2024 Outlooks

Where do you see key opportunities for European equities going into 2024?

The key feature of the market is that while there is near-term uncertainty, the long-term picture about where to invest is clear. Inflation, interest rates, geopolitical tensions and political change have all been hard to predict over the past couple of years, and few saw a pandemic on the horizon as 2020 dawned. As we look into 2024, however, we can see numerous cheap companies lying in plain sight. There may or may not be a recession next year – certainly growth forecasts for Europe are perilously low – yet many companies are already priced for recession. Indeed, there are a great many which have been in an earnings recession for years and have the potential to now accelerate.

Beyond such bombed-out bargains, we see many companies that have fallen 50% or more from prior peaks, as well as numerous names that have been in a process of de-rating throughout the year but which now could well re-rate should they return to growth and more stable delivery against expectations.

So, the key opportunities are to be brave and not afraid to take a longer-term view, looking through some of the potential volatility towards a more normal environment for corporate activity. While rates at 5% may be higher than recent history, I’m certainly old enough to remember when 5% was normality and many stocks performed well against that kind of backdrop.

What surprises could 2024 bring?

The turning point for small caps. The reality is that after the historical drawdown that we have seen, we should now be getting very close.

If we compare the typical underperformance of small caps compared to larger companies that we see around recessions, we have already witnessed the full extent of that in numerous markets. Many of the factors which hit smaller companies hard, such as higher borrowing costs, higher wage bills and sharp increases in raw material costs, are now going into retreat, giving companies an opportunity to rebuild their margins. We have always been attracted to the agility of smaller companies and we are already seeing many management teams taking the action required to address costs and improve performance. This kind of ‘self help’ puts the destiny of such companies in their own hands and delivers improvements unconnected to the market backdrop. 

As we come to the end of 2023, it is worth spending a moment to think about what the world could look like in 12 months’ time. Even in a scenario of weakening growth early next year, the likelihood is that by the end of the coming year we will be through this and with markets looking forward as they usually do, valuations should start to reflect the potential returns of 2025.

Some experts forecast a scenario where interest rates start to fall, perhaps in the second half of the year, reducing the discount rate for companies and driving an improvement in sentiment. When we consider some of the factors that drove rates lower in recent years, such as the impact of technology, the falling share of labour in costs and capital goods price deflation, it isn’t hard to imagine a scenario with rates heading lower.

While it’s hard to call the exact timing of the resurgence of small caps, and there is risk if we see more of a slowdown of activity more broadly, I feel confident that we are very close indeed to a turning point and from here we should see more of the strong returns for which smaller companies are well known. 

As we shift our attention towards next year, we try to envisage potential scenarios for the Swiss small and mid-cap asset class. Many pundits formulate detailed forecasts based on sophisticated mathematical models, enticing investors to buy or sell specific assets. In contrast, our views are based around scenarios and potential opportunities, all rooted in the reality that we have yet to learn what 2024 has in store.

What surprises could 2024 bring?

Market attention is firmly focused on earnings resilience and growth expectations for 2024. Earnings estimates for 2023 have been consistently over-pessimistic, including the most recent quarterly earnings season. While flat earnings growth for 2023 still seems relatively modest, 2024 is forecast to deliver an 11% increase for the SPI Extra Index, which tracks the Swiss small & mid-cap market. We agree that expectations are too high and should follow a steady downward trajectory over the next few months, but a severe earnings recession seems unlikely.  

The first surprise in this regard could be that earnings revisions to the downside have little impact on sentiment and market performance. One reason for this could be the greater sensitivity of market prospects to interest rates in 2024. Maybe surprisingly, we will come to realise that long-term yields peaked in 2023 and will settle at lower levels over the next 12 months.

The hyperactivity of central banks has resulted in unprecedented magnitude and speed of rate hikes, potentially foreshadowing trouble ahead. We wouldn’t be surprised to see that central bankers are behind the curve, continuing to talk about persistent inflation even as global growth slows down and inflation quickly normalises. Could it be that investors focus on earnings and overlook valuation expansion driven by lower yields?

2024 could also be the year of massive Chinese fiscal stimulus and continued US economic resilience, courtesy of spending budgeted by the US Inflation Reduction Act, as well as a potential dynamism of European green-transition spending.

Finally, after many years of stalling productivity gains, the combination of breakthrough technologies, such as AI, quantum computing and diagnostics, could herald a new phase of accelerating productivity gains.

Notwithstanding numerous known risks going into 2024, we are confident that there will be plenty of potential opportunities to benefit from.

Where do you see key opportunities for Swiss equities going into 2024?

Considering the possible surprises outlined above, we see notable opportunities in stocks that exhibit distinctive compounding qualities. In our investment approach, these companies combine high return on capital employed, a defendable moat, attractive growth prospects and smart management.

