You asked, we answered: the top questions from our 2024 Outlook webinar

February 23, 2024

Achieving a soft landing after significant monetary policy tightening is notoriously difficult. Historically, most periods of sustained tightening have been followed by recessions. However, the odds that the Fed has pulled off a soft landing are growing, indicated by economic data. Inflation has receded from its peak of more than 9% in 2022 to 3.1% in November 2023, bringing it much closer to the 2% target, while at the same time a range of indicators suggest growth in economic activity is holding up remarkably well. Geopolitical uncertainties could fuel inflation by disrupting supply chains and energy markets. Conflict and reshoring efforts may contribute to sustained high prices, intertwining geopolitics with inflation dynamics. Monitoring these tensions will be crucial for assessing their impact on economic stability and inflationary pressures.

It is worth noting that there are several other macroeconomic factors that can influence risk asset pricing, namely whether the economy falls into a recession or manages a ‘soft landing’. However, clarity in the Fed’s strategy and interest rates will allow for more effective asset pricing as costs of capital become less volatile. Over the long-term, this should see risk assets return to trading based on fundamentals which should favour quality companies at attractive valuations.

If the rate environment has finally moved from restrictive to supportive, we are likely to see investors who have been absent or underweight towards long duration in credit, or rate sensitive assets such as listed equities and real estate, continue to re-allocate, as we saw towards the end of 2023 where risk assets rallied as the US 10-year fell from its year high of ~5%.

Expectations for interest rates cuts are elevated with the market currently pricing in close to 3-4 cuts in the US in 2024. While we have seen significant changes and volatility in forward looking interest rate expectations, historically we have seen Listed Real Estate in favour after hiking cycles (US REITs have historically seen performance of +30% on average, vs. +20% for the S&P 500 Index, within 16 months of the last 4 Fed pauses).
 

During the pandemic, governments provided extensive fiscal support, contributing to the challenges of inflation, higher interest rates, and growing trade deficits. If economies enter a recession, pressure for fiscal stimulus will increase, but high deficits and debt levels may limit the extent of such measures.

Looking ahead, addressing challenges like rising interest costs and aging populations will be crucial, highlighting the need for fiscal prudence and growth-oriented reforms. Governments will likely need to strike a delicate balance between supporting economic recovery and ensuring fiscal sustainability. This may involve targeted fiscal measures to stimulate key sectors, coupled with efforts to contain spending and boost revenue in the longer term.

Moreover, the effectiveness of fiscal policy will also depend on coordination with monetary policy and structural reforms. Coordinated efforts across these areas will be essential to navigate the complex economic landscape and promote sustainable growth in the post-pandemic era.
 

Global growth has been more resilient than anticipated over the past year, with inflation falling in most major economies. While the risk of a deep global recession has moderated, we still expect growth to slow in early 2024 as the full impact of the long and variable lags of monetary policy is felt around the world. However, falling inflation will allow central banks to ease policy as the year progresses, setting the global economy up for a 2025 recovery. Our message: remain alert, but less alarmed.

In Australia, we expect economic growth to remain moderate, driven by a weaker labour market weighing on income and consumption. This will likely have knock on effects for private investment as the outlook for demand is one of the strongest drivers of corporate investment. Public sector investment should continue to grow, though at a more tempered rate.

Potential implications for investors and positioning for the year ahead

Fixed income: We see bonds as relatively attractive in the current environment, and we expect the patient investor with higher allocations to fixed income will be rewarded. In the event of a recession, fixed income investments with exposure to bonds may act as a protective lever within portfolios that contain riskier assets.

Infrastructure: With its defensive traits, its ability to protect against surges in inflation, and its relatively high yield also looks attractive to us. It also has a high exposure to secular growth trends, such as the energy transition and digitalisation.

Global equities: While equity markets may be boosted by any reduction in interest rates, a volatile economic backdrop may present an ongoing challenge. This reinforces the importance of selectivity for equity investors: quality investing, for example, may help portfolios navigate difficult market conditions, while small-cap companies and emerging market equities have both lagged the strong outperformance of US technology stocks, and now present attractive valuation opportunities.

Real estate: we anticipate will be challenged by high interest rates and the knock-on effect this has on capitalisation (cap) rates and financing costs. The office sector is also facing the headwind of reduced demand as employees continue to prefer working from home for part of the week. Logistics and rental housing are better placed, given the underlying trends supporting them in the form of ecommerce, demographics, and tightening supply.