, though we see greater uncertainty ahead with risks around an inflation wall, tightening liquidity and the delayed ramifications of tight policy. We expect greater volatility around the economic cycle and lower equity multiples.

The pathway for inflation is down but the last mile may be harder to achieve than expected. We see core inflation getting stuck around 3% mid-year, owing to a sticky shelter component resulting from a large and continued undersupply in US housing.

We expect some rate cuts over 2024, but with the market already pricing in around 140 basis points in cuts, the risk is disappointment over the pace of loosening. If the Fed cuts too early it could reignite inflation. Investors need to be open to rates staying higher for longer.

We also expect liquidity to tighten from Q1 as the very large fiscal deficit in the US will increasingly need to be funded via issuing long-dated bonds. With the Fed out of the market (adding to supply via quantitative tightening), banks, insurance companies and households will need to soak up this issuance, which means less capital available for holding other assets.

A supportive liquidity environment in 2023 disproportionately benefitted a narrow set of winners, so a deterioration will have implications for equities. Investors should focus on finding tomorrow’s winners rather than wedding to yesterday’s success stories – and paying a fair price for the quality of a company and its growth profile, not any price.

Our base case remains a mild recession in the west. The US has been more resilient as the transmission of tighter monetary policy to the real economy has lengthened largely due to the prevalence of fixed rate mortgages, but the threat of tight monetary policy may not have passed.

The labour market continues to loosen and nominal wage growth is slowing. The US could still experience a downdraft in activity, for which US equities are not priced. At 21x, earnings valuations are expensive relative to history and other regions like Europe (11x) and China (9x), which have already experienced an earnings downgrade cycle.

‘Picks and shovels’ play

The Antipodes global portfolios remain relatively defensively positioned with exposure to attractively priced healthcare stocks (such as Merck and Sanofi) and consumer staples (Diageo, Tesco). We’ve been selectively adding to global cyclicals that have attractive supply/demand dynamics (TotalEnergies) or are exhibiting bottom-of-the-cycle characteristics and are priced on low multiples.

But despite the risks, opportunities exist. We’re finding beneficiaries of emerging investment cycles in energy transition and cloud/AI monetisation that remain mispriced. Companies such as Siemens, a global leader in factory automation, energy efficiency systems that manage power consumption and rail signalling equipment.

Siemens not only benefits from the move to a lower carbon world but also onshoring. Also, Taiwan Semiconductor Manufacturing Co, the ‘picks and shovels’ play of the AI age. TSMC manufactures chips for semiconductor companies globally, with a near monopoly at the leading edge.

We’re also finding opportunities in emerging economies like Brazil, Mexico and Indonesia. Fundamentals are improving, inflation is under control and there’s scope for policy rates to fall. Examples include one of the leading private sector banks in Brazil, Itau Unibanco, and the dominant convenience store operator in Mexico, Fomento Economic Mexicano.

If it becomes more apparent that the Fed can engineer a soft landing then we will lean into our cyclical exposures – mature cyclicals and beneficiaries of long duration investment trends – and ex-US listed multinationals are an attractively priced way to play a soft landing.

David Coombs, head of multi-asset investments, Rathbones

We broadly left our equity positioning unchanged over 2023, despite the macro noise, but did take the opportunity during the summer to trim our positions in the five members of the ‘Magnificent Seven’ we held.

We also added to our medical-technology names in Q3 as they sold off on concerns relating to falling demand for their products as weight reduction drugs cured obesity for all – according to the prevailing narrative at the time.

It is easy to overgeneralise, but I think it is safe to say our focus has been on quality and growth with a significant bias to the US, given our view that the US would avoid a recession in 2023. This is despite the negatively sloping yield curve, due to fiscal stimulus offsetting higher interest rates.

We continue to see long-term opportunities in med-tech and, more controversially, in industrials benefiting from the US spend on infrastructure. Both do come with challenging valuations and the promise of more volatility as sentiment swings from ‘soft to hard landings’ and back.

Legislation such as the Inflation Reduction Act and the Chips and Science Act are encouraging investment into manufacturing through incentives worth many billions of dollars. We also believe the trend towards onshoring, where companies look to move some of their manufacturing operations closer to home is benefiting a whole ecosystem across industrial America.

This should continue whoever is elected president at the next election as the US aims to shore up its supply chains and encourage further investment into strategically important sectors.

Working hypothesis

As we head into 2024 we think that with rates having risen so far and so fast, this will weigh on economic growth. But inflation is likely to continue to trend down, which is probably what prompted Fed chair Jerome Powell’s December ‘Pivot press conference’ with interest rate falls back on the agenda, resulting in a relief rally for interest rate sensitive sectors such as Reits and retailers.

