Investment outlook webinar, 7 February 2024

This article is based on a Schroders Personal Wealth webinar from 7 February 2024. It covers a historic review of markets and economies and our current outlook.

Historic investment trends

The historic backdrop to today’s global economy and markets is fourfold:

1. Falling inflation since the early 1980s

Inflation among the seven leading democratic economies (G7) stood at around 13 percent in 1980 and followed a downward trend until 2020 (1). Inflation is a measure of the rise in prices of goods and services.

When inflation is high, central banks often raise interest rates to reduce the disposable income (or spending power) of consumers. This can exert a downward pressure on prices of goods and services and help reduce inflation by bringing prices under control.

Until 2020, we had falling inflation and falling interest rates. But these ultra-low interest rates and inflation levels we saw after the 2008 financial crisis are exceptional. From 2020 we’ve had a pandemic followed by a war in Europe. This has led to high inflation, rising interest rates and higher costs of goods and services.

2. Bonds and equities benefited from low interest rates

Prior to 2020 bonds and equities benefited as interest rates fell. Interest rates on bank accounts were very low, so investors went into more risky investments in search of returns. This drove up prices of bonds and equities.

Cautious investors typically hold a relatively high proportion of their investments in lower risk assets such as bonds. These have traditionally held up well in a range of market conditions. But interest rates have risen since 2022 and these fixed income investments have not performed well: bond prices often fall when interest rates go up.

3. Rise of China

China today has a greater share of global trade than the US. China has become the manufacturing capital of the world while the US is the consumption capital of world. The Chinese economy was previously growing at around 10 percent a year, but this level is not sustainable.

4. The rise of government debt

Government debt globally has risen significantly since the end of the 1960s, going up from around 40 percent of economic output (or gross domestic product, GDP) to more than 100 percent (1). This rise was driven significantly by the impact of the 2008 financial crisis.

Economic outlook

We believe we’ve now seen the peak in inflation and interest rates and we expect interest rates to fall. But we don’t believe we’ll get back to the levels of ultra-low interest rates we saw prior to 2022.

In our view, we are moving into an environment where interest rates normalise at the levels we saw prior to 2008. Falling interest rates typically provide a favourable environment for bonds, equities and the global economy.

Inflation fell significantly in 2023, but we expect it to now fall more gradually. Crucially the tragic situations in Ukraine and Gaza, and disruption to shipping in the Red Sea, are all potentially inflationary.

This is because the situation in the Middle East can impact the price of oil. And the war in Ukraine can affect the price of wheat, as Ukraine is a key wheat producer. Higher prices for commodities such as oil and wheat often lead to higher inflation.

The global supply of goods was constrained during the pandemic. Since the pandemic, countries have sought to bring goods production back home, creating what has now become a trend for deglobalisation or reshoring.

Deglobalisation and decarbonisation

In fact we think we are undergoing key economic changes in terms of deglobalisation, decarbonisation and artificial intelligence. These could represent long-term opportunities for investors.

In particular, the world now needs to build decarbonised infrastructure. We believe the costs of doing so are driving up inflation and will make it hard for central banks to bring inflation below 2-3 percent from now on.

There has been recent speculation about how high interest rates could go, but right now markets expect big interest rate cuts. This is because central banks in the US, UK and Europe today believe they have brought inflation significantly under control.

Even so, we think inflation may be harder to bring down than many investors expect and it will fall at a gradual pace. Consequently we believe interest rates will fall relatively slowly and shallowly. In the UK, for example, we think there could be three 0.25 percentage point cuts this year, taking rates down from 5.25 percent to 4.5 percent.

Forthcoming elections

Nearly 60 percent of the global democratic population will have elections in 2024, including the US, India and, probably, the UK (2). But high levels of debt look set to leave governments with little room for political manoeuvre and could lead to similar kinds of government policies in different countries.

In the UK, polling data suggests Labour currently has a 25 percent lead over the Conservatives (3). But whichever party wins the next election, they will find their scope for political decision-making constrained by large government debt. Even so there could be significant differences in tax policy. The Conservatives have talked about reducing inheritance tax while Labour have proposed introducing VAT on private school fees and business rates on independent schools.

