2024 Outlook: Perspectives on the global Economy

January 9, 2024

Yogi Berra's timeless wisdom, encapsulated in the famous quote, "It's tough to make predictions, especially about the future," resonates with the perpetual challenge faced by forecasters across various domains. The unpredictability of events, such as the United Auto Workers strike, the collapse of Silicon Valley Bank, or the Israel-Hamas war in 2023, underscores the inherent difficulty in achieving precision in economic, financial, and political predictions. The Mather Group, LLC (TMG) acknowledges this unpredictability and the task of forecasting with humility as it presents its 2024 Outlook. Crafted by TMG's senior investment management team, our Outlook delves into potential factors that could significantly impact the global economy's equity, fixed-income, alternative investments, and geopolitical segments.

GEOPOLITICAL OUTLOOK

Looming Domestic and Global Debt Crisis: 

The COVID-19 pandemic prompted substantial government expenditures worldwide to counteract soaring unemployment and prevent widespread business closures. In the United States alone, pandemic-related programs amounted to $4.3 trillion, leading to a notable 43% surge in government spending from Q1 2020 to Q3 2023.

As illustrated in the table below, the economic slowdown during the pandemic resulted in a sharp increase in the ratio of government debt to Gross Domestic Product (GDP). Equally concerning was the simultaneous rise in interest payments for bonds utilized to fund these programs. With interest rate hikes in 2022 and 2023 aimed at controlling inflation, these costs may persistently remain high as existing bonds mature and new bonds are issued.

The 2024 stage is set for a potential significant emphasis on curbing the growth of government debt and its associated servicing costs. This effort might hinge on two primary mechanisms: tax increases and/or a reduction in public services within pension, welfare, and health insurance sectors. The landscape for 2024 underscores the challenges of managing fiscal responsibilities amid ongoing economic uncertainties.

*Japan implemented negative interest rates in 2016 to reduce its interest payments

Cybersecurity Threats: 

As the scope of cybersecurity threats has expanded in the era of the Internet, evolving from spam to ransomware, so too have the identities of those behind these attacks. The landscape has shifted from individual hackers to state-sponsored actors, including countries like China, Iran, North Korea, and Russia.

The objectives of many "hacktivists" have also evolved, encompassing the theft of intellectual property, holding systems hostage until a ransom is paid, pilfering national security information, and engaging in cyberwarfare attacks that can immobilize critical infrastructure networks, such as utilities.

In our 2024 Outlook, we anticipate a continual rise in geopolitical risks, particularly in the Middle East and Eastern Europe. This elevation in risk may drive state-sponsored actors to intensify their efforts to infiltrate and disrupt systems in countries they perceive as hostile. Utilities like water, wastewater, and transportation could be at an increased risk of facing threats designed to disrupt and demoralize citizens.

Furthermore, with it being an election year in the United States, cybersecurity threats to the electoral system are expected to be a recurring theme throughout 2024. The intersection of technological vulnerabilities and geopolitical tensions underscores the critical importance of robust cybersecurity measures on a global scale.

Fragmentation of World Trade Network: 

The convergence of trade disputes between China and the U.S., coupled with substantial sanctions against Russia, is fostering a noticeable shift towards the fragmentation of the global trade network. Established financial and goods flows are undergoing a transformation, giving way to the emergence of regional trade networks.

A significant illustration of this trend is the disconnection of Russia from its global trade ties with Western economies, as it pivots towards a regional network involving China and India. Another example is the implementation of the Indo-Pacific Economic Framework for Prosperity by the U.S. in 2022. This framework aims to foster trade in goods and services among 12 Asian countries, including Australia, Indonesia, and Singapore, while deliberately excluding China.

In 2024, TMG anticipates that geopolitical and national security considerations will increasingly influence regional trade policies. This could manifest in heightened U.S. export controls, adjustments to tax policies, and enhanced scrutiny of foreign direct investment, particularly in strategic sectors like semiconductors. These measures are likely to prioritize supply chain resilience and reduce dependency on Chinese trade, reflecting an evolving landscape shaped by geopolitical dynamics.

EQUITIES OUTLOOK

U.S. Large-cap Stock: 

In 2023, the talk of the town revolved around the "Magnificent Seven," comprising tech giants such as Apple, Alphabet, Microsoft, Amazon, Meta, Tesla, and Nvidia. This powerhouse group collectively represented about 30% of the S&P 500’s market value at the end of 2023 and played a substantial role in driving nearly two-thirds of the index's returns over the past year. Despite this noteworthy performance, the outlook remains promising, underpinned by key fundamentals such as anticipated sales growth and improved margins in 2024.

While the stellar fundamentals contributed to the impressive gains in 2023, The Mather Group, LLC (TMG) emphasizes the significance of diversification in its investment approach. Despite the potential for continued success among the Magnificent Seven, TMG recognizes opportunities in other asset classes for growth in 2024. Some of these alternatives are trading at attractive valuations when compared to historical averages, reinforcing the importance of a diversified investment strategy.

