Art by Alex Eben Meyer
Market strategists had a hard time predicting how well the economy and the markets would end up at the beginning of 2023.
Some of the common themes at year end 2022—like predictions that the U.S. would face a recession sometime in 2023—never materialized. Instead, the S&P 500 is very close to an all-time high, and a soft landing seems ever more than likely.
Going into 2024, there could be some risks that derail what seems to be an economic recovery. Institutional investors and consultants give their thoughts on whether the following factors will be a cause for concern.
With equity and debt markets pricing in policy rate cuts in 2024, investors may be expecting a boom, but there may still be risks in the markets lurking around the corner, and uncertainty seems to be the word on top of everyone’s mind.
Inflation
While inflation is trending downward, the consensus is that the U.S. is not out of the woods yet. This is the view of Dr. David Kelly, J.P. Morgan Asset Management’s chief global strategist, whose view for 2024 is “2% growth, 0 recessions, 2% inflation and 4% unemployment,” according to the firm’s 2024 outlook.
“It should be recognized that there are many potential risks to this outlook,” Kelly wrote. “Including a U.S. election, the lagged consequences of higher interest rates and very significant geopolitical tension. Any of these issues, or something else entirely, has the potential to trigger recession in a slow-growing U.S. economy, making 2024 a year for hope but not complacency.”
Deutsche Bank, in its outlook, anticipated lower inflation forecasts for most economies but projected inflation to remain elevated across the board. Deutsche Bank anticipated inflation to stand at 1.8%, up from 0.5% in 2023. In the eurozone, the bank projects 2024 inflation to come in at 2.9%, compared with 5.7% in 2023. In the U.S., inflation is expected to hit 2.8%, down from 4.2%.
The Federal Reserve’s preferred inflation indicator, the personal-consumption expenditures price index, fell 0.1% in November from the previous month, the first decline since April 2020, according the Department of Commerce’s December 22 report. Prices were up 2.6% for all of 2023, near the Fed’s 2% target.
Interest rates
Most banks and strategists predict as many as three rate cuts in 2024, with the earliest coming in March. The markets appear to have priced in the possibility of rate cuts, with stocks surging in the last leg of December.
“We expect that most major central banks will cut policy rates modestly due to our view that inflation rates will continue to decline,” according to Cambridge Associates’ 2024 outlook. “The modest cuts will shift policy rates from restrictive levels closer to neutral levels, which are neither restrictive nor accommodative.”
There is also the possibility that the Bank of Japan could increase rates, which could become a major problem and potentially offset the effects of rate cuts from other banks, according to Charles Schwab.
“For over a decade, the Bank of Japan’s policy has enabled Japan to be an important source of investment funding; Japanese investors net outflow to the rest of the world totals over $3 trillion, including holdings of more than $1 trillion in U.S. Treasuries. Any rate hikes over the next year hold the potential to prompt Japanese investors to sell foreign assets and bring them home, a move already incentivized by a stronger currency, higher interest rates, and the 27% gain in Japan’s stock market in 2023” said Jeffrey Kleintop, managing director and chief global investment strategist at Charles Schwab, in a report.
Lisa Shalett, CIO of Morgan Stanley Wealth Management, wrote, “Interest rates are likely to stay elevated for a while. But contrary to what many people might think, that is not necessarily a bad thing and could create investment opportunities for the patient and selective investor.”
Oppenheimer Asset Management Chief Investment Strategist John Stoltzfus predicted the Fed is most likely to cut rates in the second half of 2024. “Our expectations are for the Fed to wait to cut its benchmark rate until at least the second half of next year and perhaps as late as the fourth quarter should inflation prove stickier. Expectations among some market participants for a series of rate cuts in the first half appear too rosy in our view with an interim cut or even an upward tweak in rates more likely to take place before the Fed is finally done with the current benchmark rate hike cycle,” Stoltzfus wrote in a note.
The geopolitical landscape
One of investors’ biggest fears is the uncertainty of the current geopolitical landscape. It can seem like the world is coming undone, with wars and crises spreading across the globe. In a recent survey from Natixis Investment Managers, in the fund’s 2024 Natixis institutional outlook survey polling institutional investors, geopolitical risk was called the biggest risk to the markets in 2024.
