“I am duty-bound to point out that every year we look back at some event that has caught everyone by surprise and that it is long-term investment decisions that ultimately matter” – Piers Hillier, CIO
Retaining a healthy scepticism of short-term market views and trends that can sometimes dominate sentiment is part of being an asset manager with a long-term perspective. However, there is value in questioning what we think about markets and what could affect progress in 2024. Inflation is key, as is the potential for a recession. Geopolitical risk is an obvious candidate for causing additional volatility. This uncertain environment certainly focuses the mind of our investment managers on overall investment objectives.
Outlook 2024 Podcast with Piers Hillier
In our Outlook 2024 podcast, Piers Hillier, CIO, looks ahead to 2024 and discusses the issues he believes will be prominent over the next 12 months, and where the key investment risks and opportunities may lie.
Discover the focus for Royal London Asset Management in 2024
In this year’s Outlook, our fund managers assess the challenges and opportunities in their respective asset classes for 2024.
With inflation proving persistent rather than transitory, a cost-of-living crisis and a tight labour market, higher rates and financing costs will feed into slower growth or a recession. But with a backdrop of a relatively stable global economy how much of a risk is this? With an environment of falling inflation and modest recession, the benefits or risk for equities or credit is not so clear cut and knowing your companies is key. We analyse the areas of concern and potential growth within this environment.
Extracts from our Outlook 2024
As we come to the end of 2023, inevitably we start to look forward to what the next year will bring. Writing outlooks can be a thankless task. In 2020, any outlook for that year was void after the pandemic began, and 2022 outlooks were undermined by the invasion of Ukraine by Russia. Even last year outlooks which were concerned about an energy crisis were offset by an extremely mild winter. Forecasting is a difficult thing.
As we came into 2023 the consensus as we saw it was for a recession, caused by higher interest rates and energy costs, which would negatively impact equities but would benefit bonds, which had performed poorly in 2022. All of this was incorrect. There was no recession and as a results bonds have decreased in value whilst equities have performed generally well.
When thinking about the outlook for financial markets over the coming year it pays to start with a little humility. This time last year, economists had pencilled in recessions for 2023 on the back of swingeing rate hikes and extremely high energy prices. And yet, as is so often the case, things didn’t turn out the way they were meant to.
A resilient world economy…
The first big surprise for 2023 was that the world economy was much more resilient to higher interest rates than anyone expected. The previous year had seen the most dramatic tightening in monetary policy in generations after inflation turned out not to be as ‘transitory’ as central banks had hoped. And yet the US economy trundled on as if nothing special was happening with growth more or less in line with its long run average. US home buyers are on 30-year fixed rate mortgages so, as long as they don’t move house and refinance their loan, their payments don’t increase. Most corporates are also benefitting from fixed rate borrowing. The Federal Reserve’s underpinning of ultra-low rates in 2020/1 gave indebted companies something of a Get out of Jail Free card, allowing them to term out their debt at lower rates. Elsewhere in the world, a sharp decline in energy prices kept Europe and the UK bumping along the zero growth line and China’s economy continued to expand, if not in spectacular fashion.
Sometimes, investing can be quite simple when it is stripped back to basics. When we look at the outlook for the next 12 months, we can see the prospects for issuance, the strength of corporate balance sheets and the potential for central bank action, but in my view, the starting point for next year is a very attractive ‘all-in’ yield.
It is very easy to focus more on credit spreads – after all, this is an essential premium we want to receive for the credit risk we take – but while these have not really moved a great deal over the past few years, the underlying gilt reference yield has increased dramatically.
At the start of the year, we were forecasting a higher default rate than the trend we have ultimately seen play out, with defaults set to end the year around 3% to 4% – and we see 2024 playing out similarly. We see defaults sitting around 3% to 5%, with our most pessimistic case seeing 7%.
Even if defaults do end up breaching 5% and creeping towards 7%, we don’t see this as particularly worrying as it won’t change the fundamentals of the high yield market and will only come about from US Federal Reserve monetary policy, which has been priced into corporate valuations, instead of, as of yet, unknown increased economic hardship.
Should you be dovish or bullish gilts?
Looking to next year, there are multiple events we need to consider when trying to predict how markets will react: there is a lot of supply coming; there is an expectation where the increased volatility seen this past year may well continue. Given this, it is easy to present a case to be positive or negative on gilts. Government bond markets find themselves at a really interesting juncture following this summer’s rally.
Generally, the Rates team is pretty downbeat on the UK economy’s prospects for next year. Our Senior Economist Melanie Baker feels the outlook is lacklustre with a technical recession still assumed in the next 12 months, but a modest one.
As the world emerges from the shadows of a pandemic and navigates the complexities of geopolitical tensions and economic uncertainties, central bank policy is likely to continue to dominate near-term market headlines and drivers of indices. This presents a complex range of opportunities and challenges for investors in global equities in 2024.
After more than a decade of interest rates and bond yields globally at or near very long-term lows, the post-pandemic landscape has been characterised by a period of inflation in developed economies that turned out to be more than initial ‘transient’ expectations and has consequently caused major central banks to increase interest rates rapidly and substantially.
When I look back on 2023, one of the important features that sticks in my mind is the impact on businesses of destocking within supply chains. This happened across a wide range of industries and hit some manufacturers hard. The origins of the problem go back to Covid lockdowns when some goods were hard to source.
This prompted many consumers and the supply chains servicing them to over-order goods once they were available again, and to carry higher inventory levels. As supply chains normalised, that stock build has been unwound. Essentially, in many industries, end customers found their demand satisfied from their own existing stocks or from stock held by intermediaries in the supply chains, leading to sharp decreases in demand from manufacturers. As manufacturing volumes fell, operational gearing came into play, causing sharp falls in profitability for manufacturers. These impacts are transitory, but painful nonetheless.
As 2023 draws to a close, the outlook for the property sector appears gloomy to many investment commentators. We acknowledge that there are several factors posing significant challenges to real estate investors, but we also believe that these generate attractive opportunities for the best to generate long-term value. Some of these factors – such as rising interest rates – are broad macroeconomic trends affecting multiple asset classes, but some are more specific to – and nuanced within – the property market.
Rising interest rates are a clear challenge for almost all asset classes. From a returns perspective, the higher risk-free rate will always make some investors move to less risky assets. Real estate markets are more sensitive to changes in the interest rate than other sectors. The fact that many buyers rely on debt financing is crucial when considering how interest rates affect capital values. As the cost of debt increases, the expected return for final investors also increases, which then pushes prices down. In this environment, being a ‘fully funded’ buyer can be a huge advantage – allowing a longer-term view rather than one driven by the cost of debt.