Switzerland has always been a fertile ground for compounders, courtesy of the ideal ecosystem of business-friendly politics, strong innovation power and global leaders in niche sectors. At current levels, valuations have compressed significantly, offering attractive potential entry points.

We expect additional opportunities to arise from the separation of growth stocks that deliver on their embedded expectations from the pseudo-growth names that don’t. We would also expect the environment of higher interest rates to favour smart capital allocators that operate with an entrepreneurial mindset regarding investments and expansion. We are weary of businesses that embark on major investment projects or acquisitions predicated on unsustainably low financing rates. Expect their day of reckoning to arrive at the date of refinancing.

Finally, a lack of visibility should increase volatility and more frequent shifts in sentiment. A disciplined approach with a compass pointing to compounders at reasonable prices should guide us through potential storms and point toward attractive investment opportunities.

Where do you see key opportunities for emerging market equities going into 2024?

The turn of the year is often seen as a time of fresh starts and new opportunities. For emerging market (EM) equities, 2024  could well deliver much of what was predicted — but failed to materialise — for 2023. 12 months ago, a China-led recovery was rapidly priced in by the market, only to unwind when the pace of recovery disappointed. But now, more supporting factors are in place.

As a reminder, historical precedent suggests that when EM growth is outpacing developed market (DM) growth, and DM isn’t undergoing a deep recession, EM equities tend to outperform. This norm didn’t play out in 2023 largely because, whilst EM GDP growth outpaced DM, this failed to translate into a broad-based corporate earnings upcycle. The anticipated earnings recovery was delayed by various factors including China’s property woes, weak consumer sentiment and destocking within the tech supply chain. We’re now seeing concerted attempts to support the Chinese property sector, as well as restore consumer confidence. At the same time, household savings are at historical highs.

Additionally, a fresh consumer tech replacement cycle also looks set to coincide with inventories back at normalised levels. All of which present the potential for a recovery in the corporate earnings cycle.

Another point of historical significance is that the period immediately after peak US rates normally sees EM equities outperform DM equities, partly thanks to the tailwind of a gradually weakening US dollar. If the US experiences a relatively soft landing, as currently expected, that should also protect the more export-reliant nations within EM from the issue of weaker demand. A goldilocks scenario in the US of lower inflation, robust employment and a resilient consumer at the same time as falling interest rates is one of the most favourable economic environments for EM equities.

Lower interest rates globally in 2024 also pave the way for EM rates to come down in support of economic growth. EM nations including Brazil, Chile and Poland have already begun their cutting cycles ─ a sign that inflation pressures have been dealt with more quickly than in DM. This creates the opportunity to support EM businesses and consumers with lower lending rates, which provides further momentum for a new corporate earnings upcycle.

What surprises could 2024 bring?

Stepping into 2024 after a challenging time for the asset class, we have many reasons to be optimistic. We’re heading into a global environment of lower rates, a weaker US dollar but robust employment and a healthy global consumer. At the same time, we have normalising inventories, a replacement cycle in technology and the beginnings of a new corporate earnings cycle. Taken together, 2024 could surprise us as the year 2023 first promised to be.

Where do you see key opportunities for global fixed income going into 2024?

We see opportunities across all parts of the fixed income universe going into 2024, given we expect to see differing effects from a slowing economic environment, alongside lower inflation and rate cuts. Timing will be key, but we expect positive total returns from most of the sub-asset classes, albeit in differing scales.

In terms of macro, we’re expecting US inflation to swiftly track downwards from the highs of 2023, but ultimately settle between 2.5–3%, so a little above the target 2%. Interest rate reductions therefore seem inevitable in 2024 (led by the Federal Reserve but with the UK and Europe following neatly behind) as we move towards a much slower economic environment. This in turn should reduce general uncertainty, which is what has driven market directionality this year. I would expect this type of macro environment to result in continued strong returns for higher-quality, longer-duration bonds ─ both in developed and emerging markets. The latter will be more dependent upon a weaker US dollar, but that’s to be expected as interest rates begin to fall.

When the economic slowdown hits and rates begin to fall, this is when we would expect risk to outperform. Our target on high yield bond spreads is around 500bps; we believe this level would indicate a clear buying opportunity. Then, as rates are cut to stimulate growth, we would expect to see lower-quality credit begin to perform.

What surprises could 2024 bring?

I think seeing inflation re-accelerate, or firmly settle in above 3%, would be a big surprise for most market participants. This would leave us in a macro scenario of ‘higher for longer’, with more rate hikes on the horizon and broad risk-off sentiment. While this is not our expected outlook, all would not be lost for bond investors. High carry instruments, like global investment grade bonds and high-quality global high yield bonds, should still deliver positive returns.

At the other end of the spectrum, should the US, Europe or the UK fall into a deeper-than-expected recession, then quality fixed income, like global government bonds, offers outperformance potential.  

Ultimately, whether we end up with a soft landing or the economy heads towards one extreme or another, we see the possibility for attractive return potential from fixed income markets in 2024.

