Investors contending with an unstable global economy and multitude of conflicting forecasts for the future may be struggling to find a safe place to put their cash.
The future of global markets is foggier than it has been for more than a decade, but Franklin Templeton chief market strategist Stephen Dover has six essential themes to anchor a portfolio around.
“With the macroeconomic climate causing increased volatility across asset classes, traditional allocation strategies have not been providing the same type of risk/return characteristics that they have historically,” he said.
“Investors need to prepare for increased volatility and capture alternative sources of growth and income when navigating the current economic environment.”
High rates could stick around longer than expected
Inflation may be on its way down, but Dover warned that rates could stay higher for longer than markets are currently estimating.
He said the Federal Reserve (Fed) fears inflation “roaring back” as soon as interest rates come down, just as it did in the 70s, so it is unlikely to ease in the first half of 2024 like most economists expect.
“The Fed has to ensure inflation isn’t just falling, but also gain confidence prices are anchored for a period of time and no longer detrimental to the economy,” Dover said.
“The rise in equity markets this year implies that investors seem to be pricing in the Fed cuts a little earlier than we anticipate.”
A long-term slowdown in the US is coming
Concerns over the US falling into a formal recession have largely passed, but Dover said its future long-term growth will be much lower than it has been for much of the past decade.
It is unlikely to match the growth investors have become accustomed to, although some areas that were worst affected by Covid – such as travel – have undergone their own recessions and could be shielded from a wider slowdown.
Not everywhere will avoid recession
While the US may avoid it, other parts of the world could be less successful in swerving a recession, according to Dover.
“While we anticipate a slowdown and not a recession in first half of 2024 in the United States, recessions are either already underway or look likely in certain regions of Europe where economies are more vulnerable,” he explained. “We are less sanguine about growth prospects and see more sticky inflation across Europe.”
Emerging markets are a better alternative
As the US slows down and Europe drops into recession, emerging markets could be a more attractive alternative than developed ones, according to Dover.
Many central banks in emerging markets were early to ramp up interest rates than the likes of the Fed, meaning they are at the end of their monetary cycles as other parts of the world go through theirs.
Dover said: “With those emerging market central banks starting to ease, both earnings and valuations may have tailwinds.
“That said, we advocate for active management in emerging markets, as opportunities and risks are not uniform across the various subregions.”
But be cautious of stocks
Despite his interest in emerging markets, Dover said investors should be wary of equities. Most markets have picked up since last year’s downturn but they are unlikely to meet the returns markets are forecasting, he warned.
The resurgence in stocks this year is likely to slow down and the current expectation that earnings growth could be up between 12% to 15% in 2024 is “a high hurdle to achieve given the economic uncertainties we see”, he said.
“Some of the momentum growth darlings are now facing challenges. This time of year has historically been challenging for equities, so a slight tilt toward a risk off bias seems prudent.”
Bond are more attractive than ever
Rising interest rates have pushed bond yields up to their highest levels in years, making the asset class more attractive to investors. Dover pointed out that many corporate bonds are now offering a better yield than the dividends available from most stocks.
“For many years, fixed income was more of an insurance policy rather than a generator of income but now we are excited about the types of yields offered across the credit spectrum,” he said.
Investors wanting exposure to these high levels of income might want to look to investment grade bonds, as they offer a better opportunity for less risk than high-yield bonds, according to Dover.
Investors need to broaden their asset class exposure
Despite bonds returning to favour, the traditional 60/40 portfolio needs to evolve if investors want to keep their savings secure, according to Dover.
Investors often attempt to diversify their portfolio by spreading their money across equities and fixed income, but these two asset classes are not enough.
A truly diversified portfolio needs to have allocations to alternative assets if investors want protection in the face of today’s economic uncertainty.
Dover said: “Alternative assets can play a significant and positive role in diversifying traditional bond and stock portfolios.
“It’s become much easier for many investors to access these markets, and while the democratization of private assets is a positive trend, one does have to be prepared for some illiquidity.”