CIO views: the 2024 outlook edition

Yannik Zufferey CIO Core Business

 

2024 will most likely be the year that rate hikes bite. The latest central-bank rhetoric certainly seems to point to an end to hikes for this cycle. However, a continued commitment to returning inflation to target levels will keep rate levels high for as long as required.

From a duration perspective, the recent move higher in long-end yields, alongside reasonable progress in the inflation fight, has made us more comfortable with the overall level of yields and shape of the curve. We feel it limits further bouts of substantial downside in this space. Real yields are in high territory, so duration will offer attractive diversification in the event of a growth shock.

 

Who can withstand higher funding costs?

Such a surge in central bank rates cannot come without costs, and we believe the knock-on effects of the increased cost of capital for corporates will be felt more and more as time progresses, consumer demand wanes and balance sheets are run down. The magnitude of the impact for credit markets comes down to the capacity of corporates to absorb the shock of these higher funding costs, which largely hinges on the health of balance sheets.

Investment grade and higher quality high-yield corporates (with BB credit ratings) possess strong balance sheets. In fact, our calculations show that they are broadly robust enough within this rating category to absorb current yield levels for refinancing needs even if maintained for the coming 24 months, despite a sizable maturity wall. Alongside the carry from elevated yields and a well-capitalised financial sector, this makes higher quality credit an appealing proposition.

But this is not the case for the whole market. We highlight corporates rated B and below, particularly in Europe, as those most exposed structurally to higher funding costs. Many issuers within this space do not have room on their balance sheets to stomach the cost to refinance their maturing debt. Primary markets are effectively shut to them, and if they are unable to access funding from elsewhere, more defaults will be inevitable.

 

Finding relative value

Ultimately, we expect this narrative to increase the importance of bottom-up fundamentals and to drive an increase in spread dispersion within rating buckets – currently low by historical standards given spread levels. Wider dispersion should provide fertile ground for relative-value active managers to generate alpha through 2024.

 

Discover more about fixed income.

Dhiraj Bajaj Head of Asian Fixed Income

 

Eyeing US cuts in 2024

Given the Federal Reserve’s (Fed’s) sharp increase in interest rates from zero to 5.5%, almost everyone at the start of 2023 anticipated a US slowdown or recession. However, US 2023 real GDP is likely to end up as strong as 2.2% due to corporates and homeowners having termed out their funding at low rates after the pandemic, and consumer savings standing at high rates, albeit in a declining trend.

Nevertheless, tight financial conditions are starting to sting and the US slowdown is simply delayed until next year, in our opinion. We expect US unemployment to rise above 4%, consumer savings rates to fall, property prices to correct and corporate earnings growth to decelerate, and even go negative in 2024. This backdrop should prompt the start of a Fed rate-cutting cycle in the second half of 2024: we anticipate US interest rates falling from 5.5% towards 3.5% to 4% by end-2025.

The expected rate cuts should bull steepen the US Treasury curve in 2024, and begin a strong, multi-year return environment for fixed-income assets, especially those with quality duration embedded. Asian central banks are ready to cut rates from 2024 onwards as global growth cools and Asian inflation drops for the second consecutive year.

 

Strong potential in any environment

A simple and diversified portfolio of quality Asian emerging market (EM) bonds denominated in USD currently yields 7.5%¹ with a six-year duration, comprised of almost 5% US Treasury yield and 250 bps of credit spread. It would potentially return 30%² by end-2026 (or a three-year period) if Treasury yields moved to 4% and spreads marginally rolled down, without any compression.

Fixed-income assets are now so cheap in Asia and EM that the risk-reward is wholly asymmetric, offering strong potential regardless of a bearish or bullish environment. For instance, the same portfolio would potentially return 20% by end-2026 if all-in yields increased from 7.5% to 9%. Conversely, it would potentially return 37% if yields dropped from 7.5% to 5%. These scenarios assume letting duration slide with no rebalancing of the bonds.

To further benefit from this asymmetric return outcome, we are increasing the convexity of our portfolios by buying cash bonds at lower prices into 2024. This further enhances the capital gain while focusing on growth markets such as India and southeast Asia, as well as developing Asia, including Australia, South Korea and Hong Kong.

 

Discover more about Asian fixed income.