Where do you see key opportunities for emerging market debt going into 2024?

Broadly speaking, we think the outlook for fixed income assets in 2024 has improved considerably across the board. US core interest rates are now at their highest levels in 15 years, thereby shifting the probability of bond returns dramatically to the upside, including all segments of the emerging market (EM) debt universe. We expect uncertainty to remain elevated regarding the outlook for both growth and inflation, but our base case scenario is for EM bonds to outperform on the back of high levels of income and a benign outlook for core rates and the US dollar.

The dispersion of returns across regions and countries will likely remain as high as it has been this year, with large differences in performance across local currency between the best (Latin America, Eastern Europe) and worst (Asia) performers of 2023. On the credit side, in the absence of a hard recession, we expect high yield will likely continue to outperform investment grade, offering a broad range of investment opportunities on both corporate and sovereign debt.

Overall, we expect 2024 to deliver another year of positive returns across EM local, sovereign and corporate debt.

What surprises could 2024 bring?

Within EM, a positive scenario could unfold in both Turkey and Argentina ─ two of the largest economies that over the past few years have suffered severe macro negative consequences and loss of confidence from deeply unorthodox economic policies. In both cases, the 2023 elections marked a ‘before & after’ moment regarding the political will to change, which is now at its highest.

In the case of Turkey, the return to orthodoxy got underway in mid-April with a new team at the ministry of finance and the central bank. In Argentina, the newly elected government will not take office until 10 December.

Execution risks are elevated, particularly in the case of Argentina, where the new government aims to end more than two decades of Peronism/Kirchnerism and restore its former glory via a deep state reform, fiscal restraint, a privatisation programme and eliminating inflation through dollarisation.

Many things will have to go well in order to bring down inflation in both countries, but if they succeed and confidence returns, we believe the probability that Turkey/Argentina end up being the best-performing local/hard currency markets respectively in 2024, will be much higher than what the market is currently expecting.

An additional positive surprise could be China. Should the government implement much larger policies in order to revive the property market, Chinese assets could potentially leave behind some of the stigmatisation that has dominated for over two years. Investor confidence might not be fully restored, but Chinese assets might perform better than anticipated.

One potential negative surprise we are watching for is Mexico, which despite riding high on the tailwinds of near-shoring, and benefiting the most from the woes in China, is the most exposed to a hard landing in the US and the potential return of Trump to the White House.

Where do you see key opportunities for convertible bonds going into 2024?

If recession fears materialise, interest rates will likely decline and provide a tailwind to convertibles by triggering a rise in bond values and ─ all else being equal ─ a price appreciation of low-delta names. Convertibles’ valuations are supportive and should benefit from a short to medium-term normalisation in rates, given the current low levels of volatility and the mispricing of low-delta convertibles that more often than not trade wider than their equivalent straight bonds.

New issues are also an interesting area of potential opportunity. They are offered to the market at a discount to their theoretical "fair" value from financially stronger and well-established companies (the current percentage of investment grade ratings within global issuance is 3x larger than the 10-year average), which tend to have lower credit risk. They also bring income (the 2023 average coupon is ~3%) and convexity (the 2023 average delta ~50%).

M&A was an interesting theme through 2023 and one that we believe will remain prominent in 2024. We expect activity benefiting convertible bond issuers to remain robust as higher interest rates have not deterred large companies from growing externally. It is important to remember that convertible bond holders generally enjoy different forms of takeover protection through a temporary downward adjustment to the conversion price or a possible early redemption at par.

Finally, as refinancing becomes a more pressing issue, we anticipate companies will increasingly look to convertibles as a funding channel offering equity upside potential against lower coupons (between 300-600bps depending on the rating), while potentially buying back outstanding convertibles trading at a discount to par to optimise their balance sheets. On top of our comments regarding new issues, this should also support valuations as these purchases are made at premium to market prices.

What surprises could 2024 bring?

The last few quarters have marked the dominance of mega-caps against the rest of the market to a point where more than 75% of the S&P 500 Index’s year-to-date return[1] has been driven by the so-called ‘Magnificent Seven’, which is Apple, Amazon, Alphabet, Nvidia, Meta, Microsoft and Tesla. The performance and valuation spread of large caps against small caps, and broader markers against convertible bonds’ underlying companies, has reached new highs. We think this dominance may start to reverse going into 2024, even in a recession scenario where large caps would traditionally outperform as positioning, expectations and multiples become stretched.

Through 2022 and 2023, convertibles have suffered their longest net outflow streak in history. But things are changing. As issuance picks up and convexity returns, with 1.17x more upside than downside of convertibles’ underlying stocks captured year-to-date, and carry and downside protection the highest they’ve been in years, convertibles are now screening at their most attractive metrics since the Global Financial Crisis. We expect to see a positive inflection in flows as 2024 gets underway.

[1] As of 30 November 2023