PERSPECTIVE3-5 min to read

Schroders Solutions' 2024 Outlook

2023 proved a great year to be contrarian, with the heavily-touted global recession failing to materialise. Today, we find ourselves asking if markets have tipped too far in the opposite direction and are now overly optimistic.

08/01/2024
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Authors

Tamsin Evans
Head of Solutions Investment

Snapshot of views

Our positive case in 2023 was premised on economic buffers such as household savings protecting consumers from higher interest rates. However, those buffers today paint an increasingly complicated picture. There is a fine line between indicators showing an encouraging direction for inflation and a more worrying sign for economic growth. This highlights the challenge policymakers face in lowering inflation while preventing a recession.

We expect the longer inflation persists above central bank targets, the less freedom policymakers are afforded to protect growth. The consequence is that, on the balance of probabilities, the US economy becomes increasingly susceptible to economic shocks and ultimately a recession in the second half of 2024. As a result, we expect there will be a time this year when we need to be defensive. However, the lack of obvious excesses in the economy gives some comfort that volatility could be short lived. The implications for portfolios are twofold: prioritise diversification through a range of return drivers, and ensure portfolios have sufficient liquidity to both protect against market volatility and capture potential opportunities. If recent history is anything to go by, 2024 may well be another year where it’s beneficial to be contrarian.

Schroders Solutions' 2024 Outlook

2023 proved a great year to be contrarian. Looking back twelve months, an imminent recession was the consensus amongst economists, only for growth to prove robust and risk assets to deliver a strong year of returns. We didn’t subscribe to that forecast, anticipating that economic buffers such as household savings and low unemployment would provide a cushion from the effects of higher interest rates. Fast forward to today, and with economists now predicting a positive (albeit below average) year of economic growth, we find ourselves asking if markets are overly optimistic and whether those economic buffers remain in place.

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Our positive base case in 2023 was premised on economic buffers remaining intact until inflation was fully back to target. Today, those buffers paint a complicated picture. For example, both US payrolls and the rate at which employees are quitting their jobs are trending downwards – a positive sign for falling inflation but also evidence of a weaker labour market and growth outlook. This highlights the continued narrow path policymakers face to deliver lower inflation without causing a material rise in unemployment. The likelihood of such an outcome falls the longer inflation remains above central bank targets, and those final hard-yards remain until victory over inflation can be declared.

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Optimism appears most apparent in the forecasted path of inflation and interest rates. While the path of inflation globally is proving encouraging, interest rate markets are predicting major central banks will cut rates by close to 1.5%. This would reflect an unusual path for interest rates, with policymakers typically advocating steady changes of policy direction rather than a ‘Matterhorn’ approach of sharp hikes followed by meaningful cuts.

We think this market pricing reflects an average of two outcomes: a US recession in which policymakers slash interest rates to prevent economic scarring (an economic ‘hard landing’), and inflation failing to return to target meaning policymakers have less scope to reduce interest rates (an economic ‘no landing’). While the middle ground between the two outcomes (an economic ‘soft landing’) is still feasible, we expect the likelihood of such an outcome gets lower the longer the global economy is subject to the impacts of higher interest rates. The result is that, on the balance of probabilities, the US economy becomes increasingly susceptible to economic shocks and ultimately a recession in the second half of 2024.

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The forecasts included are not guaranteed; they are provided only as at the date of issue and should not be relied upon. Our forecasts are based on our own assumptions which may change. We accept no responsibility for any errors of fact or opinion and assume no obligation to provide you with any changes to our assumptions or forecasts. Forecasts and assumptions may be affected by external economic or other factors.

It doesn’t always follow that economic headlines translate directly to market returns – 2023 proved as such, with a strong year for markets despite high interest rates and slowing economic growth. The reality is that markets react to economic outcomes compared to expectations (rather than the data in isolation), particularly when investors are positioned for an alternative scenario. It is the optimism heading into 2024 that makes markets more exposed to disappointing news and gives us reason to be cautious. As a result, we expect there will be a time this year when we need to be defensive, with current positivity likely to be challenged by interest rate uncertainty and continued geopolitical risk. However, the lack of obvious excesses in the economy, such as housing exuberance pre 2008, gives some comfort that volatility could be short lived and any recession would most likely be shallow in nature.

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Conclusion

Ultimately, the market outcomes for 2024 will be heavily influenced by the freedom policymakers are afforded by lower inflation. Higher starting interest rates provide greater firepower for central banks to loosen policy, while elections in seven of the ten most populous nations adds extra incentives to support growth through government spending. The power of such a coordinated policy response should not be underestimated, as proved post Covid-19. Therefore, policymakers’ reaction function to any initial signs of economic stress will be a key indicator of the likely path for markets and is an area we are watching closely. The implications for portfolios of this uncertain environment are twofold: prioritise diversification through a range of return drivers, especially those such as structured equity that are contractual in nature, and ensure portfolios have sufficient liquidity to both protect against market volatility and capture potential opportunities. If recent history is anything to go by, 2024 may well be another year where it’s beneficial to be contrarian.



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Authors

Tamsin Evans
Head of Solutions Investment

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