In a highly complex and changing world, investors face the challenges of regime change amid socioeconomic supercycles and systemic megatrends.
We continue to see long-term upheaval across global markets, economies and society reshaping the world in which we live. Specifically, we note a normalizing of monetary policy, escalating conflict risk, a disorganized transition to cleaner technologies and industrial processes, and the lightning-quick socialization of generative AI. (Note that this piece is still written by humans!)
In our last annual Themes and Opportunities paper, Déjà New, we identified that some of the experiences and challenges we faced were comparable to those of the 1970s, a period also characterized by inflation volatility, conflict and sustainability issues. We identified lessons from that period that investors could draw from to enhance their decision-making and guide future positioning to meet their long-term objectives.
The past 12 months have further underlined some of the fragilities in the global economy and have accentuated other themes (for example, nature and artificial intelligence). Investors are rapidly waking up to opportunities presented by rising interest rates and nature risks as well as other emerging themes. Opportunities can evaporate quickly in these fast-moving and hyperaware times, and investors will need to be flexible in their approaches to capitalize on these. We are now in an age where agility must be the foundation for how investors take and make decisions.
In such an environment, understanding the key trends that will drive markets is crucial. We believe this is best done by applying a series of frameworks to the market landscape that offer investors a structure for shaping their decision-making. We identify what these frameworks should be and how, through these paradigms, investors should assess opportunities and pitfalls in 2024 and beyond.
Three investment themes and opportunities for 2024
Heightened geopolitical risk, inflation volatility, and transition risks all point to greater volatility, dispersion and dislocation, conditions that are ripe for dynamic alpha generators, such as hedge funds, and strategies that can step into spaces that traditional lenders have left, such as private debt. Coupled with higher rates, hedge funds look poised for stronger returns this decade, welcome news to an industry that struggled to compete in the one-directional, liquidity-fueled equity markets of the last decade.
Sharply weakening sentiment related to China has contrasted starkly with US market strength in recent periods. We continue to recommend investors’ base allocations to China and EM are at benchmark weights at least, and indeed the negative sentiment may present a contrarian opportunity, to the extent that risks are priced in (at the time of writing).
While rates may have peaked, they seem unlikely to revert all the way back to the very low rates of the 2010s. This shift means the value of fixed income in multi-asset portfolio construction is clearly greater today. Investors with infrequent, periodic strategic asset allocation reviews would be wise to accelerate the next review. It would not be so wise, however, to assume that the defensive role of fixed income will be as strong as in the last decade – there is no guarantee we will automatically return to a period of negative correlations between equity and bonds.
While interest rate increases are having an impact and cyclical inflationary pressures are subsiding, many significant structural inflationary pressures remain. Increasing protectionism, supply chain pressure, and the needs of the long-term energy transition all skew inflation risks to the upside. Furthermore, the co-ordination of fiscal and monetary efforts at the time of the pandemic could now devolve into a tension between a more restrictive monetary stance and continued accommodative fiscal support from governments eager to fund transition and/or win votes.
The greatest deflationary force, on the services side of the equation, is likely to be AI. 2023 was arguably the year AI came of age, with those stocks deemed as AI enablers completely dominating global equity market returns. The dynamic between these two opposing forces could result in a pattern for inflation that is near or at target for reasonable lengths of time, only to be punctuated with shocks that filter through to slightly higher long term average levels.
Higher rates today are once again highlighting the fragility of heavily indebted players in the market. It has shifted power from borrowers to lenders – in our view private debt is very attractive in this environment, providing liquidity to an economy in need of it, and offering investors strong risk-adjusted returns.
The disruption in energy supply clearly highlighted the need for energy security, not just of short-term oil and gas supplies, but also homegrown renewable energy for the long term. Innovation will be key to delivering on the next wave of the transition – the hard-to-abate sectors: heavy industry – steel, cement, chemicals; and heavy transport – trucking, shipping, aviation.
The role of critical minerals, essential components of the transport and infrastructure build needed for the great electrification to occur, is more widely recognized today, and a feature in recent protectionist policies. At the time of writing, however, market pricing does not fully account for the anticipated demand. Active management is essential, as step changes in innovation and regulation will impact demand structures over time.
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