6 essential considerations to help investors navigate 2024 and beyond

Navigating the long-term forces reshaping the financial markets will continue to test investors this year. The effects of decarbonization, demographics, and deglobalization—key trends that we’re calling the 3D Reset—will continue to challenge the growth versus inflation dynamic.

As these forces evolve, investors need to be nimble and flexible amid rapidly changing markets. This year, elections in 40 countries, a tense geopolitical environment, and central banks’ continuing efforts to "land the economy" may create conditions that could generate volatility. We discuss how we see the 3D Reset outcomes changing this year and where we see opportunities for investors.

3D Reset outcomes evolve

With decarbonization, we see businesses spending more to shift from carbon-intensive to greener energy sources. This trend is accelerating as global electricity and energy demand grows amid underinvestment in the space. The US election in November could have a particular impact on the energy transition, as a Republican administration would likely shift the approach to energy, yet renewable technologies will remain attractive and cost-effective alternatives.

Meanwhile, we continue to see aging populations and declining birth rates globally, especially in China. Ongoing demographic changes are challenging the global workforce and creating an even tighter labor market. As companies offer higher compensation to attract and retain staff, wage growth may remain above central bank targets and slow progress on inflation. While automation could help offset the labor shortage, technology investments will also increase companies’ costs.

Deglobalization will continue as more companies look to onshore or near-shore their vendor relationships and increase domestic control of key economic inputs. Countries are also looking to enhance their energy security and find more opportunities for local energy production. Meanwhile, heightening geopolitical crises could exacerbate all these issues, causing more disruption for supply chains and international trade and higher prices for commodities like oil.

Collectively, the three Ds mean that central bank policies will continue to prioritize managing inflation over economic growth, even as rising prices for goods and services decelerate. That’s because we foresee elevated inflation pressures persisting as growth remains resilient over the rest of 2024.

The 3D Reset focus on the inflation and growth trade-off

Throughout 2024, the inflation growth trade-off should remain a challenge. Inflation levels have cooled as central bank tightening has taken hold yet the trade-off between growth and inflation has become more fraught than in the years following the great financial crisis.

Figure 1: The growth-inflation trade-off has worsened

^{Source: Schroders Economics Group, Refinitiv, 30 June 2023 with quarterly data points. The US Output Gap is the difference between actual GDP and potential real GDP. For illustrative purposes only and should not be viewed as a recommendation to buy or sell. Forecast may not be realized.}

To respond to the 3D Reset’s evolving outcomes and capitalize on opportunities, we believe there are six key areas for active investors to keep in mind this year: the energy transition; private equity; fixed income; private debt; international equities; and retirement income solutions.

Six considerations to navigate the three Ds

1. Identify energy transition opportunities

Investment levels in both renewable energy and conventional energy need to increase significantly as energy transition infrastructure requires nearly $120 trillion in investment between 2020 and 2050.

In addition, more countries recognize the need for energy independence. Deglobalization and the Russia-Ukraine war have prompted many governments to explore decentralized and localized renewable energy sources.

Given these factors, we believe a holistic approach to investing in the energy sector will be critical in coming decades. As conventional oil and gas companies transition their business models, specialist expertise and active management are crucial to understanding the valuation cycles and managing risks.

On the renewables side, the US market is primed for growth. This boils down to increasing demand for electricity and Inflation Reduction Act tax credits providing incentives for clean energy technology production. Still, common misperceptions about renewables, including incorrect assumptions about their cost, present hurdles. We believe investors will require a careful and broad approach to separate genuine opportunity from hype and momentum in this promising space.

2. Rethink the re-up in private equity

Many limited partners simply opt to “re-up” in their existing general partner’s (GP) next fund. Considering the new market dynamics driven by the 3D Reset, we believe it's crucial to ask several key questions. Can a GP’s past successes be replicated? Are existing partners and strategies well-positioned for today's trends (e.g., the three Ds and the AI revolution)? Are the fundraising and dry powder dynamics within the sub-sector healthy?

