What does 2024 hold for markets?

It is time to look ahead to 2024. This year has been marked by expectations of recession in the developed world and of China re-opening to positive effect. Both have proved to be the wrong horses to bet on. In this weekly edition of Simply put, we analyse the likely shape of next year and evaluate which asset classes stand to benefit.

 

Need to know: Our base case scenario for next year is a disinflationary soft-landing that will eventually justify a central bank pivot towards policy easing That scenario would be supportive for all asset classes – but emerging market (EM) assets as well as global high yield (HY) and European equities could offer strong opportunities Alternative scenarios, such as a hard-landing or a no-landing, would potentially favour sovereign and Swiss bonds, and global equities and convertible bonds, respectively

 

Which asset classes for a soft landing?

Much of the reason why investors were wrongfooted owes to their positioning, the fast-paced central bank interventions in March, and the misunderstood consequences of inflation on corporate earnings. Now, markets are pricing a rather angelic scenario and, as much as we would like to adhere to it, it is essential to take stock of the macro forces in place to test its validity. Inflation has declined but remains high enough for central banks to pivot tomorrow rather than today, while the tightening of monetary policy in the US and in the Eurozone continues. Therefore, 2024 should see a soft landing, and with that, eventually a central bank pivot towards policy easing. 

With this scenario in mind, which asset classes offer the most appealing prospects in this context of a disinflationary soft landing? What would happen to markets in the event of the two alternative scenarios: an early pivot hard-landing year and a continuation of the current ‘no landing’ situation? We provide our analysis below.
 

Of scenarios and expected returns

Linking economic scenarios and market performance is always tricky business. The safest approach involves breaking down asset returns between a cash rate component and excess returns. Then, the computation of historical excess returns per regime helps connect regimes and excess returns. Expected returns are then deduced from the sum of short rates projections and regime-dependent excess returns, here in the context of a USD-denominated portfolio.

When it comes to 2024, our analysis leads us to believe events will unfold in one of three ways (see figure 1):

1. Base case: a scenario that involves a soft landing, amid ongoing disinflation and a central bank pivot in the second part of the year, as inflation finds levels consistent with central banks’ mandates
2. Alternative scenario 1: involves a hard landing, meaning a genuine recession, deflation, and explicitly dovish monetary policy – not just a pivot, but central banks shifting their policy forcefully once faced with unemployment rising beyond expected levels
3. Alternative scenario 2: the blind spot is one of a ‘no landing’, meaning no growth contraction at all and pervasive inflationary pressures accompanied by a hawkish monetary policy, with four more rate hikes in the US

Using our nowcasting indicators for growth, inflation and monetary policy as a mean to date each type of regime, we computed average excess returns from each of these periods. The final expected returns combine our projections in terms of short rates and these case-by-case regime-dependent excess returns. So which asset classes stand to shine in any of these given scenarios?

FIG 1. Market scenarios for 2024 (overview) 
 

	Base case	Alternative scenario 1	Alternative scenario 2
Growth	Soft landing	Hard landing	No landing
Inflation	Disinflation	Deflation	Inflationary
Monetary policy	Pivot	Dovish	Hawkish
Average corresponding cash (US)	5.00%	3.00%	6.00%

Source: Bloomberg, LOIM. For illustrative purposes only.

Emerging markets or bonds? 

Figure 2 shows the expected returns for each of the three scenarios based on our calculations. While past performance can be a poor guide to future results, our key takeaways are the following:

• Soft-landing: as inflation moderates while short rates decline into a tepid bull steepening, risk assets could enjoy a decent run. The decline in short rates adds to the USD’s retreat, meaning emerging market credit and equities as well as European equities could offer potential opportunities
• Hard-landing: with lower short rates and declining earnings prospects, equities would be hit the hardest, leaving government and Swiss bonds to play their ultimate role as diversifiers. Here, emerging market assets should be expected to suffer less as their valuations are already discounting pessimistic prospects
• No landing: the higher cash rates would somewhat lift expected returns while earnings progression profits from still-elevated inflation. Against that backdrop, most equity markets would trade at a similar level, while bonds would struggle to beat cash, as has been the case this year. 

This leaves us with three asset classes distinguishing themselves: emerging assets in the event of a soft landing, sovereign and Swiss bonds in the event of a hard landing and, finally, high yield and global equities in the event of no landing. 

Convertible bonds could also deliver their usual convexity. The wise, diversified investor would be incentivised to allocate across asset classes in a global portfolio, but we are not judging those who seek more concentrated exposures. The key point here is to acknowledge how a soft landing and a central-bank pivot could make 2024 a year with decent prospects after two complicated years. We are cautious towards the prospect of a surprise hard-landing, which is next year’s Achilles’ heel.  

FIG 2. Expected return per asset class for each scenario
 

Source: Bloomberg, LOIM. For illustrative purposes only. Past performance is not a guarantee of future results.

 

Simply put, in the event of a soft-landing and a pivot, emerging market assets and fixed income could help investors further reclaim some of the ground lost in 2022. But we remain cautious on the prospect of a surprise hard-landing.

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Nowcasting corner

The most recent evolution of our proprietary nowcasting indicators for global growth, global inflation surprises, and global monetary policy surprises designed to track the recent progression of macroeconomic factors driving the markets.

Our nowcasters indicators currently show:

• Growth: continued to deteriorate over the week, mainly as a reflection of job market-related data 
• Inflation: rose over the week, amid rising costs, and especially in the US. It remains at low levels for now
• Monetary policy: remained unchanged. This low and declining regime we find ourselves in is consistent with an incoming Federal Reserve pivot
   

World growth nowcaster: long-term (left) and recent evolution (right)

World inflation nowcaster: long-term (left) and recent evolution (right)

World monetary policy nowcaster: long-term (left) and recent evolution (right)

Reading note: LOIM’s nowcasting indicator gather economic indicators in a point-in-time manner in order to measure the likelihood of a given macro risk – growth, inflation surprises and monetary policy surprises. The Nowcaster varies between 0% (low growth, low inflation surprises and dovish monetary policy) and 100% (the high growth, high inflation surprises and hawkish monetary policy).

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