We started 2023 with expectations of low global economic growth and elevated fears of recession. However, significant government aid in the U.S. and Europe, and the strength of U.S. consumers, stabilized growth. A faster-than-expected decline in inflation has led to expectations of rate cuts in 2024 and we believe those expectations, along with enthusiasm over artificial intelligence, have contributed to strong positive returns for risk assets.

While we see declining inflation in 2024, we also expect economic growth to decelerate. Given this economic outlook, global political risk and expensive valuations , we are cautious about equity performance but find high yield bonds attractive.

Below, we highlight key topics from our complete 2024 Global Investment Outlook paper.

Economic Growth

In the U.S., we anticipate a soft landing as the most likely scenario, where inflation (Exhibit 1) and the labor market cool off in 2024, leading the Fed to possibly start cutting rates in mid-2024. We expect economic growth to slow to the 1% to 1.5% range, avoiding a recession, while the unemployment rate may rise to around 4%. We note that 2024 is a U.S. presidential election year, but we don’t expect the election to dictate monetary policy decisions. The coming election does, however, provide an added incentive for the current administration to support the economy.

The eurozone economy proved surprisingly resilient in 2023, but two military conflicts near its border complicate the outlook. The Russia-Ukraine is approaching a costly stalemate, casting a lingering shadow over Europe’s supplies of food and energy. If Israel’s conflict with Hamas reduces oil flows, we think the eurozone will quickly feel the burden of higher energy prices. Compared to the eurozone, the U.K. has struggled more with inflation while its incomplete network of trade agreements and weakness in the pound have raised import prices. Prospects for the U.K.’s growth remain muted, and downside risks are elevated.

In Asia, China may enter a prolonged period of slower growth after four decades of a startling economic rise. The country’s once-booming property sector is crumbling, with several leading developers in serious trouble. Spillover from property markets to other areas of the economy is dragging growth below the government’s annual targets. For a nation accustomed to a dazzling pace of growth, 2024 will likely feel recessionary to China.

EXHIBIT 1: INFLATION IS A CRITICAL FACTOR

U.S. Inflation moderated in 2023. Its trajectory during 2024 will be critical to the U.S. economy’s outlook.

Interest Rates

With inflation in the U.S. still well above the Fed’s target, we view the outlook for U.S. interest rates over the next six to 12 months as closely connected to the path of inflation. We expect inflation to decline gradually, likely resulting in lower and flatter Treasury yield curve as 2024 (Exhibit 2) with the Fed possibly starting to cut rates mid-year. In the meantime, we see potential for a bumpy ride for U.S. yields in the near-term. We think the European Central Bank also will want to feel sufficiently confident they have won the battle on inflation before cutting rates in order to avoid the risk of reigniting inflation or causing economic stagnation. We see the end of the second quarter as the earliest starting point for cuts, barring material changes in the economic data. Stickier inflation in the U.K. suggests the Bank of England’s moves will lag central banks in Europe and U.S. We expect interest rates to be held for a prolonged period as the most likely scenario, with the second half of 2024 as a likely timeframe for any normalization to begin.

EXHIBIT 2: LOWER AND FLATTER U.S. CURVE

We expect inflation to decline gradually, likely resulting in a lower and flatter Treasury yield curve in 2024.

High Yield Bonds

We think stable fundamentals will support high-yield bond valuations and a benign default outlook provides an attractive backdrop for total return potential. High yield bonds’ historically limited downside relative to equities could offer support as investors contend with risks associated with a slowing economy. Larger and more diversified high yield issuers are in a better position to weather economic adversity compared to smaller companies, and the high yield market is effectively of its highest quality in history (Exhibit 3). With BB- and B-rated issuers comprising close to 90% of the asset class, we believe default exposure is low.

EXHIBIT 3: HIGH YIELD CREDIT QUALITY AT HISTORICALLY HIGH LEVEL 

Compared to its 20-year average, the credit quality of the high yield market is relatively high, with BB- and B-rated issuers comprising close to 90% of the asset class.

