The world economy looks set to achieve a remarkable soft landing in 2024 – this will continue to support global equity markets, but quality and focus will be key.
The MSCI World Equity Index has risen by almost 8%[1] this year, delivering its best first-quarter return in five years. Gains came both from rising corporate earnings, especially among AI-linked technology names, and from higher valuations in Europe and Japan, as last year’s US-centric market has begun to broaden.
Investor sentiment has been buoyed by a global economy that should see inflation return to close to central bank targets by year-end, without triggering recession. Engineering a soft landing such as this is notoriously difficult, but a near picture-perfect one looks increasingly possible in 2024.
Yet, as markets reach new highs, investors could be forgiven for feeling queasy. It was little more than a year ago that they faced near double-digit inflation and one of the most aggressive interest rate tightening cycles in recent history.
In addition, geopolitical challenges have emerged in quick succession, including Europe’s biggest land war since 1945, the risk of regional escalation in the tragic Israel-Hamas conflict and, of course, an uncertain US election.
The key question for 2024 is not hard to frame: should investors embrace the soft-landing narrative and add to equity risk, or is this the moment to step back and raise cash, in the face of rising market complacency?
It looks like a global soft landing…
The economic transformation achieved over the past 18 months is certainly impressive. High inflation appears to have been quelled across the western world, with little penalty in terms of growth or employment. True, US consumer prices ticked up modestly last month (from 3.1% to 3.2%, driven by used cars and housing), but we expect a further fall to around 2.5% by the end of 2024. In the UK, the year-end figure could be even softer, at 2.1%[2].
At the same time, US growth has remained robust (annualised gross domestic product or GDP grew at 3.4% in Q4 2023) while unemployment, at 3.8%, is very close to the lows of the last 50 years. Indeed, the International Monetary Fund (IMF) now sees something close to a soft landing as the most probable outcome not just for the US, but for 15 of the G20’s members.
It is worth remembering that soft landings are typically difficult to achieve. The US has only truly succeeded in making two soft landings: in 1995 under Chairman Greenspan and before that in 1965, under the longest-serving Fed Chair, William McChesney Martin. A simultaneous global soft landing, as we are seeing today, is particularly rare.
Can controlled disinflation continue?
So, what lies behind the rapid decline in inflation rates worldwide? First, the remarkable transformation of US domestic energy production has made America both the largest oil producer and gas exporter in the world. This has stabilised global supply and offset restrictions on Russian exports. Despite conflict in Ukraine and Gaza, and production cuts from the Organisation for Petroleum Exporting Countries (OPEC), oil prices are little changed from the eve of the Israel-Hamas conflict, while European gas prices are 80% lower than their peak, after Russia’s invasion of Ukraine. Yes, there are risks today, particularly in the aftermath of the attack on the Iranian consulate in Damascus this month. Encouragingly though, non-OPEC production continues to rise: Canada, Brazil and Guyana, alongside the US, have all increased output.
Second, supply chains that were severely disrupted by the pandemic have healed remarkably quickly. Even with today’s challenges in the Red Sea (Suez Canal traffic is down 50% year-on-year[3]), measures of transport costs, delivery times and supply chain stress remain at or close to pre-Covid levels. This has helped suppress inflation and underpin corporate profits.
Third, sharply higher interest rates have been a lot less destructive than commentators initially feared. Households in the US and UK have been shielded by fixed mortgage rates while global corporations had already locked in much of their financing at lower rates. The large technology stocks in particular have unprecedented cash reserves and so actually benefit when rates rise.
Sticking with equities and right-sizing risk
To us, equities continue to be the most attractive asset class. Robust earnings and dividend growth, combined with the prospect of lower interest rates from mid-year, continue to be supportive, even after this year’s rally.
Yes, US valuations are high but there is no shortage of other opportunities. Global dividend portfolios are attractively priced, as are many international markets that are trading at near-record discounts to the US. Corporate activity too is re-accelerating. Our climate change theme looks particularly interesting, as decarbonisation gains impetus after world temperatures again hit new highs in 2023.
To stay the course with our global equity exposure we do need to de-risk other areas of our portfolios.
Bond yields, in particular, are trending higher as governments seek to raise near-record new borrowings. A recent OECD report forecasts that debt issuance by 38 industrialised countries will rise by 12% to $15.8 trillion this year[4]. This has been exceeded only once, in 2020, when governments were scrambling to support economies at the height of the pandemic.
Whatever the result of the presidential election, the US – already home to half of OECD sovereign debt – will likely see even higher issuance. A Biden administration will tend to keep spending elevated, while a Trump administration will try to cut taxes (or make previous cuts permanent). Against this backdrop most central banks will no longer be natural buyers of government bonds: instead, they will be actively selling the government debt they accumulated via QE programmes to support the economy and markets.
The risks have not gone unnoticed. The director of the Congressional Budget Office, the US government’s financial watchdog, recently warned that a repeat of the disastrous Liz Truss budget fiasco is possible, even in the US. Central banks are alert to this and will be quick to pause or slow bond sales if market volatility rises, but the disruption could still be substantial. We have reduced exposure to government bonds across portfolios.
Equity concentration risks are ebbing
Encouragingly, equity market leadership has finally started to broaden this year. At the end of March all but one of the S&P 500 sectors delivered a positive return for the quarter, while returns from Asia actually outstripped the technology-rich S&P 500. However, market concentration remains a concern. The first quarter saw both Meta and Nvidia add, in a single day, more in terms of capitalisation than has ever occurred in market history.
Managing concentration risk doesn’t require investors to sell down positions in all AI-related companies. Indeed, their robust growth dynamics provide good reasons to retain them. But it does mean managing position sizes, being disciplined about valuation targets and putting portfolio insurance in place (or overwriting positions), where appropriate, ahead of any unwelcome increased volatility.
Rising real interest rates will squeeze leveraged assets
A further worry is the increase in real interest rates as inflation falls but nominal rates remain high. This has the potential to expose strategically fragile assets and penalise high leverage. Our principal worry here is commercial real estate, where investors are already facing multiple challenges, including remote working, sharply higher funding costs and the need to upgrade buildings to meet tougher emissions goals.
Indeed, many older buildings may have little equity value remaining. Newmark[5], a US real estate advisory company, estimates that $2 trillion of US real estate loans will mature by 2026, of which $670 billion may be troubled. This argues for caution on more leveraged assets, and in particular toward commercial real estate developers and those who have lent to them.
Quality and focus will be key in 2024
With these caveats, the prospect of a soft landing across multiple economies provides powerful support for global thematic equities. But to benefit we must reduce portfolio risk elsewhere – this will mean lowering bond allocations, managing concentration risks and reducing exposure to leveraged, climate-vulnerable assets.
So yes, we will stay the course, but quality and focus will be key to maximise our ability to ride out the shocks that will – almost inevitably – occur.
[1] All data in this article sourced from Macrobond, Bloomberg, 04/03/20224-07/03/2024
[2] Sarasin research, March 2024
[3] IMF, Red Sea Attacks Disrupt Global Trade, 07/03/2024
[4] OECD, Global Debt Report 2024, 07/03/2024
[5] Newmark Group, Financial Results Presentation, 22/02/2024
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