We remain cautious in this regard, with a working hypothesis that rates will stay higher than the more optimistic commentators are predicting. This keeps us away from more highly leveraged areas or deep-value cyclicals. So our equity portfolios will continue to be dominated by the US this year.

Elsewhere we have concerns around UK growth, and while the impact of economic policy may not have a material effect on the FTSE 100, which is largely full of global businesses, we maintain limited exposure to companies with significant revenues from the UK economy in the portfolios. The Bank of England, at the time of writing, seems hell bent on creating unemployment and a recession to reduce inflation – mostly caused by external factors – while the government and opposition looks to squeeze businesses and the consumer through a high tax regime.

Europe could be interesting if there is a resurgence in the Chinese economy, which seems more likely than it has since Covid. We see value in many mid-cap industrial names, which have had a torrid few years. We also expect the European Central Bank may turn more dovish by Q2. Asian and emerging markets could benefit from a weaker dollar if US rates start to fall. However, within a multi-asset context – or from a risk/reward perspective – we still prefer to own businesses in the US and Europe with customers in the region, rather than owning local companies.

In 2024, we expect there will be greater dispersion in share price movements and a broadening out of performance leadership. This is due to the impact of multiple years of higher costof-capital starting to feed through into operating margins. Forget geography, access to cheap capital is the key to success – together with sector dominance and markets where the consumer still has money to spend.

This article was written for our sister title Portfolio Adviser’s January magazine.

In a commentary note, the fund rating firm’s client engagement manager Katie Sykes and MPS accounts manager Scott McNiven noted the conflicting signals in the global markets.

“2023 hasn’t quite been the disaster area expected when it comes to recession, but savings built up by households and businesses during the pandemic must be nearing depletion point by now,” they said.

“Government influence through spending and taxation is coming to an end and with the cost of living having skyrocketed over the last two years, refinancing needs are back with a vengeance in an environment of credit tightening.”

See also: What does 2024 hold in store for the wealth management industry?

The pair acknowledged the prevailing view is that interest rates have peaked as inflation is being brought under control, but the timing on rate cuts remains very uncertain.

The question of whether central banks will wait until damage from higher rates becomes ‘obvious’ or move early enough to avoid a recession is a crucial one.

“Europe is slowing down faster than the US and we’re already seeing signs of a recession,” they noted. “Will this direction of travel take hold, and will we see the same trend in the US in the coming months?”

“Wall Street seems convinced that a soft landing will be achieved, and a deep recession avoided, but economic growth will be slow as a result. No matter where you’re placing your bets, it’s all to play for in 2024 and the mood may shift at pace.”

Turning to equities, RSMR urged caution over the ‘Magnificent Seven’ US giants that dominated the stockmarket last year: Apple, Amazon, Alphabet, Meta, Microsoft, Nvidia and Tesla.

See also: Mattioli Woods eyes ‘robust acquisition pipeline’ as assets inch down to £15.2bn

“Coming into 2024, between them, they were worth more than the stock markets of the UK, Japan, France, China, and Canada combined,” they said.

“They now make up roughly 20% of the global stockmarket and last year their shares rose by around 70% on average, heavily contributing to stock market gains as a whole. If you had them in your portfolio last year, you were likely to be sitting pretty, but the outlook for 2024 may not be quite so marvellous.”

RSMR added that data from Refinitiv shows market shares of the Magnificent Seven fell by $316bn over the first two trading days of 2024.

“Given that they have many similar characteristics, one thing seems likely – if one falls, the domino effect will render them all much less magnificent,” they noted.

The firm pointed to emerging markets  as potential bright spot with companies expected to have higher earnings growth than the developed world in 2024.

“Divergencies exists of course and not all countries will profit to the same degree, but emerging markets equities should benefit from an improving growth premium and increasing exports, forging a brighter earnings outlook.”

China remains a concern, but there are some positive signs. “Investors have been concerned over slowing growth and high levels of debt and with investment in real estate in China floundering in recent years, there’s definite room for improvement,” the RSMR team said.

The firm also noted industries in China such as aviation, healthcare, renewable energy, and high-end manufacturing are showing ‘high growth potential’ and are open to foreign investment.

See also: Schroders launches multi-asset income fund

The AI theme is very much in play in China, with the direction of global AI governance and China’s role in the developing panorama being something to watch.

RSMR also said India has ‘gone from strength to strength’ in 2023 achieving 7-8% economic growth and prospects remain bright, supported by mainly domestic demand. By 2028, India’s economy is expected to be bigger than Germany and Japan, making it the third largest globally.