Equities

Just a handful of technology-related companies contributed to last year’s equity rally and the corresponding increase in valuations, fueled by the promise of artificial intelligence. Despite flat earnings growth and profit margins at near-record levels, analysts’ consensus earnings growth expectations remain strongly positive for the next two years. While we’re sanguine about the potential of artificial intelligence, we believe the near-term returns from the technology will come piecemeal and investors will find those returns difficult to gauge and time accurately. As a result, near-term growth and margin expectations supporting current equity prices and valuations may prove overly bullish.

We find further evidence of concern through the equity risk premium, or the difference between the forward earnings yield (earnings divided by price) of the S&P 500 and the real 10-year Treasury yield. This reflects the relative attractiveness of holding equities, a risky asset, over less-volatile Treasury bonds. The equity risk premium is at its lowest point in the since 2006 (Exhibit 4), suggesting limited rewards for investing in equities.

Although somewhat less pronounced, a similar story has played out outside of U.S. large caps. In 2023, developed non-U.S. equities returned more than 18%, U.S. small caps were up over 16% and emerging markets weighed in at 10%. In all cases, returns have depended more on stretching valuations rather than on positive earnings growth. While we are predicting a global soft economic landing in 2024, we expect earnings growth to fall short of analysts’ expectations. As a result, we expect downside risk to most major global equity markets.

EXHIBIT 4: RISK PREMIUM SUGGESTS MINIMAL REWARDS FOR INVESTING IN U.S. STOCKS

The equity risk premium — the difference between the forward earnings yield of the S&P 500 and the real 10-year Treasury yield — reflects the relative attractiveness of holding equities, a risky asset, over less-volatile Treasury bonds. The equity risk premium is at its lowest point since 2006, suggesting limited rewards for investing in equities.

Real Assets

Global real estate, which underperformed in 2023, appears positively positioned for 2024, with greater clarity on the path of inflation and interest rates. We expect global listed infrastructure to continue to serve as a useful tool for diversification, inflation protection and income generation. Many areas of the asset class may benefit from a decline in interest rates, given their bond-like profile. With natural resources, we think persistent cash flows, tight commodity markets, stronger balance sheets and lower capital expenditures make the asset class an important hedge against higher inflation and geopolitical tensions. Natural resource equities also remain attractive from a valuation standpoint (Exhibit 5), when compared to both historical metrics and the broader equity market.

EXHIBIT 5: ATTRACTIVE REAL ASSET VALUATIONS

Global real estate, global listed infrastructure and natural resources valuations are below median, aiding their prospects for 2024.

Falling Inflation and Rates, Rising Political Risk

In 2024, we see inflation and interest rates declining across the globe, and a resilient U.S. consumer likely  helping to  avoid a recession. Global political risks have risen with the growing conflict in the Middle East and continued war in Ukraine. Further, political polarization is driving contentious elections worldwide. European stocks face a challenging environment and U.S. equities, though more promising, appear expensive. As a way to help manage these risks, high yield bonds could prove a good fit for 2024. Let’s take a closer look.

Lower inflation will likely trigger the reduction of interest rates globally in 2024.  Supply-chain disruptions from the pandemic have largely ended, causing goods-related inflation to retreat. However, housing-related inflation and wages continue to rise, contributing to stubborn services inflation. We expect that housing related inflation will likely soften this year, triggering an overall reduction in U.S. inflation. U.S. rate cuts may start around mid-year. European central bankers likely will want to be certain of having conquered inflation before reducing interest rates. Meanwhile, U.K. inflation risks remain elevated. 

Forward-looking markets responded to declining inflation and the promise of AI with a global equity rally last year. While US large caps surged more than 26% in 2023, earnings stayed flat, and valuations therefore expanded. Thus, U.S. large caps merit some caution. Global markets followed a similar pattern, though to a lesser extent.

Declining inflation and rate cuts will likely come with a slowing economy and political unrest that may dampen investment gains globally. In this environment, high-yield bonds look promising as credit quality is high and default risks remain low..