 

	Didier Rabattu CIO Equities
	Pascal Menges CLIC® Equities, CIO Office

 

After turbo-charged rate hikes and an initial normalisation of a steeply inverted US yield curve, investors will adjust to a new regime in 2024. It will be characterised by higher-for-longer interest rates until a material deterioration in economic activity unfolds, in our view.

When that happens, consumers will likely feel the pinch of stubborn, albeit decreasing, inflation as wage growth and employment cool. Markets will focus on consumers’ health, credit quality, their down-trading to cheaper products and prioritisation in spending. Decelerating growth, margin compression and higher funding costs will compel corporates to seek savings and productivity gains through artificial intelligence (AI) and other efficiency-boosting measures.

Secular themes that we focus on – like renewable power, energy efficiency, water infrastructure, robotisation and smart farming – should be supported by continuing fiscal expansion and constructive industrial policies, with the roll-out of subsidies in some key economies.

 

A rebound?

2023 has also been marked by risk aversion, with bifurcated markets driving significant valuation dispersion across sectors, market capitalisations, regions and styles – epitomised by the dominance of the ‘magnificent seven’. This has resulted in considerable gloom being (perhaps unfairly) priced into specific market segments.

For instance, small and mid-caps have reached abnormally cheap valuations versus larger companies, especially mega caps. Chinese companies have been discounted to a level not seen in decades, and rising rates have hammered bond-proxy equities in the consumer staples and utilities sectors.

If either recession hits or the economy keeps humming, we believe asymmetrical opportunities exist as many growth concerns are already priced in. Interestingly, the consensus among bottom-up analysts monitored by Bloomberg is for a 2024 earnings expansion of almost 10%.

 

On-the-ground change

Inflation, supply-chain and energy-supply disruptions are increasing the costs of resources. We anticipate the adoption of renewables and energy-efficiency solutions to continue amid the USD 1.7 trillion investment in clean-energy technologies expected this year and cumulative global capex for electrification forecast to reach USD 24.5 trn by 2030, according to our research.

Progress is evident in other sustainability themes, too. In agriculture, AI and advanced cameras that can distinguish crops from weeds are enabling precise watering and reduced chemical spraying. In the US, more than USD 100 million is being committed to recycling projects to improve physical waste management, planning and data collection.

Such change is not currently reflected in markets. But in the medium term, we expect sustainable assets to be revalued upwards towards their intrinsic value.

 

Discover more about sustainable equities.

	Didier Rabattu CIO Equities
	Henk Grootveld Head of Trends Investing

 

2023 has been an odd and challenging investment year from many different angles. In the equity market, performance has been extremely narrow with a handful of mega-cap growth companies – the ‘magnificent seven’ US technology conglomerates responsible for more than 90% of the world index return.

For our World Brands strategy, the magnificent seven have been core holdings aligned with its investment philosophy, supporting performance in the last three years.³ Portfolios exposed to the investment themes of artificial intelligence (AI) and obesity also stood to benefit this year.

However, strategies focused on other secular trends – such as the demographic shifts of the growing middle class and ageing societies, or the digitalisation-driven advances of fintech, healthtech and robotics – suffered as the market narrowed severely, resulting in flat or even negative returns compared to the general index.

 

Value’s return to bring back breadth

In 2024, we expect this narrowness to reverse as the market recognises opportunities beyond US mega-caps. These will include smaller sized companies with market caps below 100 billion that are currently trading at attractive discounts to the mega caps. This will be a feature in the return of value, as expensive and non-profitable stocks are beaten by more attractively valued and profitable companies, in our view. 

We have already seen an early sign of this change: the market’s general preference in valuing companies is shifting from a focus on sales multiples to earnings and cashflow multiples.

 

Strong companies, strong trends

Due to structurally higher (re)financing costs for companies, balance sheets and debt profiles will remain on investors’ agenda in 2024. In our view, the ideal business will be one which can still grow sales despite the more challenging macroeconomic backdrop through a combination of both pricing power and volume growth. This will be backed by high profit margins, so strong brand power will remain important.

Investment trends that offer access to such secular and profitable growth, and which are less hindered by cyclical headwinds, can be found in the ongoing digitalisation of the economy and the changing demographics of the world population. Additionally, we expect 2023’s boom in AI-chip manufacturers and AI-cloud providers will broaden to Al software and service firms that are able to increase efficiency in sectors like manufacturing, finance and healthcare, and are able to cause some deflation in our high-inflation world.

