Investors will need a new mindset for 2024, adjusting for an environment where higher inflation and interest rates is the norm, and recession is still likely, according to American Century Investment’s Q1 2024 outlook.
Victor Zhang, American Century’s CIO, says the post-GFC “new normal” that propelled markets for over a decade is giving way to a more normal, lasting environment of higher inflation and interest rates.
“Today, credit is tight, interest rates are high, and the consequences of slower economic growth and capital allocation mistakes may be more severe.
“Investors should ask what adjustments they must make to their portfolios if such conditions hold for the long term, as is likely.
“First, investors must come to grips with the idea that the risk-taking that worked so well for many of us after the GFC may not be as successful in this environment. Second, they must embrace broader portfolio diversification to deal with greater uncertainty,” Mr Zhang says.
He adds that despite the US Federal Reserve’s dovish pivot, a recession is still a likely economic outcome in 2024.
“Though many observers are now calling for an economic soft landing, we think high interest rates and tight credit conditions will continue to wear down consumers and businesses, slowing economic growth and weakening the jobmarket.
“We expect the US economy to slow further in the coming year. Higher-risk assets could experience greater volatility in that scenario, so investors may need to build more buffers into their portfolios.”
John Lovito and Charles Tan, co-CIOs, global fixed income at American Century Investments, agree the US economy’s surprising resilience will give way in 2024 to the weight of higher interest rates, elevated inflation and tighter lending standards.
“Currently, a modest recession seems the most likely outcome. Against that backdrop, US Treasury yields should move lower and credit spreads should likely widen. We expect inflation to moderate, but reaching the Federal Reserve’s 2 per cent target rate may take time. Ultimately, a contracting economy likely will force the Fed to cut interest rates to help restore growth.
“While recessions often trigger market anxiety and uncertainty, they also may reveal some potential silver linings for bond investors. Bonds have historically tended to perform well in periods of falling interest rates, benefiting from the price gains that accompany declining yields.”
The American Century fixed income team believes the next move by the Fed is likely to be a rate cut, but that the European Central Bank (ECB) may be first to ease.
“Following its fastest tightening pace in history, the ECB remains on hold and adopted a “wait and see” approach amid heightened recession worries. Policymakers said they would hold interest rates at their multiyear highs until inflation cools to the 2 per cent target,” it says in the Q1 outlook.
“But with recession looming, the ECB’s commitment remains in doubt. Inflation rates are notably higher in the UK, where elevated prices and a slowing economy complicate the Bank of England’s strategy. Furthermore, rising wages have pressured the inflation rate, fuelling expectations for an extended central bank pause or even potentially more tightening, even as growth stalls.”
In the US, inflation is expected to ease overall in 2024, but base effects, geopolitical unrest and fluctuating energy prices will likely fuel volatility in the monthly inflation readings, according to American Century.
“While the Fed remains hopeful its cautious approach will engineer a soft landing, we're sceptical. Historically, soft landings have been rare. As the economy – particularly the consumer component – continues to absorb the full effects of the Fed's aggressive rate-hike campaign, we expect a recession to unfold.”
