The pivotal issue for markets in 2023 was whether central banks could avoid inflicting severe economic damage while taming stubborn inflation. The reasonably positive returns delivered by global financial markets, particularly US and Japanese equities, attest to policymakers’ relative success. But what might lie ahead in 2024?
Major fiscal challenges
Politics will certainly be high on the agenda over the next year. Several key elections will be due, including the US presidential battle and a UK general election required by January 2025.
Whatever new governments gain power, they will face major fiscal challenges. Colossal amounts were borrowed in the wake of the global financial crisis and during the Covid pandemic. With interest rates higher now they must also find more money for repayments.
The wiggle room will be limited, as spending will have to be reduced and tax revenue increased. That means cutting budgets and increasing taxes.
However, politics is notoriously difficult to forecast and while it can be a source of significant noise over the short term, it tends to have a low impact on investments over the long term.
Overall we are positive
And over the longer term, we remain positive on the outlook for markets.
Investors’ concerns do still weigh on markets. The trajectory of interest rates remains a key issue, as shown by the impact of central bank warnings during the fourth quarter of 2023 that they will have to stay higher for longer than many expect to tackle inflation, although markets did rally from November on rising expectations that a more dovish tone would feature early in 2024.
Geopolitics, including the conflicts in Ukraine and the Middle East, and US-China tensions, are also still an issue.
However, the main fears that hung over 2023, including a deep recession, have not materialised, and inflation is falling. The $960bn cost of funding the US’ deficit cannot be ignored but the strength of its economy and those of other developed markets has surprised on the upside this year.
While there are short-term challenges posed by sentiment and the potential for an economic slowdown, we feel, on balance, that this widely held view is priced into markets, with equity valuations outside of the US sitting at historically attractive levels and bond yields at the highest they have been since the financial crisis.
As a result, we are optimistic but cognisant of the potential for short-term headwinds. As long-term, disciplined investors with a tried and tested process we recognise that short term noise, while posing a challenge to investor conviction when it generates market volatility, is a source of long-term opportunities due to the mispricing it generates.
Tactical asset allocation
From an overarching perspective we are broadly constructive on markets and that is reflected in the fact that we have scored the overall environment a four out of our scale from one to five over the course of the year.
We continue to believe markets are attractive for disciplined investors. We believe equities offer attractive valuations and long-term fundamentals. While we are broadly neutral on fixed income, we favour corporate bonds, and we have a bias to overweighting equities, where we are positioned for a recovery in small caps and value stocks.
Based on our 12-18 month ‘tactical’ view, we favour the UK, Japan, Asia ex-Japan and emerging equity markets.
The UK is unloved, but that can also mean undervalued. We believe the FTSE All Share index represents good value that compensates for the political uncertainties and gloomy forecasts for the domestic economy that has weighed heavily on sentiment. UK small-caps have been particularly hard hit over the last year and we believe they are likely to have greater potential for future growth than the FTSE 100 index.
In the fourth quarter of 2023, we raised our outlook on Japanese equities and small-caps from neutral to positive. Japan’s stock market has waited more than three decades for its moment in the sun.
The combination of genuine structural reforms in the corporate sector combined with the resumption of inflationary forces for the first time in decades are likely to reflect a period of economic reflation in Japan and consumption that we anticipate will benefit the beleaguered stock market.
Asia offers a relatively strong economic growth outlook, benign inflation and potential policy easing. This should translate into generally stronger corporate balance sheets. In a manner akin to the UK, Asia ex-Japan markets have been experiencing a headwind to returns from investor sentiment, which has led to a paucity of flows into the market.
Emerging markets’ poor performance over the past two-to-three years has a lot to do with problems in China. But now there is a more pro-growth, stimulus-oriented stance in China, emerging markets could benefit from the relative appreciation of their currencies versus a weakening dollar and they are set to be boosted by international strategic supply chains being re-ordered.
Valuations count in the long term
Investors will still face risks, as always, including economic, social and geopolitical uncertainties. In 2024, these risks could easily have a negative impact on markets, which are driven by fear and greed in the short term.
Markets continue to be fickle, with excessive volatility driven by over-reliance on whatever the latest data or news angle dictates. There is ample fodder for both positive and negative market watchers.
But, longer term, markets are driven by valuations. We believe these are currently attractive for investors with a long-term perspective.
Timing markets is notoriously difficult to do. Instead, the secret to wealth creation is compounding and this requires staying invested in markets. The longer they invest, the more opportunities investors have to grow their wealth. Investors should also remember that equities have proved time and again to be the best asset class to beat inflation over the long term.
John Husselbee is head of the Liontrust multi-asset investment team. The views expressed above should not be taken as investment advice.