Market pulse

Recap and highlights: panel discussion

January 18, 2024

Frances Donald

Frances Donald’s macroeconomic outlook is for more restrained economic growth this year, leading to an eventual growth rebound—one that she believes could yield attractive investment opportunities as the market recognizes pent-up economic potential.

“Even though it sounds on the surface like somewhat of a more negative outlook, within it I see tremendous opportunities both in the fixed-income space and in equities,” she said.

As for whether a recession is ahead, Frances believes that the U.S. economy is likely past its period of peak growth. But she believes the question of whether the economy contracts for two consecutive quarters—the most commonly accepted technical definition of a recession—is overly simplistic.

“I actually do have a recession in my forecast in the middle of this year, but I don’t think it’s nearly as important as a lot of financial media make it out to be,” Frances said. “For most companies and most households … it’s a lot more about ‘Will companies be earning more or less?’ And on aggregate, people will probably be spending less in 2024. That’s why you’re going to have to find the portfolio managers who can find good companies that operate in that kind of environment.”

“Recessions that are short and shallow like the one that we’re seeing also sometimes present fantastic opportunities on the other side,” she said. “Even though we’re in the first half of the year and we’re thinking about this deceleration, we’re also preparing for conversations we think will happen in 2024 about how we’re going to ride the upside of that rollercoaster.”

Frances expects monetary policy will continue to heavily influence markets in 2024, with the current shift toward policy easing likely to provide a positive catalyst: “Global central banks everywhere have conceded there will be no more rate hikes … These are really important moments not only for bond markets but also for the global economy, and it’s happening across the world.”

The current policy trend toward rate reductions rather than further hikes could upend conventional thinking about the relationship between rate levels and inflation, she said: “We believe that central banks will be cutting rates even with inflation above their targets. And so this concept of inflation and interest rates being intricately tied, well, that might be a theme for 2024, as we think about whether those relationships hold.”

Another new wrinkle for the global economy is the lingering fragility of labor markets and supply chains.  Frances said that the end of the COVID-19 pandemic didn’t make these problems disappear entirely; as a result, the overall health of the economy is increasingly tied to whether there are adequate supplies of goods and services to meet demand.

“We’ve always said that economies were run on our willingness and ability to spend, but now, in this new economy, we’re seeing much more that it’s not ‘Do I want to go to a restaurant?’ but rather, ‘Will that restaurant be open because it has enough workers? Will I be able to buy a television? Is it going to get stocked in a supply chain globally?’ These are changing the ways that our economies work. They’re disrupting several of our indicators, and we have to remain aware of that.”  

“We believe that central banks will be cutting rates even with inflation above their targets. And so this concept of inflation and interest rates being intricately tied, well, that might be a theme for 2024, as we think about whether those relationships hold.”

Frances Donald

Josh White

Josh White believes that the strong 2023 performance of a relatively small number of technology stocks resulted in excessive market index weighting for those stocks relative to market segments that didn’t perform as well. Those disparities have created opportunities in undervalued segments, he said.

“When we look at valuations today, growth still looks moderately expensive compared to its own history, while value is kind of roughly in line with its historical median,” Josh said. “But we do think we’re finding interesting pockets of ideas from a value perspective in the market today.”

He believes that 2024 will present a more favorable environment for active equity investors than was seen over much of the past dozen years, when near-zero interest rates tended to lift all stocks in roughly equal magnitudes, making it hard for active managers to stand out from the crowd. In today’s higher-rate environment, that’s no longer the case, he said.

Josh is focusing on companies that he believes could be well positioned in an economy in which borrowing costs are higher.

“I think it’s become much more important for companies to be able to generate their own internal free cash flow and be able to fund their own growth initiatives and not have to be reliant on outside capital,” he said.

As policymakers shift to a more accommodative stance and the market transitions to a somewhat lower rate regime, Josh is mindful of potential risks.

“The economy is kind of still plodding along pretty well,” he said. “So, I would be a little nervous that, as you start to lower interest rates, and if we don’t have a recession, I think we’re probably going to see a return of inflation at some point.” 