The remarkable performance of the Magnificent Seven stocks is undeniably impressive, but it raises concerns reminiscent of the late '90s dot-com bubble, marking a level of market concentration not seen since then. In 2023, a striking 72% of S&P 500 stocks underperformed the index for the year. While this concentration poses a risk, there is a silver lining in the form of improving market breadth, suggesting increased participation from a broader spectrum of companies in price appreciation.

Despite the positive trend in market breadth, it's crucial to keep an eye on other areas of the investible market, such as small-caps. These smaller companies have the potential to experience rapid appreciation, especially as market breadth widens during a recovery. Additionally, the concentration risk observed in U.S. stocks is less pronounced in international markets, where the dispersion in returns between the top performers and the worst performers is comparatively smaller. Diversification across different asset classes and regions remains a prudent strategy in navigating the dynamic landscape of the global market.

Source: Bloomberg, Apollo Chief Economist 

U.S. Small-cap Stock: 

U.S. small-cap stocks currently find themselves at a historically significant discount when compared to their larger counterparts, reminiscent of the notable levels observed during the dot-com boom. As we step into 2024, historical patterns suggest that small-caps tend to thrive during periods of rising interest rates and high yet diminishing inflation. Although interest rates seem to have reached a peak, with expectations of a decline in 2024, the prevailing outlook anticipates a continued decrease in inflation. This scenario presents a potential area of opportunity for investors as they navigate the investment landscape in 2024.

Analysts are optimistic about the small-cap sector, forecasting a robust improvement in earnings for 2024. Projections indicate a substantial 29.8% earnings growth for the Russell 2000, outpacing the +11.4% growth rate anticipated for the S&P 500, as reported by Schwab.

Examining price-to-book ratios, a metric commonly used by capital market experts to assess perceived value, small-caps are currently trading at one of the most significant discounts relative to large-caps on record. Considering these attractive discounts and the anticipated earnings growth, small-cap stocks emerge as promising contenders within the framework of a diversified portfolio.

FIXED INCOME OUTLOOK

In December 2008, the Federal Reserve slashed interest rates to zero in a bid to stabilize the global financial system following the Great Financial Crisis. Subsequently, financial markets reaped the benefits of low borrowing costs, fostering growth through leverage and boosting asset valuations. However, this boon came at the expense of savers and retirees, who received minimal returns on cash holdings. The prolonged period of historically low interest rates compelled investors to venture into riskier assets to meet their return targets.

This paradigm shifted when inflation surged to levels unseen since the 1980s. In response to this inflationary pressure, the Federal Reserve embarked on a series of interest rate hikes, 5% over 16 months, commencing in March 2022. After a span of 15 years, Income finally found its way back into Fixed Income, marking a notable change in the financial landscape.

Duration: 

In straightforward terms, duration is a way to gauge how sensitive a bond is to changes in interest rates, and it's a crucial factor that shouldn't be overlooked. Currently, cash and money market funds offer a 5% yield with minimal interest rate and credit risk. However, there is an often-neglected consideration called reinvestment risk.

TMG, like many others, holds the view that the Federal Reserve has either concluded or is nearing the end of its rate-hiking cycle. Following a phase of maintaining higher rates for an extended period, the next likely move is expected to be a rate cut, particularly in response to an economic slowdown or recession. Moreover, the escalating cost of servicing U.S. government debt, now surpassing defense spending, may add pressure on the Fed to reduce rates.

It is important to note that cash and money market yields closely follow the Fed rate. Therefore, if rates are cut by 2%, investors could face a similar reduction in yield. This is why TMG emphasizes the significance of mitigating reinvestment risk by extending bond duration from short to neutral. Beyond managing reinvestment risk, longer bond duration also serves to counterbalance equity risk, offering additional diversification benefits.

Credit: 

A bond's credit rating gauges the issuer's likelihood of repaying the borrowed amount, akin to a measure of reliability. Given the current landscape with tight spreads, increased borrowing costs, and potential challenges for heavily leveraged companies in refinancing debt, our advice is for investors to avoid excessive credit risk and stick to higher-quality investments. If a recession occurs, it is expected that credit spreads will expand, resulting in negative price returns, especially for bonds rated below investment grade. Therefore, adopting a cautious approach centered on sustaining higher credit quality can be a wise strategy amidst the uncertainties in the current economic environment.

Favorable Total Return Outlook for Bonds in 2024: 

In 2022, bonds faced their most challenging year on record, witnessing a 13% decline in the U.S. Aggregate Bond Index (AGG) due to the adverse impact of rising interest rates. As interest rates climb, bond prices decrease. However, there's a positive aspect to this scenario: as bonds approach maturity, their prices gradually move closer to par, or face value. This suggests a potential for positive price returns for bonds in 2024.

