2024 Investment Markets Outlook from the M&G Treasury and Investment Office (T&IO)

Bond yields have firmly left behind the low-rate era, in both nominal and real terms. This has improved the prospective return environment for fixed income. Meanwhile, the yield for other asset classes, such as equities, has been more stable, reducing implied estimates of risk premia.

On balance, the changed relative value environment and ongoing geopolitical concerns warrant a rethink about the weighting within multi-asset portfolios between fixed income and equities.

Similar to other risk assets, real assets are also adjusting to the higher rates. Whilst the risks around inflation become more evenly balanced in the short term, the medium term risks remain skewed to the upside. This is driven by changes made on trade relationships, geopolitical rivalry, demographic shifts and the necessary energy transition.

Therefore there are still benefits in having inflation mitigating assets in the portfolio. For real assets the adjustment to higher interest rates over the past year gives a cleaner starting point.

From a structural perspective, increased geopolitical tension will present headwinds to the outlook for trend growth in the global economy in coming years. Consequently, having a better grip on sources of growth will be key to enhance returns. Certain economies, such as India, stands to benefit from their own unique characteristics of domestically general growth.

The de-synchronised economic cycles mean that geographical diversification has never been more important. The different drivers of growth attributed to each countries highlights the importance of having individual geographical building blocks in the asset allocation palette.

We are undergoing a shift in the economic regime, away from the benign conditions of the Great Moderation era, to an environment of great upheaval for a number of structural factors. The consequence of this is likely to place constraints on the policy environment and lead to shorter, more volatile economic cycles.

This is likely to lead to more oscillations and opportunities to rebalance our allocations. Whilst our asset allocation has always been dynamic to the evolving opportunities in capital markets, we will need to be ready to potentially take action on a more frequent basis in this environment.

As we’ve entered 2024 we appear to be at peak rates with inflation falling, though we remain wary that inflation may arguably remain higher than the pre-pandemic average. The economic regime is changing, for example as global supply chains re-adjust, countries transition to renewable energy, or heightened geopolitical risks. These could create shorter economic cycles and more inflation spikes.

For the first time in many years we believe government bonds can once again play a greater role in the portfolio, offering reasonable yields and diversification for portfolios should cyclical weakness materialise. Corporate bonds yields have been at 15 year highs. We continue to increase fixed income exposure at appropriate times to capture higher yields.

Corporate credit spreads suggest a benign outlook for credit markets, though there remain challenges to navigate. The shift in the yield environment has naturally raised refinancing costs for corporate issuers. Maturity walls generally don’t pick up until 2025 with firms likely to begin refinancing in 2024. High yield spreads tightened versus investment grade over the past year.

Earnings growth is expected to reaccelerate, driven by a combination of sales growth and margin expansion.

Geographically, valuations across different markets appear to largely reflect respective growth expectations, though weak sentiment continues to weigh on Chinese equity markets relative to the outlook for earnings growth in the years ahead.

We are not sure the effects of interest rate tightening have fully fed through to equities as fixed-rate debts mature and excess savings reduce.

The outlook for property has been directly impacted by the monetary tightening cycle since 2022 as asset prices have undergone adjustments. Commercial property has been impacted by this more than Residential, due to the higher concentration of office and retails assets alongside the growing cost pressures on improving energy efficiency.

Post pandemic the shift to more remote working hit sectors such as offices, impacting vacancy rates. For example, vacancy rates in UK offices have risen from 10% in 2018 to now over 15%. The retail sector has also seen longer-term price declines, partly as a result of the growing online shopping trend.

From a longer-term perspective whilst there will be challenges, it may be a time of opportunity for long-term investors to make selective allocations at the current level of valuations.

Infrastructure – Looking ahead, the asset class is likely to benefit from tailwinds of decarbonization and digitalisation. Infrastructure is a valuable addition to our multi-asset portfolios owing to its inflation linkages and defensive characteristics. The shift to remote working and the climate transition are expected to draw capital to this asset class over the medium-to-long term. The current infrastructure investment gap, marking the difference between government spending and the investment need is expected to increase globally to $15 trillion by 2040.

Private debt – Last year was a better year for private debt compared to other private assets. Structurally higher interest rates may continue to underpin the overall popularity of private debt. We feel it is well placed to provide robust and diversifying returns in an environment of heightened inflation and interest rate uncertainty.

Private Equity – has been vulnerable to the sharp rise in interest rates and overall tightening of financial conditions. It’s worth noting that there are still pockets of opportunity within the different parts of the private equity market such as secondaries (buying from another investor), due to current low transaction volume and exit opportunities in the primary space.