“The highest geopolitical risk in decades has compounded economic uncertainty. Between the ongoing war in Ukraine, a humanitarian disaster in the Middle East, and rising tensions between China and the West, executives and investors can no longer assume a placid geopolitical backdrop when making decisions,” said Ronald Temple, Lazard Asset Management chief market strategist, in the firm’s 2024 outlook.
Some see the geopolitical risks weighing down outlook for stocks, such as J.P. Morgan, which estimated meager S&P 500 earnings growth of 2 to 3% in 2024.
“While it is difficult to pin down the start date and depth of a recession ahead of time, we think it is a live risk for next year, even though investors are not pricing in this uncertainty consistently across geographies, styles and sectors yet,” said Dubravko Lakos-Bujas, global head of U.S. equity and quantitative strategy at J.P. Morgan, in a 2024 outlook report.
Geopolitical tensions between different world powers could also accelerate tensions, as countries become more hostile to one another. Competition between the U.S. and its allies and the bloc of Russia, China and Iran could cause economic uncertainty. U.S. tariffs and restrictions on the Chinese semiconductor industry have already had an impact.
Concerns are also growing about how geopolitics could affect access to the natural resources, including minerals, needed to promote the growth of alternative energy industries and other sectors.
“The low volatility of the past will be disrupted as new alliances form, again, both within and between countries,” predicted Samantha Foster, a managing director at Russell Investments, and a CIO 2023 Knowledge Broker. “Within countries, we see the politicization of corporations and aid organizations. Across international borders, we see governments restricting capital flows, both into and out of countries. Higher overall uncertainty leads corporations to have wider bands around capital allocation and forecasts, which in turn leads to higher uncertainty in equities, which are central to institutional investors.”
Historically though, major geopolitical events have had muted effects on the markets. This is according to Savita Subramanian, Bank of America Merrill Lynch’s head of U.S. equity strategy and global research. “More generally, history tells us that geopolitical shocks that don’t fundamentally impact the economy have tended to result in a 5% to 10% pullback in the S&P 500. Fortunately, our research shows markets have typically more than recovered from such losses within three months,” Subramanian said in a report.
“Geopolitics used to be considered a lower-level financial risk. Now, it may be the top risk,” said Chris Hyzy, CIO for Merrill and Bank of America Private Bank, in the report.
Geopolitical conflicts could be beneficial to some sectors, the Merrill report noted. The war in Ukraine and the conflict in Gaza boosted aerospace and defense and, interestingly enough, freight and transportation stocks rallied in the wake of the pause of traffic in the Red Sea.
Geopolitical risk, and even domestic political issues, are easily and quickly absorbed by the markets, with corresponding declines in the market quickly corrected, according to Stoltzfus. “With the global economy still on the mend and geopolitical risk remaining at elevated levels we’ll keep emphasis on quality and our expectations right-sized across asset classes and regions of the world,” Stoltzfus wrote in a note.
Stock market volatility
Institutional investors are mixed on whether there will be a smooth landing in 2024, although the consensus seems to be trending in the direction that there will. Still, some are cautious about the markets in 2024.
“We see 2024 mark the beginning of a new world,” said Mark Haefele, CIO at UBS Global Wealth Management, in the firm’s outlook. “While it can be easy to feel a sense of trepidation when faced with new challenges, years of adversity reinforce three things in terms of investing—the value of global diversification, the virtue of patience, and, most important, the resilience of humankind.”
The biggest risk for the markets is in the short term, according to Stoltzus, and are most likely company and sector specific. Stoltzus is one of the most bullish of all Wall Street strategists, with an S&P 500 target of 5,200.
“It is important to look beyond immediate market volatility and focus instead on what economic and other developments in 2024 could mean for investors—and what might force a reassessment,” said Christian Nolting, global CIO of Deutsche Bank, in a note.
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Tags: 2024, Bank of America, Cambridge Associates, Charles Schwab, David Kelly, Dubravko Lakos-Bujas, J.P. Morgan, J.P. Morgan Asset Management, Jeffrey Kleintop, John Stoltzfus, Lazard Asset Management, Natixis, Oppenheimer Asset Management, Ronald Epstein, Ronald Temple, Special Coverage: Investment Returns and Monetary Policy