“I think it’s become much more important for companies to be able to generate their own internal free cash flow and be able to fund their own growth initiatives and not have to be reliant on outside capital.”

Josh White

Emily Roland

Emily Roland said that recent months have presented unusual challenges for investment strategists such as herself to develop asset class forecasts, given the disconnect recently seen between recently sluggish to slightly negative earnings growth and the strength of the stock market’s late 2023 gains.

“We’re cycle-based investors. We think one of the most important inputs in making cross-asset decisions is understanding ‘Are we early cycle? Mid? Late? Are we in a contraction?’” Emily said. “Now, I don’t like the question because it hasn’t been helpful at all. We’re now at 17 months in a row of the leading economic indicators being negative, and the yield curve has been inverted for over 18 months. All of the classic things that Frances [Donald] and I look at are kind of broken in a way.”

However, Emily sees plenty of potential in the markets, despite her expectations for an economic slowdown ahead.

“What we’re thinking about today is really continuing to position for that late-cycle environment, where we do think that the lagged impact of Fed tightening and the higher costs of capital that companies are going to contend with will lead us into a contraction at some point this year,” she said. “How do you position for it? First and foremost, you want to own high-quality companies. These are ones with great balance sheets, lots of cash, and a limited need to tap the capital markets.”

While many technology-oriented stocks currently have many high-quality characteristics, their valuations don’t necessarily make all of them attractive current investments, Emily said.

“The starting point for stocks is really, really tricky here. We like quality, but we want to diversify from it,” she said.

Emily sees an abundance of current opportunities in some of the more traditional value-oriented sectors.

“On the value side, we like healthcare a lot,” she said. “These companies were left in the dust last year. Who needed a healthcare or utilities stock when you could own high-flying tech stock? So now we think that healthcare is trading at a 10% discount to the broad market. We think it’s going to benefit as consumer spending starts to slow … You’re still going to need to go to the doctor.”

Fixed income also continues to offer attractive potential, she said, in the wake of a challenging couple years for the asset class, eased somewhat by a fixed-income rally seen in late 2023 as the interest-rate outlook shifted.

“We think this higher-rate environment sets up for a really attractive opportunity now to grab onto income, earn 4% to 5% in high-quality bonds, and get paid to wait, as this potential [economic] contraction plays out,” Emily said. “So we do think that bonds can do some more heavy lifting amid this late-cycle environment.”  

“First and foremost, you want to own high-quality companies. These are ones with great balance sheets, lots of cash, and a limited need to tap the capital markets.”

Emily Roland

Brij Khurana

Brij Khurana believes that the U.S. economy will face headwinds in 2024 that it didn’t experience in 2023. Last year, Brij said, U.S. growth was supported by elevated government spending and disinflation that boosted consumers’ real (inflation-adjusted) income. He believes that this is unlikely to be the case in 2024, given slower fiscal spending and a slowdown in jobs growth.

Brij said the monetary policy outlook remains generally favorable for fixed income.

“It is a world where the Fed can be cutting [interest rates],” Brij said. “If you look at what’s priced into the bond curve in the medium term, we’re still well above where the Fed thinks its own policy rate should be over the longer and medium term. So I do think it’s a good environment for bonds.”

“I would caveat it to say that I do think we’re in somewhat of a range–call it 3.50% to 4.50% on 10-year U.S. Treasury bonds. People who missed the rally in November and December [2023] are going to be very excited to buy bonds with yields at 4.50%. And then if we do get to 3.50%, I think there’s some selling that you’re going to see from people who are going to be nervous about the election, and if you have one-party rule, what that means for the deficit.”

As for bond market segments, Brij likes U.S. agency mortgage-backed securities (MBS). He believes that the value of these securities has been diminished by a lack of buying interest in recent years from U.S. banks, which have traditionally been a big player in the MBS market. “These [bonds] could be very attractive if the Fed is cutting and no longer doing quantitative tightening, and so it’s one asset that we’re really, really excited about this year.” 

“If you look at what’s priced into the bond curve in the medium term, we’re still well above where the Fed thinks its own policy rate should be over the longer and medium term. So I do think it’s a good environment for bonds.” 

Brij Khurana