Presently, the underlying bonds within the AGG are trading at a discount, averaging $92.80 against a face value of $100. This discrepancy implies a potential price appreciation of 7-8% in the coming years, a phenomenon known as "pull to par." Considering our perspectives on yield and price recovery, The Mather Group (TMG) holds a favorable total return outlook for bonds in 2024.

ALTERNATIVE INVESTMENTS OUTLOOK

Private Real Estate: 

The real estate landscape presents a varied picture, especially as the commercial office market continues a more sustainable shift towards a remote and hybrid workforce. The prevalence of long-term leases with major office tenants is prompting a reevaluation of space needs as leases approach renewal, contributing to sustained elevated vacancy rates that may not peak for several years.

On a different note, multifamily housing and industrial properties remain resilient, enjoying strong fundamentals that translate to low vacancies and high rents. However, some sectors within the real estate market are experiencing pockets of distress, primarily stemming from overleveraged property owners grappling with the need to refinance debt amid higher interest rates and a more stringent lending environment. Against this backdrop, the most promising opportunities in real estate in 2024 may emerge from the debt side rather than equity. Banks, in an effort to preserve capital, have scaled back lending, creating a gap that private lenders are poised to fill with attractive terms for even well-capitalized properties. In instances of highly leveraged and distressed properties, there's potential for lenders to take possession of buildings, offering potential returns reminiscent of equity investments. Residential real estate values have demonstrated resilience, even in the face of rising mortgage rates throughout 2023, resulting in historically low housing affordability. The sustained high prices can be attributed to a significantly limited inventory, as homeowners are hesitant to relocate and secure new mortgages at elevated rates. In the U.S., where home mortgages are typically a fixed rate over their lifespan, the present effective interest rate on existing mortgages stands at a modest 3.7%^[i]. However, the scenario changes for families aiming to move, as securing a new 30-year mortgage could mean an interest rate of nearly 7%, translating to substantially higher monthly payments, even for a home of similar value.

Historically, housing prices have adjusted to accommodate higher mortgage rates, leading to a negative impact on prices over the long term. Considering the current context of mortgage rates being down by a full percentage point from their peak, signals from the Federal Reserve indicating a shift towards interest rate cuts, a substantial housing shortage estimated at 2.5 million units, low unemployment, and robust consumer health, the residential real estate market is poised to find price support throughout the year.

Final Thoughts 

As we step into 2024, we extend our sincere gratitude to our clients, prospects, and friends for entrusting TMG to be a part of their financial journey.

At TMG, we persistently apply our risk management tools, considering a range of factors in line with our 2024 Outlook. We want to emphasize that clients who remain committed to their financial plans are equipped with a robust framework to navigate potential periods of volatility. Your trusted advisor at TMG stands ready to address any questions related to the insights shared in this 2024 Outlook, ensuring that your financial plan remains both timely and actionable.

Please reach out to your advisor for guidance at any time. Here is to a healthy and prosperous 2024 for all!

Sources: Bloomberg; Congressional Budget Office; Cybersecurity and Infrastructure Security Agency; Federal Bureau of Investigation; Fitch Ratings; Forbes; International Monetary Fund; JP Morgan; National Security Agency; Reuters; Charles Schwab; Statista; Treasury Department; White House; Wall Street Journal; World Bank; World Trade Organization

[1] U.S. Housing Outlook, Apollo Global Management, December 2023

The Mather Group, LLC (TMG) is registered under the Investment Advisers Act of 1940 as a Registered Investment Adviser with the Securities and Exchange Commission (SEC). Registration as an investment adviser does not imply a certain level of skill or training. For a detailed discussion of TMG and its investment advisory services and fees, see the firm’s Form ADV on file with the SEC at www.adviserinfo.sec.gov, or on the firm’s website at www.themathergroup.com. The opinions expressed, and material provided are for general information and should not be considered a solicitation for the purchase or sale of any security. The opinions and advice expressed in this communication are based on TMG’s research and professional experience and are expressed as of the publishing date of this communication. All return figures and charts shown are for illustrative purposes only. TMG makes no warranty or representation, express or implied, nor does TMG accept any liability, with respect to the information and data set forth herein. TMG specifically disclaims any duty to update any of the information and data contained in this communication. The information and data in this communication does not constitute legal, tax, accounting, investment, or other professional advice. Investing involves some level of risk. Past performance does not guarantee future results.

An index is a portfolio of specific securities, the performance of which is often used as a benchmark in judging the relative performance of certain asset classes. The index returns are all “Total Return” with dividends re-invested, which means the return is not only the change in price for the securities in the index, but any income generated by those securities. Indexes are unmanaged portfolios and investors cannot invest directly in an index. An index does not charge management fees or brokerage expenses, and no such fees or expenses were deducted from the performance shown.

S&P 500® Index: (registered trademark of The McGraw-Hill Companies, Inc.) is an unmanaged index of 500 common stocks primarily traded on the New York Stock Exchange, weighted by market capitalization.  Index performance includes the reinvestment of dividends and capital gains.