 

Discover more about trends equities.

 

(3) Past performance is not an indicator of future results.

Morten Rossé Head of Nature and Climate, HolistiQ

 

Featuring the warmest global average temperatures on record, 2023 will go down in history as the start of the ‘global boiling’ era. The El Niño climate pattern has shown a glimpse of how nature will react to rising temperatures, laying bare how ill-equipped global markets are to handle this risk. Some 55% of the world’s GDP is moderately or highly dependent on nature: wildfires and droughts make global value chains vulnerable.

Nature is one of our best climate-change mitigation strategies, but it is often overlooked. There is no net-zero world without nature as it removes two-thirds of human-linked emissions. Yet, nature receives less than 2% of climate finance.⁴

It is time to rethink the role of nature in the global economy. Our conviction is that nature should be treated as an asset class.

 

Integrating nature into markets

In the past three years, strong interest in nature has been expressed in the fast growing carbon markets. These markets come with design and delivery challenges but we believe rapid growth will resume in 2024, driven by improved market standards and new compliance markets, particularly in emerging economies.  

The big opportunity for nature is how it can be integrated into large, established markets – such as food, fashion, cosmetics and pharma – to de-risk value chains. The most plausible way for food, land use and agricultural companies to mitigate their greenhouse gas (GHG) emissions and adapt to rising temperatures is to create production systems that regenerate nature rather than extract from it.

 

The investment case for nature

In 2024, government policies could be a positive catalyst for this shift. European Union deforestation regulation (EUDR) comes into force with significant penalties for non-compliance if imports include deforestation in their supply chains. The EU corporate sustainability reporting directive likewise takes effect, requiring reporting of all GHG emissions hereunder from nature conversion. Next year also brings the first protocols for accounting of GHG emissions and removals from nature, and a number of voluntary standards and guidelines for how corporates can integrate nature, including the Taskforce on Nature-Related Financial Disclosures (TNFD) framework for disclosures.

These market and policy drivers underpin a fundamental investment case for nature. Our conviction is that the current opportunity is in a real-asset strategy that can bring capital upstream to the nature-positive production of food products. Value arbitrage exists in the commodity and land markets. Such a strategy could offer investors core return potential, portfolio diversification, low correlations, an inflation hedge as well as exposure to emerging nature premiums.

 

Discover more about nature-based real assets.

 

(4) Source: United Nations Framework on Convention on Climate Change, Climate and Biodiversity: an ambition for the planet. June 2020.

	Arnaud Gernath Co-Head of Convertible Bonds
	Natalia Bucci Co-Head of Convertible Bonds

 

Convertible bonds are well suited to help investors navigate the uncertain macro backdrop in 2024. Our key medium-term convictions include:

• Disinflation is underway
• Global growth will be slower but with no hard landing
• Rates will be high for longer
• China has limited room to implement a significant stimulus programme

 

In this context, we believe that corporate margins will be stable, supporting earnings per share growth in 2024, and we have more confidence in corporate and government spending than in household spending as savings rates decline. Geopolitical risk is almost certain to remain high. Other outcomes – such as recession or a strong market rebound – cannot be ruled out, making decisions and timing difficult for investors.

Either way, convertible bonds offer investors strong potential due to the hybrid features of the asset class. Convertibles currently have a yield that is in line with global equity market dividend yields, downside protection due to their quality credit bias and the potential to participate with an eventual rebound.⁵

 

Strong US picture but Europe subdued

By region, we are neutral to positive on the US and Japan. US labour markets are holding up with limited wage pressures. Supportive conditions for Japanese risk assets include a potential exit from deflation and potential flows into equities. Our outlook for Europe and Asia, meanwhile, is neutral to negative. Subdued European growth should persist due to higher energy prices and weakness from China weighing on European exporters. There is upside risk for Chinese equities if greater stimulus is implemented, making timing tricky. Still, demographics, youth unemployment and geopolitics remain headwinds. 

 

Favouring companies exposed to capex and IT

Given these considerations, in the short term we prefer companies exposed to capital expenditure and IT budgets (infrastructure, cybersecurity, semiconductors, non-residential solar and wind-power suppliers, cloud computing) to consumer spending (autos, retail, payments and luxury).

