Asset Allocation Strategy
11 December 2023
Outlook 2024 Part 2: The Investment Market Outlook
Constructive Global Backdrop Heading into 2024

Global equities have delivered strong returns this year, led by the tech-heavy US market. Both the US economy and the US earnings cycle have been better than feared.

Economic resilience has kept interest rates elevated, though inflation is now in a well-established downtrend. This is belatedly buoying hopes that the Fed is done hiking and is likely to commence a significant rate cutting cycle in 2024.

After a period of strength, US economic data has recently shown evidence of cooling, while earnings are holding up. Our central case expectation of a further decline in global inflation, slower but still positive growth and the prospect of central bank rate cuts should provide a supportive backdrop for both equities and fixed interest in 2024.

Figure 1: Global equities defied bearish predictions in 2023, led by US growth stocks

From Inflation Risk to Growth Risk in 2024?

The key risk we are monitoring is whether the global economy and earnings cycle deteriorate more than our central case over the coming year. As discussed last week, we believe the US labour market will not experience a recessionary deterioration. 

Consumer spending is likely to slow but low unemployment and increasing real incomes (wages should outpace inflation in 2024) should keep consumption growth in positive territory. However, we will be watching the US labour market and US consumer (70% of the US economy) closely in coming months. 

Figure 2: Resilient US growth pushed bond yields up in 2023 before a late year reversal

Earnings outcomes in 2023 have been better than expected. The resilience of the US economy has undoubtedly helped but easing cost pressures (and better cost control) has also aided the earnings cycle. 2024 estimates look optimistic but a degree of consensus downgrading is typical going into a new calendar year. Our central case is that mid-single digit earnings growth in the US will be achievable.

Figure 3: The large US earnings downgrades seen in 2022 faded into a benign earnings cycle in 2023
Figure 4: US valuations have expanded again as bond yields ease

Value versus Quality

Valuations are not cheap in the US but company quality is high. Medium- to longer-term growth prospects for US equities continue to look attractive. Valuations look reasonable when calibrated against the US market’s historical and prospective earnings growth. The prospect of lower interest rates over the coming 12 months should also ease valuation concerns. That said, our central case is for flat rather than expanding US multiples, which would see a more moderate return profile in 2024 relative to 2023.

Figure 5: Global equities (ex the US) look inexpensive but face growth challenges in 2024

The narrowness of the US equity market advance in 2023 has been much discussed and is arguably cautionary. It is encouraging that the recent revival in the US stock-market has been broader.

The prospect of a Fed easing cycle kicking in in 2024 has the potential to foster a broader advance over the coming year, as long as the US/global economy can continue to eke out modest growth.

Valuations are less demanding outside the US, although structural earnings growth prospects are generally less strong, and cyclical growth risks are higher, particularly in Europe. With European growth close to stagnating, it is likely that the European Central Bank (ECB) will pivot and ease earlier than the Fed, aided by the rapid fall in inflation across the region (assuming a relatively normal winter). Should the central bank pivot in the first half of 2024, it may give at least a short-term boost to Eurozone equity prices, but also prompt Euro weakness. If it prompts enough, it may well avert an outright recession but is unlikely to drive a significant acceleration in growth in 2024. Hence, we retain a preference for the defensive quality growth on offer in the US equity market.

Figure 6: The US earnings cycle has consistently outpaced the rest of world
Figure 7: Key equity market valuation and earnings metrics
MSCI World US UK Europe Japan EM Aust
1 Yr Fwd PE 16.8 18.8 11.7 13.2 18.1 11.6 15.1
CY23 EPS growth 0 2 -11 -2 3 -4 -3
CY24 EPS growth 11 11 6 6 14 18 -1

Source: Refinitiv, Wilsons Advisory.

Emerging markets (EM) have been disappointing in 2023 but offer a combination of attractive growth at cheap valuations. Our expectation of a weakening trend in the US$ should help EM assets. The Chinese economy appears to have bottomed out, although investor sentiment towards China remains very cautious. We believe EM can outperform developed markets (DM) in 2024, driven by a weaker US$, superior earnings growth and a shift in underweight investor positioning.

Australia: Confidence in Peak Rates Rises, Rate Cuts back on the Horizon

Australian equities have had a modest year relative to global equities. Australia’s sector mix has been a clear headwind, while lingering uncertainty around the inflation and interest rate outlook has also held back the local market.

We still believe global shares will outperform Australian ones, at least on a 6-month view, though the prospect of a further revival in the AU$ may crimp this global outperformance. We retain a partial currency hedge on global equities.

Figure 8: Australian equities do not look expensive
Figure 9: However the Australian market has been struggling against a lacklustre earnings cycle

While the recent cooling in local inflation and growth data has lifted the equity market in recent weeks, Australia likely needs more confidence that a Reserve Bank of Australia (RBA) easing cycle is commencing before the market can break free of its current trading range. 

From this perspective, the path of inflation in 2024 will be critical with the fourth quarter 2023 consumer price index (CPI) due to be released on January 31, a key signpost on the path to lower policy rates.

Figure 10: The market is beginning to price in policy easing later in 2024

Stronger resource sector performance, based on improved sentiment towards the Chinese economy, could also aid the local market, however the prospect of an overall slower year for global growth may well keep a lid on commodity prices. Overall, we retain a neutral view on the local market.

Base Case Remains Constructive Heading into 2024

In summary, our central case macro view of ebbing inflation, slower but still positive economic growth, moderate earnings growth and central bank rate cuts should be a relatively constructive backdrop for equities and fixed interest.

While we continue to monitor inflation closely, we are relatively confident global inflation will continue to fall over the next 12 months. A bigger-than-anticipated global economic (and earnings) slowdown presents the main risk in our view, although our base case is for a relatively benign slowdown. While a significant global growth deterioration would be a problem for equities, it will increase demand for fixed interest, hence our overweight in fixed interest given its attractive risk-return profile.

Australian inflation is proving stickier than global inflation, though we expect it to come down enough over the coming year to allow the RBA to ease policy in the latter stages of 2024. The economy should expand at a below-trend pace in 2024 but avoid a recession. Australian equities do not appear expensive but are struggling for both macro clarity and earnings growth into 2024. Positive global share-market conditions should support the domestic market but a decisive break to the upside may be delayed to later in 2024 when the outlook for domestic interest rates becomes clearer. 

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Written by

David Cassidy, Head of Investment Strategy

David is one of Australia’s leading investment strategists.

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