As we approach the end of 2023, it is imperative to reflect on the pivotal macroeconomic developments that have defined the year and to carefully consider potential risks that investors should monitor as we enter into 2024.
Reasons for Confidence: Surpassing Expectations Amid Challenges
Despite gloomy projections at the onset of 2023, coupled with another push higher in interest rates and geopolitical upheaval, the global economy has managed to exceed expectations. The U.S. economy, a major driver of global growth, demonstrated resilience by outperforming the rest of the world. This success was attributed to robust household spending supported by steady job creation and income gains.
Better-than-expected economic growth paved the way for corporate profits to exceed subdued forecasts. Q3 earnings for large-cap U.S. and European companies resulted in 80% and 60% beating expectations, respectively. Additionally, inflation continued its decline due in part to lower energy prices, base effects, and slower demand. This enabled major central banks, including the Federal Reserve, to adopt a more stable stance on interest rates, inflation, and growth.
Reasons for Prudence: Navigating Persistent Headwinds
While cautious optimism prevails, the global economy is expected to face challenges. A notable source of uncertainty arises from the impact of rate hikes implemented by central banks worldwide. Central banks in the U.S., Canada, and Europe have signalled a desire to pause rate hikes but anticipate interest rates to remain at high levels for an extended period due to lingering inflation concerns.
Higher rates and lower willingness from banks to extend loans may suggest challenging credit conditions for households and businesses. These restrictive borrowing costs and limited credit access will likely act as a drag on economic activity. Afterall, consensus projections for 2024’s Global and U.S. real GDP growth is forecasted to moderate to 2.7% and 1.2%, respectively, from the current year's 2.9 percent and 2.4%.
Signs of strain from the monetary tightening campaign are evident, with most major economies experiencing fewer job generation, decelerating wage gains, falling job openings, and an uptick in corporate defaults. Although they are starting from healthy levels, there is a risk that these metrics could trend in the wrong direction heading into the next year.
Investment Takeaway: Balancing Optimism and Prudence
As long as the global economy maintains an upward trajectory, consensus estimates project low double-digit profit growth for major equity indexes in 2024. While these numbers are subject to revisions, an "upgrade to quality" approach to portfolio allocations remains prudent. Within equities, a preference for companies with consistent cash flows, lower debt levels, and growing dividends enhances resilience if economic conditions deviate from market expectations.
The upward trends of interest rates in 2023 has impacted returns in fixed income markets. Despite this, bond prices over the past 20 months have improved the overall risk-reward profile, presenting compelling opportunities. While bond yields have experienced recent fluctuations, allocating into fixed income continues to make sense, with many markets offering opportunities to lock in all-in yields ranging from mid-to-high single digits.
Looking Ahead: Navigating 2024
As we look towards 2024, the key concern remains the lingering impact from the previous rate hikes on economic activity. The delicate balance between sustaining growth and managing inflation poses a challenge for central banks. Monitoring job markets, wage trends, and corporate defaults will be crucial for investors. The delicate equilibrium between optimism and prudence is essential as we enter 2024, ensuring that investment strategies are well-positioned to thrive amidst evolving global economic dynamics. Call us to review your portfolio positioning to start the new year.