In the current geopolitical context, oil and gas prices could remain volatile and skewed to the upside. This is likely to generate positive returns for the broader energy complex but will be detrimental for sectors which are negatively correlated to the oil price (airlines and shipping). It is also likely to favour continued spending in defence. If long rates stabilise, bond proxies, such as telecoms and utilities where we have seen an increase in issuance in 2023, could benefit.

 

Supply and volatility benefits

Next year, convertible bonds could also benefit from a buoyant level of new issuance and the return of volatility.

Convertible bonds have suffered from a lack of volatility in 2023. Vega added as much as 7% to performance between 2020-2022 but detracted more than 2% this year.⁶ Although idiosyncratic volatility remains high, broader market levels remain supressed. If the hoped-for Goldilocks scenario fails to materialise and volatility increases in 2024, convertible bond valuations may converge towards fair value, potentially adding 1-2% to returns next year.

 

Discover more about convertible bonds.

 

Aurèle Storno CIO Multi asset

 

When the manufacturing industry does well, the economy does well, and equity valuations rise. On the contrary, a manufacturing slowdown bears the message that earnings are at risk, and a decline in equities and credit bonds’ relative value are in order. Armed with that way of seeing markets, portfolio managers were in the perfect situation to miss their returns target in 2023 – as the exact opposite happened.

One reason was the strength of sentiment. Low positioning in 2022 led the average investor to revisit their equity exposure in Q1 and then again in Q2, pushing valuations to their edges as the services industry grew strongly and lifted the world economy. The subsequent rise in rates that happened for that precise reason lowered the valuation equilibrium point for equities, while adding to bond investors’ fatigue. That H2 evolution needs to be seen for what it is: a turning point. Its implications should light the way to 2024.

 

A perfect combination of detrimental factors?

Rates are now high enough to slow the world economy, and the recent earnings season has displayed that remarkably. Rates should stabilise while remaining on their long end around current levels – say 5% for US Treasuries – as real rates remain elevated because of a savings shortage and tight monetary policy. With that, growth in 2024 is likely to remain subdued, while expectations from analysts remain stellar. Furthermore, inflation should further roll over while wage growth adjusts more slowly and commodities remain higher, weighing on margins. With that perfect combination of detrimental factors, defaults should occur, leading to a healthy cleanup of tight and risky asset valuations, while restoring the appeal of government bonds.

Now, sentiment is not so bullish that the potential for a decline would be large. Also, with long rates potentially 1% lower, a possible 15% decline in equities and high-yield spreads of around 700 bps, risky assets would finally look appealing in the context of a soft landing. This would lead to the final act of a turbulent cycle: a more standard recovery.

To our investors, we say: don’t expect long-lasting downtrends in 2024. Keep your liquid, fast-paced strategies at hand. They could make a significant difference in such a U-shaped environment, as they did in 2023.

 

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Christophe Khaw CIO 1798 Platform

 

2023 has brought about a shift in the balance of supply and demand dynamics for US Treasuries. The growing US fiscal deficit means a greater supply of Treasuries, while the de-dollarisation of many economies, baby boomers retiring and the Federal Reserve’s (Fed’s) quantitative tightening translates into less demand for Treasuries. These dynamics should support higher-for-longer rates, unless a risk-off event pushes rates lower.

The Fed and market’s base-case scenario is now (as of the time of writing in November 2023) a soft landing as core inflation has been tracking lower for three months and growth remains on track. In these conditions, we believe it will be hard for the market to be surprised on the upside and that 2024 will be more susceptible to downside shock surprises.

 

The appeal of long/short and absolute-return strategies

We are surprised by how risk assets remained somehow insulated from the move in rates. Ultimately, equity risk premia is currently extremely tight and subject to a repricing. Credit is more attractive than equities to us, even though credit spreads remain relatively tight. Investor surveys reveal a perception that investment-grade spreads will widen over the next six to 12 months. As such, we expect 2024 to be a more challenging year for long-only strategies and believe long/short and absolute-return strategies could look increasingly attractive to investors.

Higher interest rates make it harder to run a company. We expect to see higher dispersion between corporates, which should offer opportunities for stock pickers and long/short portfolio managers. Rates of bankruptcy can also be expected to increase and, as such, we like long secure versus short unsecure relative-value corporate trades in leveraged corporates approaching bankruptcy. At the time of writing, equity volatility remains also very low – the VIX index currently stands at 15 – and, as such, we favour building a long volatility profile in some of our portfolios.

 

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