By Nicolas Sopel
What are the economic and market trends for 2024?
In the age of Instagram, it's fashionable to reduce complex ideas to a pithy quote. So, I will do that in regard to the outlook for the global economy and markets – sharing two quotes for the price of one.
First: "All I know is that I know nothing." Socrates said that and I fully agree. We need to be humble when forecasting the future as the only certainty is that it is uncertain. Here is a second quote: "Nothing is permanent except change." That statement from Heraclitus, another Greek philosopher, is likewise spot on. The trends we see taking shape today will inevitably not remain consistent over time; change is an inevitability.
With those Instagram-style disclaimers out of the way, let's turn to the global outlook for 2024.
At the start of 2023, we anticipated a year marked by a "triple P": peaking inflation, a pause in central bank tightening and a pick-up in Chinese economic activity. We've seen this take place in 2023 to varying degrees. Inflation has indeed retreated from the peak and central banks have now stopped raising interest rates, but China's pick-up was short lived and morphed into another "P": pessimism. Moving forward, we are likely to see a continuation/evolution of these dynamics, but other trends will also emerge.
Let's start with some good news! It appears that central banks are now winning the battle against inflation. This is the result of the unprecedentedly rapid and sharp tightening of financial conditions that took place in 2022 and 2023. But – because there's always a "but" – it is essential to gauge the extent to which the economy has been damaged by these restrictive policies. In addition, it's also critical for investors to assess how markets will react to the combination of slowing growth and less restrictive policies because that is what we anticipate in 2024. In other words, will bad news (slower economic growth) be good news for markets (as central banks will have room to be more accommodative)? The answer not that straightforward, so let's dig deeper.
We anticipate that economic growth will prove below trend in 2024. We continue to expect mild recessions at the start of 2024 as the broader economy feels the impact of restrictive policies and a weaker-than-expected Chinese economy. This is already more or less the case in the eurozone and the UK. Pockets of the US economy are now slowing, albeit from high levels as the US economy remains broadly resilient. For now, we expect that recessions will only be mild as job destruction is limited, and today's economy is not marked by the imbalances that characterized previous recessions.
Emerging markets are a little bit out of sync. We see China slowing and then stabilizing below trend as the Mainland faces multiple headwinds, including a lack of significant stimulus and a property crisis amidst longer-term structural changes and economic rebalancing. China is a drag on the region, but there are other forces at work. Central banks in this part of world are keener to support growth while several economies could pick up – benefitting from the reshuffle of production and supply chains, the latter likely to have a multi-year impact. Overall, global growth prospects appear sluggish in 2024.
Inflation will continue to slow but will likely remain above trend (and central bank targets). This is the good news as prices have obviously skyrocketed since the pandemic. But keep in mind that inflation normally slows only as the economy slows. So, this "good news" may prove a decidedly mixed blessing.
The real good news may be for the markets. With inflation slowing, central banks have room to turn less restrictive, i.e., stop raising interest rates. This is where we are today. By around mid-2024, we expect central banks to become even more accommodative, with lower interest rates as growth slows. Increased accommodation could tempt investors to return to taking more risk, i.e., buying more risk assets, such as equities. But this message needs to be nuanced for several reasons.
First, history shows that when central banks cut interest rates equities tend to fall. Cutting interest rates tends to occur when something has gone wrong, such as growth going south. And equities are dependent on growth. Consider that, in 2000 and 2008, the US S&P 500 fell approximately 50%. Obviously, those were systemic crisis, and we do not foresee one on the horizon. As such, until central banks cut, markets could potentially stay supported as interest rates stop rising.
Major equity indices rose with little volatility in the years following the global financial crisis as interest rates were grounded to zero (or even below zero in the eurozone), and central banks were buying government debt (so-called "quantitative easing"). Volatility, and some drawdowns, returned when interest rates rose. This could be the flight path for equities in the first part of 2024, which we expect to remain volatile, with markets assessing the damage central banks inflicted on the economy, as noted earlier.
The second reason is valuations, including relative valuations. A six-month US Treasury bill currently yields 5.5%, which is roughly 1 percentage point higher than what S&P 500 earnings yield today. Government bonds are arguably a bit safer than equities. In essence, the compensation for risk is not that great.
Over a six-month horizon, what are the odds that the US economy defaults on its debt? It's certainly not zero but nonetheless very low. This illustrates that high-quality bonds, such as those issued by governments (in the US or eurozone) are currently priced at very attractive levels.
History also shows that when interest rates peak, so do bond yields. At these yields, between 3-5% depending on the side of the Atlantic, bonds also offer a decent cushion as growth slows, and even more if growth were to decelerate to a greater degree than expected. We therefore continue to believe that government bonds make a lot of sense as part of a diversified portfolio and that the risk/reward is interesting.
What could go wrong? Central banks could raise interest rates further if inflation were to prove stickier than expected. But after having raised so much in 2022 and 2023, they might only hike once more in the current cycle; otherwise, they clearly risk jamming the growth engine. As a result, investing in high-quality bonds could prove wrong by a relatively small margin, but it could also prove right by a larger one.
(Geo)political risk adds another layer of uncertainty. Russia's war in Ukraine continues, and there is now also conflict in the Middle East. However, geopolitical tensions tend to have a short-lived impact on markets – typically an initial reaction to the shock, primarily for commodity markets.
The new year could also be marked by policy volatility. In November 2024, the US will decide who will lead the country for the following four years. The UK, too, will go to the polls. Another 21% of the world's population (in India and Indonesia) will cast a leadership vote. This could matter greatly in a multi-polar world still marked by protectionism. It could matter for budgets, too, and perhaps for gold. Gold prices are currently near historical highs, and the precious metal remains a safe-haven asset that could benefit from lower interest rates.
Until now, we've rather talked about the near term. At Quintet, we believe it's important to look beyond short-term news or cycles towards mid-to-long-term themes to gain exposure to structural growth and diversification. There are many areas where innovation is continuing, and new business models are emerging. Broadly speaking, our outlook is defined by macroeconomic trends but also geopolitics, innovation, the environment, demographics, and markets.
While looking at the current environment of slowing growth, we also see some of the more resilient themes that may offer defensive growth. They may benefit as yields fall, having less exposure to economic cycles and supported by long-term investment outlooks. These themes include clean energy, water & waste, future health, and infrastructure.
Finally, as I hinted earlier, we are at the beginning of a multi-decade rebalancing of the world's economic model. Some major shifts are already reshaping the world, such as the reshoring of production (the China Plus One Strategy, for instance). In this more multi-polar world, the drawbacks of globalization, especially dependence on China, were laid bare by supply chain challenges during the pandemic and inflation exacerbated by wars and geopolitical tensions. Countries and economic blocs have started to focus more sharply on domestic control of key sectors and technologies, while companies are shifting some operations from China to rebalance supply chains. Investments are shifting from China towards other emerging markets like India, Mexico, and Vietnam, among others. We believe this major shift could last many decades and boost emerging economies. As noted earlier, nothing is permanent except change.
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Nicolas Sopel serves as Head of Macro Research & Chief Strategist, Luxembourg, at Quintet Private Bank. The statements and views expressed in this article are those of the author as of the date of this article and are subject to change. This article is also of a general nature and does not constitute legal, accounting, tax, or investment advice. All investors should keep in mind that past performance is no indication of future performance, and that the value of investments may go up or down. Changes in exchange rates may also cause the value of underlying investments to go up or down.
