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Even after markets rallied in anticipation of economic normalization, opportunities remain in capital markets, but portfolio construction is key. Get the design right, focus on research to tap opportunities, and be nimble in adapting to what unfolds in markets. We think this formula will serve investors well in 2024.
2024: Normalization and Interest-Rate Cuts on the Menu
Despite many investors fretting about a hard landing in 2023, capital markets posted a strong – though uneven – year. The exclamation point? A historical stretch of performance to close out the year, fueled by plummeting interest rates: bonds roared to their best two-month return since the 1980s and the S&P 500 logged its 12th-best two-month return over the last 75 years.
In fact, rates have been the main storyline in market returns for the past couple of years. At the intersection of economic growth and inflation expectations, the response of rates to those two signals ultimately drove markets – whether it was up or down.
Along the way, the soft-landing narrative was reinforced and things played out much better than many investors – and even the Fed – expected. Inflation saw further declines, while resilient economic growth and labor markets defied expectations. The Fed began to signal that rate cuts would eventually be on the way, and markets doubled down on those expectations.
So, where does that leave us as we start a new year?
The consumer has powered growth so far, but we expect that power to wane a bit during 2024, in part because fiscal support has fallen away. Core inflation should tail off toward 2.5%, with real GDP growth moderating to a below-trend 0.8%. Rate cuts, which will likely kick off around midyear, will likely end up somewhere between the market’s and Fed’s estimates (Display), with Treasury yields continuing their decline.
The Market’s More Optimistic than the Fed on Rate Cuts
Federal Reserve and Market Expectations for Fed Funds Rate
Historical analysis and current forecasts do not guarantee future results.
LR: long run
As of December 31, 2023
Source: Bloomberg, US Federal Reserve and AllianceBernstein (AB)
Equity: Think Quality and the “Magnificent Others”
On the equity side of the fence, let’s start with valuations. The price-to-earnings (PE) ratio, one of the most common metrics, finished 2023 at elevated levels, historically speaking (Display). From an earnings perspective, if we expect economic normalization with slowing growth, we would look for the same from top-line sales, which would temper earnings.
Equity Multiples Finished 2023 at Elevated Levels
Valuation Ratios for US S&P 500
Current analysis does not guarantee future results.
Price/earnings (P/E) is for the trailing 12 months; price/blended forward earnings (P/BFE) is for the next 12 months (calendar year 2024)
*February 21, 2020
As of December 31, 2023
Source: Bloomberg, S&P and AB
As this process takes place, certain parts of the equity market should respond well, as they have historically. Yes, we’ve seen an avalanche of headlines on the “Magnificent Seven” stocks, and for good reason; however, we think it would be short-sighted to overlook the “Magnificent Others” in 2024 and 2025.
Areas we like include quality growth stocks and value—in many ways the forgotten style. Both offer better valuations and strong balance sheets, two attractive qualities as money looks for new investments to call home. Likewise, high-dividend stocks seem worth pursuing. Bonds have been a hot topic, given where yields stand and are likely headed, but don’t lose sight of dividend payers in a falling-yield environment.
Low-volatility stocks are also worth a look, given that valuations have trended higher and the upside potential for earnings growth is lower. These stocks have traits that equip them to play defense as we head into what’s likely to be a moderating economic environment. As we see it, that capability makes them attractive building blocks for equity portfolio construction.
In the Bond World, the Ride Is Far from Over
As we’ve noted, the story continues to be rates. In the fourth quarter of last year, the 10-year US Treasury bond yield fell by almost a full percent (Display), a stunning development that drove sizable capital gains in the bond world. Investors who took heed of suggestions to add duration, or interest-rate sensitivity, benefited more than those who didn’t.
Long-Term Rates Fell Just as Quickly as They Rose
Term Structure of Interest Rates
Historical analysis does not guarantee future results.
Bps: basis points
As of December 31, 2023
Source: Bloomberg and AB
The biggest question we hear from investors now is this: Is it over? From our perspective, there’s still plenty of room to go. If our estimates bear out, investors can still generate substantial returns from the bond market in 2024 and beyond. That potential extends beyond Treasuries, which provide the most potent exposure to further rate declines.
Credit sectors also continue to offer a compelling proposition, particularly high-yield bonds. This segment of the market enjoyed a robust 2023, in part because of falling rates. But all-in yields are still appealing, and yield has historically been a reliable indicator of returns over the next five years (Display).
Yield Has Been a Good Indicator of Future High-Yield Returns
Past performance and historical analysis do not guarantee future results.
Yield to Worst and returns are represented by the Bloomberg US Corporate High yield Index.
HY: High Yield
As of December 31, 2023
Source: Bloomberg, J.P. Morgan, S&P, US Federal Reserve and AB
Muni bonds closed 2023 with a bang, and a likely soft landing and rate cuts seem to paint an optimal backdrop for 2024. We think it makes sense to consider adding duration exposure, which would bolster returns if rates fall, and to consider a barbell maturity structure to harness the inverted yield curve without increasing interest-rate risk. Muni credit, including BBB-rated bonds, outyields higher-rated issues and remains compelling—but a selective approach is warranted.
The Big Picture: Moving from Sledgehammer to Scalpel
From our viewpoint, 2024 and 2025 will represent the last links in a chain that leads toward normalization—aka the pre-COVID world. Investors still have an opportunity to reap meaningful returns from capital markets, but normalization also means that we should expect a rebalancing of asset prices.
Translation: As we move beyond the “sledgehammer” phase of market movements and trends and into the “scalpel” phase, thoughtful portfolio construction will be key. Get the design right, stay focused on tapping opportunities through effective research, and be active and nimble in adapting to what the market brings us. We think this formula will serve investors well in 2024.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. Views are subject to revision over time.