Being highly selective in private equity investments is critical. We believe there is abundant transformational growth in the lower-middle market, with a focus on specialized investors who have a much deeper understanding of their specific fields. Finally, political, social, and economic pressures are reshaping the world, creating diversification and potential return opportunities for investors willing to rethink their home country bias as private market opportunities continue to expand.

3. Seize fixed income’s moment

Fixed income markets today offer a compelling opportunity for income. Nominal yields have been close to the 100^th percentile over the last decade and the top quartile over the last 20 years. Bonds are cheap relative to their own history and yields are attractive relative to earnings yields in equities. Also, demand is high, as many investors have been waiting to deploy capital that has been sitting on the sidelines in cash.

The macroeconomic environment also looks supportive. We expect inflation and growth to moderate even as yields remain above the previous decade’s levels. We also believe fixed income will once again assume its traditional role of providing steady income.

Increased volatility from the three Ds favors active strategies that can adjust risk levels and rotate opportunistically between sectors to capitalize on market dislocations.

4. Seek differentiated income through private debt

In this new interest rate environment, we anticipate a reversion to more normal levels for interest income. After 15 years of quantitative easing, a new regime for growth, inflation, and fiscal policy means investors want new income opportunities. As higher interest rates also mean more pensions are near fully funded and need income, we are seeing a trend to move from equity (growth) to debt (income).

Therefore, the traditional approach of buying beta and relying on price appreciation may no longer suffice. As central banks withdraw liquidity and interest rates normalize, we expect higher volatility across fixed income.

Amid this market turbulence, private debt and securitized credit investments, as well as income-linked securities, can provide diversifying income with attractive protective characteristics. These products are designed to offer uncorrelated income that stabilizes cash flows or dampens volatility; opportunistic income as a growth alternative; or defensive income to insulate returns.

5. Explore international equities through an active lens  

The end of free money and negative yields represents a significant market shift, calling once again for discerning, analytical and valuation-focused investment approaches. We believe equity investors will need an active management mindset to capture alpha opportunities amid the shift away from narrow market breadth and historically low volatility.

Now may also be the time for more diversification across regions. International markets appear attractive, especially emerging markets and Japan. The valuation gap between the US and the rest of the world sits at extreme levels that pose a risk for investors whose portfolios may have become too US-centric.

Selection is incredibly important in a highly diverse market, and individual international markets—and companies—often deliver exceptional performance. International and emerging markets are not a homogenous asset class. The drivers of companies, industries, and countries across the world vary considerably.  While the US stocks known as the “Magnificent Seven” received substantial attention in 2023, it is important to remember that, on average, nine of the top 10 best-performing global stocks each year over the past decade have been non-US equities.

6. Reassess risk for retirement

As the three Ds increase volatility and the frequency of rate cycles, savers approaching retirement should seek smoother paths by redefining risk for income solutions and rethinking fixed income’s role in their portfolios. More actively managed and forward-looking approaches can help retirees and plan sponsors manage risk and achieve return objectives amid inflationary pressures.

As part of that reassessment, plan sponsors may have to reconsider their reliance on target-date retirement funds, particularly as they’re currently constructed. These funds became especially popular in the post-2000 era when, at least up until 2020, the correlation between stocks and bonds remained negative—a historically unusual trend.

Plan sponsors may need to investigate options for participants that will provide the diversification they need to pursue strong returns and mitigate volatility, a necessity for those near or already in retirement. As retirement approaches and participants get ready to make withdrawals, they also require simplicity and flexibility so they won’t have to worry about a major market downturn affecting their portfolios as they begin taking distributions.

Generation X workers urgently need these options. Many among this cohort participate in underfunded defined contribution plans approaching the decumulation phase, leaving them with insufficient savings to retire comfortably.

The new environment demands an active approach

Even though the exact impact of the 3D Reset will continue to evolve, the effects of decarbonization, demographics, and deglobalization still point to elevated inflation levels that will preoccupy central bankers and shape markets for some time. However, we believe those who take a more active approach to their investments in line with the essential considerations we address here will find opportunities in this new environment.