Strategically Positioning for the Cycle’s Next Phase
PGIM asset managers share key trends shaping the second half of 2024 and ideas to capitalise on opportunities in the next phase of the cycle.
KEY HIGHLIGHTS
- Equities had a strong 2023, though performance was concentrated in a handful of growth stocks
- The Bloomberg US Aggregate Bond Index has yet to fully erase its losses from 2022, setting it up for at least some potential gains
- With equity/bond correlations remaining positive, portfolio diversifiers such as commodities are potentially attractive
U.S. SOFT LANDING LIKELY DESPITE DOWNSIDE RISKS
Equities had a strong 2023 even though performance was concentrated in a handful of growth stocks. While some of the banking system-related troubles continued to keep markets volatile, stocks—especially in the Information Technology sector—surged amid excitement around artificial intelligence. Government bonds struggled, pressured by sticky inflation and rate hikes in 2023. The Bloomberg U.S. Aggregate Bond Index has yet to fully erase its losses from 2022, setting it up for at least some potential gains in 2024.
Inflation has moved steadily lower, with some hiccups, since peaking in 2022. While the Fed’s urgency in hiking seems to have done its job, any stubbornness in inflation coming down to target could keep the Fed on hold for longer, wrong-footing market participants for the umpteenth time. It's hard to see a resurgence of higher rates, barring unforeseen events or shocks. Those aside, lower inflation and a dovish Fed point toward rates being flat to lower from this point forward, albeit with some higher-than-usual volatility as the Fed remains data-dependent.
A U.S. recession does not appear to be in sight. Hard data remains resilient and soft data appears to have bottomed with even the weakest parts of the economy, such as housing and manufacturing, seemingly turning a corner. As we look ahead to 2024, economic and market resilience seem to have legs, and we believe that the probability of a significant left-tail outcome has lessened.
EARNINGS EXPECTATIONS REMAIN SOLID
Following modest growth in 2023, consensus expectations are for low double-digit growth in 2024 as the economy cools, with many industries having already experienced an earnings recession and a tightening of purse strings, setting the stage for margins to improve. Labor productivity has also accelerated in recent quarters. Even if current expectations get revised lower, earnings growth could still turn out moderate barring a hit to sales due to a significant slowdown in the economy. Outside the U.S., expectations are for moderate growth in other developed markets and for a double-digit rebound in emerging markets after declines over the past two years.
Higher rates and slower growth are likely to keep major asset classes volatile, reducing the confidence to handicap their relative risk-adjusted performance in 2024. Investors face a dramatically different landscape for building diversified multi-asset portfolios than in the period prior to the Fed’s latest hiking cycle. Equity/bond correlations remained significantly positive heading into 2024 following a generation of the relationship being negative. As such, the traditional hedge that bonds provided investors in periods of equity market turbulence is more tenuous. While higher rates have generally improved our long-term outlook for multi-asset portfolios from a return perspective, building a diversified portfolio has become more challenging in a regime of positive stock/bond correlation.
Stocks’ correlations with diversifiers such as commodities and safe havens (like gold) have turned negative, making them potentially attractive from a portfolio context in 2024.
UNEVEN GLOBAL GROWTH OUTLOOK
Outside the U.S., Japanese private consumption will likely be supported by pent-up demand, stronger wage growth, and the government’s new economic stimulus package. Business investment is likely to benefit from the subsidies for green and digital investment and high corporate profits.
Meanwhile, Eurozone economic activity is expected to struggle in early 2024 with the manufacturing overhang. While the U.S. has been able to shake off Fed rate hikes, ECB rate hikes have put the Eurozone economy in a more precarious position. Although private investment will likely remain under pressure until financing costs ease, private consumption continues to be supported by tight labor markets and receding inflation as real incomes improve.
China’s economy is expected to moderate but still grow at a solid pace in 2024. The ongoing transition to a more consumption-led economic model remains fraught with risks. Ongoing adjustment in the real estate sector is driven by falling investment and continued financial stress. Given the diminishing returns from infrastructure spending, the government is moving away from this as the main strategy for boosting growth. Exports are likely a modest contributor given slower global growth and tense trade relations with the U.S., which are unlikely to improve with the upcoming U.S. elections in November 2024.
VOLATILE BUT MODEST RETURNS FOR COMMODITIES
Commodities returns are likely to be moderate but volatile after a down year in 2023. Tight monetary policy and a strong dollar were negatives in 2023 but could reverse in 2024. OPEC+ is expected to continue to manage supply expectations by maintaining its guidance on supply. However, there are still downside risks from sharply slower global growth and higher-for-longer interest rates.
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