A soft landing in 2024?

• Lower long-term rates could present a Goldilocks scenario
• Decline in rates favour diverse winners
• Growth investing benefits from anticipated decline

While the equity markets ended 2023 on an optimistic note with a robust year-end rally, investors are now looking to 2024. Although many questions remain, consensus no longer seems to fear a recession scenario and now expects a rate cut in the second quarter of 2024.

Lower long-term rates could present a Goldilocks scenario

Long-term rates are sharply down in this context. Since its October high in 2023, the US 10-year Treasury yield has fallen by 100 basis points from 5% to 4%, somewhat easing the pressure weighing on risky assets. If 2023 was characterised by the ‘higher for longer’ mantra, 2024 could be the year of ‘lower and sooner,’ potentially pointing to a Goldilocks scenario of an economy that is neither too hot nor cold, with moderate growth and low inflation.

The European market has rebounded sharply and is setting year-on-year records. This significant rise has occurred even though yields on sovereign bonds throughout the Euro Zone have been trending sharply downwards. While the level of unemployment has remained stable, disinflation continues at a faster-than-anticipated pace, and more and more investors now expect the European Central Bank to reduce its rates in 2024. In this context, investors have shifted away from the energy sector and moved into industrial and tech stocks, reversing the trend seen over the last two months.

The valuation of European equities remains very attractive and is currently trading at a discount to its historical median.

Decline in long-term rates favour diverse winners

In the US, the bullish trend continued for the S&P 500, which hit a one-year high of 4,650 points on 12 December 2023. Unlike the rest of the year, the performance was not driven by the tech giants, the Magnificent 7 of Apple, Microsoft, Alphabet, Amazon, Meta, Nvidia, and Tesla, but rather by stocks that had fallen out of favour, such as real estate, financial and industrial stocks that benefited from the decline in long-term rates. This decline also benefited unprofitable companies with unsound balance sheets. After the recent rally, the S&P 500, at 19 times earnings, is now trading at valuation levels above the historical median.

However, this re-rating is largely explained by the advent of the artificial intelligence (AI) theme, which, by boosting growth expectations, justifies this historic premium. Excluding the Magnificent 7, the price-to-earnings (P/E) ratio for the S&P 500 is at 16 times P/E levels, in line with historical levels. The year 2024 will also be marked by the US presidential election. Historically, election years have generally translated into solid performances for the equity market, especially in the second half of the year.

In Asia, persistent high volatility in the Asian equity markets in 2023 has kept up the pressure on performances for now. Pessimism and negative sentiment about the Chinese economy remain high. The recent acceleration in stimulus measures is expected to be positive for the Chinese economy and could gradually translate into more optimistic sentiment about the country. In the region, an attractive value proposition exists in the tech subsectors in Taiwan, including AI, cloud and data centre; in South Korea, mainly high-bandwidth memory (HBM); as well as in the automotive sector in Asia, particularly electric vehicles and the vertical supply chain.

From a sector standpoint, the focus is on a barbell-type strategy: consumer discretionary and IT, and energy and high dividends. In China, preference is given to the consumer discretionary, new economy and electric vehicle supply chain sectors, putting the focus on strong government support, and selected state-owned enterprises that generate significant cash flows. Overweight positions are maintained on South Korea and Taiwan, mainly AI-related technology supply chains. In 2024, stock-picking will be more critical than ever in Asia. There will be winners in all the Asian markets, including in China.

Growth investing benefits from anticipated decline

The decline in long-term rates was particularly beneficial for the Growth style, which is made up of companies that have long-duration business models and are therefore heavily influenced by interest rate levels. The Quality style also benefited, but to a lesser extent than the Growth style, because it is also made up of more defensive companies that yield consistent dividends and stable earnings regardless of the state of the overall stock market or economy. It is worth noting that this decrease in rates also benefited other styles, including the Value segment where valuations remain extremely low. Lastly, while small-cap companies had suffered from the rate level, the decline in rates has allowed this segment to perform well once again.

Some of the many risks faced in 2023 have somewhat abated, but geopolitical risks remain. For instance, there are ongoing multiple wars and upcoming elections in 2024. For the coming months, a constructive stance is maintained on the equity markets given the resilient macroeconomic environment and the continued strong financial health of companies.

Laura Corrieras is the Equity Portfolio Manager at Indosuez Wealth Management, a global brand of Crédit Agricole Group.