In the US, we can probably expect a re-run of the Joe Biden versus Donald Trump election. But Trump’s prospects could be hindered by his various legal challenges. A Biden win could lead to the continuation of current political and economic conditions.

But a Trump presidency might be more pro-business and lead to a change in relations between the US and China. These differences could create both opportunities and challenges for long-term investors.

We have become more optimistic about economic growth, and now expect a 2.2 percent rise in global economic output in 2024. We view the US as an economic bright spot. We believe low US unemployment could support consumer confidence, lead to a willingness to spend on goods and services and underpin economic performance. We also consider Japan a bright spot, given its low inflation and ultra-low interest rates.

In contrast, we view China as a potential economic challenge. It hasn’t yet recovered from the pandemic, and its forecast 5.2 percent economic growth for 2023 is lower than in earlier years (4). It is also struggling with an ailing property sector.

The UK and Europe face elections in 2024 (or possibly early 2025 for the UK) as well as recession risks. But we believe any such recessions would be relatively short and shallow.

Overall, economic and political challenges remain, but we believe there are reasons for optimism.

Market performance and optimism

Global economic strength helped markets generate good returns in 2023, despite the geopolitical troubles. US, Japanese and European equities rose significantly, but the rise in UK equities was more muted. Bond markets made positive returns in local currencies. But global government bonds fell as investors appeared willing take on more risk for higher potential returns.

As a whole, global government bonds, corporate bonds and other fixed-income securities had a turbulent 2023. But they rose in the final three months of the year as investors anticipated interest rate cuts: bonds often rise when interest rates are expected to fall. Against this backdrop, all of our PDPS (Personal Discretionary Portfolio Service) portfolios and Portfolio Funds performed more strongly than cash in 2023.

We’ve seen a mixed picture so far in 2024. US and Japanese equities have made strong gains, but UK, emerging market and Asia Pacific (excluding Japan) equities have fallen.

Dominance of big tech companies

The strength of US equities has been driven by the massive ‘Magnificent 7’ technology stocks, such as Microsoft and Facebook-owner Meta. These have particularly benefited from their involvement in artificial intelligence (AI).

The huge US technology companies have performed very strongly since the start of 2023 (see Chart 1). But the US and global stock markets have a high concentration in a few stocks as a result. Historically, an active approach to stock selection, rather than just ‘passively’ replicating stock market indices, has been fruitful when stock market concentration is high. At Schroders Personal Wealth, one of our key principles is to take an active approach to stock selection, in line with your willingness and capacity to take on investment risk.

Chart 1: Technology companies have driven the US equity market

Source: FactSet, Schroders Personal Wealth, February 2024. Past performance is not a reliable indicator of future results.

Yields (or income) from bonds have soared in comparison to dividend income from equities (see Chart 2). In consequence, income is available from both bonds and equities that compares favourably with interest from bank accounts. And this income may become even more favourable if, as expected, interest rates fall.

Chart 2: How bond yields compare with equity dividends

Source: IBES, LSEG Datastream, MSCI, ICE and Schroders Strategic Research Unit. Data to 31 December 2023. Corporate bond yield = unhedged local currency yield e.g. US = USD corporate bond yield, except for EM which is in USD. Based on 12-month forward-looking numbers. Forecasts are not a reliable factor of future performance.

Looking ahead, strong company earnings growth is expected globally in 2024 and 2025, with double-digit growth expected in the US and emerging markets. In our view, this could lead to a rise in share prices and dividend yields.

We expect inflation and interest rates to fall and our favoured scenario is for a global economic slowdown, rather than a recession. We believe fixed income and equities could perform well in the medium to long term against this backdrop of a ‘soft landing’ for the economy.

Sources:

(1) Schroders Economics Group, January 2024.

(2) IMF, World Bank, Wikipedia, Schroders Economics Group. 31 January 2024.

(3) YouGov (yougov.co.uk), ‘Voting Intention: Con 21%, Lab 46% (7-8 Feb 2024)’, 9 February 2024.

(4) Statista (www.statista.com), ‘Growth rate of real gross domestic product (GDP) in China from 2012 to 2023 with forecasts until 2028’, 30 January 2024.

(5) LSEG Datastream and Schroders Strategic Research Unit.