What 2024 has in store for investors: Part 3
18 March 2024
In 2024, global interest rates will fall faster than expected. This impacts bond, equity, and currency markets in particular. Lower rates are due to falling inflation and slower consumer spending in the major economies. This means lower earnings, particularly for those markets reliant upon high growth.
Markets are currently not pricing in these risks. The result is a risk to equity markets and an opportunity for some corporate bond investors. Overall, it means that 2024 is a year to be more active, not less.
This article is the third in the 2024 Investment Markets series. The first two articles covered the largest under-researched risks: The implications of China’s slowing economy resulting in them exporting deflation to the world; with the second focussed on the added volatility in 2024 that comes from the unusually large global election cycle.
Risk #3: Market risk and models
The next risk is an unusual one. Market risk is always present, but rarely makes this sort of list as it is usually more predictable. But in 2024, markets will be forced to make a decision that growth will be high, as currently priced into equity markets or will fall.
Right now, growth markets(1) are priced for perfection. This perfection requires an optimistic set of assumptions for inflation, corporate profits, and consumer spending. Some global analysts(2) are already calling for a more defensive stance in equities by shifting to higher dividend (lower growth) stocks or the corporate credit of the same companies. This is a fairly typical strategy at the downturn end of the economic cycle, and in our view, well justified.
Figure 3: Markets priced for perfection
Below is the CAPE (Cyclically Adjusted Price Estimate) ratio for the US equities market from 1871 to 2023. We tend to look at the CAPE ratio as it adjusts for interest rates, inflation, earnings, and other factors that swing around when one looks so far back. And given the recent and unusual global pandemic, it pays to look a long way back to get some perspective.
The shaded line running through the middle of the chart allows for some shift upwards in the CAPE ratio over time, showing the higher price/lower uncertainty priced into equity markets as information and transparency have improved.
But even allowing for this increase over time and using the longer-term 10-year CAPE data (as used below), this chart illustrates the point being made here: Global equity markets are currently priced for perfection. Yet in our view, there is little to no chance that such growth markets should be priced above long-term averages at the moment.
These sorts of markets make me nervous. I get nervous because growth markets today are priced according to past evidence, but the current global economy is so unusual, that it is very hard to see the future better by looking backwards.
2024 requires investors to decide on whether or not pricing for near perfection is fair or commands a more defensive position. Let’s be really honest about this: As the chart above shows, equity markets are pricing for significant earnings growth over the next few years, and not for uncertainty. But all we know today is that the downside for corporate earnings is greater than the upside.
The implications of this are that growth markets, particularly the growth sectors of equity markets, need to correct their lofty growth assumptions at least. Equity markets being as large as they are means that this will create significant market volatility across all investment markets.
This, in turn, creates an opportunity for savvy investors to identify segments of the market that are oversold as markets adjust, with the winners in our view being those that back companies with high quality earnings, whether that is through equity or corporate debt markets.
Craig Swanger,
Chief Investment Officer, IAM
To discuss your investment strategy and allocation to corporate debt, please contact your relationship manager.
(1)Growth markets are markets like equities or commodities; they are typically priced on earnings growth, not yield per se; and tend that to be priced higher when markets are more certain about growth prospects for the economy, the sector or the asset itself.
(2)See Morgan Stanley’s comments here, for example.
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