Dilok Klaisataporn
Transcript
Oscar Pulido: Welcome to The Bid, where we break down what’s happening in the markets and examine the forces changing the economy and finance. I’m your host, Oscar Pulido.
2023 has seen high volatility across global markets driven by high interest rates, bank failures and a surge in bond yields. The financial landscape witnessed a year colored by nuances and unexpected turns. Despite initial optimism, the year unveiled challenges that reverberated across global markets. Central banks grappled with persistent inflationary pressures amidst structural constraints, while investors sought new opportunities amid heightened market volatility. So, after a tumultuous 2023, what can investors expect in 2024?
Alex Brazier: This is a macro environment that’s more complex and interesting, perhaps, than anything we’ve had in the last 20 years. There are now rewards for getting the calls right and for being precise, selective, and agile in portfolios. And that’s a big contrast to the last twenty years. So, it’s time to grab the wheel!
Oscar Pulido: I’m pleased to welcome back Alex Brazier, Deputy Head of The BlackRock Investment establish to help us look ahead to a new year. The BlackRock Investment establish has just released its 2024 Outlook and Alex will give us an overview, help us comprehend the structural shift to a new macro regime and explain how investors can consider the 5 mega forces that the BlackRock Investment establish sees as being the key drivers of the new regime.
Alex, welcome.
Alex Brazier: Hello again, Oscar. Thanks for having me back.
Oscar Pulido: So, Alex, as we near the end of 2023, a year that has felt appreciate quite a rollercoaster ride, how are you feeling as you look ahead to a new year?
Alex Brazier: Well, in short, excited! And this is, notable. It’s rare for an economist appreciate me to be excited, that’s why I make a point of it. Why excited? Well, this is a macro environment that’s more complex and interesting, perhaps, than anything we’ve had in the last 20 years. So, in some respects, it’s making me feel young again but more importantly, it’s an environment where there are now rewards for getting the calls right and for being precise, selective, and agile in portfolios. And that’s a big contrast to the last twenty years where broad, static, asset class exposures worked about as well as anything else. So, the way I think of it now is the economic and investment road is actually a very bumpy and windy one. And that means there are big rewards for good, agile drivers to outperform others, rather than driving along the straight highway we’ve been on for the last 20 years. So, in the words of The Outlook, it’s time to grab the wheel.
Oscar Pulido: I think you are a pretty upbeat guy in general, but I can sense that extra level of optimism in your voice. And as you said, you ae an economist so tell us more about the global economy as we finish 2023 and perhaps that will help us comprehend the excitement you feel going into next year.
Alex Brazier: Well, the macro environment isn’t straightforward, which is actually what makes this an interesting time. Now, the good news is, as we end the year, we see inflation coming down on both sides of the Atlantic, in the US and in Europe. And that’s happening as the mismatches that arose as a result of the pandemic, we were all spending a lot on goods and not on services, for example, they’re all unwinding.
And in Europe, the energy shock is unwinding too. So, inflation’s coming down. That means central bank policy rates have probably peaked as a result. that’s all good, but then take a step back and look at the broader context, because actually the context is everything here. And there are three aspects of this macro picture that are really quite interesting.
The first is that we seem to be on a weaker trend growth path. Before the pandemic, the US economy typically was growing at around about 2.5% a year. Since the pandemic, on average, it’s been growing at about 1.7% percent a year. Now, employment growth has been pretty strong recently, but that’s because it’s been catching up with the restart of activity.
And overall, over the last three years, that’s been quite muted as well. We’ve got weak output growth, weak employment growth, and yet we haven’t really got unemployment or slack in the economy. And that’s because the workforce is growing less quickly now as the population ages. That’s telling us that the economy can’t actually grow faster than this new muted rate without resurgent inflation. So, the first kind of really interesting aspect of the macro regime, the really important piece of context, is that trend growth is somewhat lower than it was pre pandemic. The second really important piece of context is it’s going to take higher interest rates than we were used to in the past for central banks to keep growth muted. And that’s because they’re pushing against fiscal policy, which has become looser and is stimulating the economy, and they’re leaning against that, and they’ve got to lean down to keep growth muted. Interest rates probably coming down at some point next year, but not to where they used to be. So, weaker growth, higher interest rates.
And then the third important piece of context is that in this environment of geopolitical tensions and the energy transition, we do expect future bouts of inflation. So, this bout of inflation going away, but we’re likely to get future bouts too- we don’t know when or precisely what will bring about them. But this is the opposite of the past 20 years when geopolitical integration of supply chains, all repeatedly pulled inflation down. And now we’re turning that on its head. And central banks are going to be squashing inflation down over time, with higher rates, rather than trying to push it up over time with lower rates.
So weaker growth, structurally higher rates, and more volatility, and that’s what makes this road really windy and bumpy. And it’s a road where investors who can be precise, selective, and drive in an agile way can actually outperform.
Oscar Pulido: So, from what you’re saying it sounds appreciate inflation and interest rates are trending down but probably not to the levels we were accustomed to for the last 20 years. You also talked about the need to grab the wheel in this new macro environment. Sticking with this driving analogy, how can investors think about avoiding the bumps or maybe the ‘potholes’ in 2024?
Alex Brazier: Well, this is the first theme of the Outlook that we’re publishing now, and that’s about managing macro risk. This isn’t a road for the autopilot or for taking unintended macro risks, you have to be very deliberate about macro risks in this environment and pilot them skillfully. I would just highlight two in particular that we’re paying attention to.
The first in fixed income markets is really the US fiscal position. Because in this regime of muted growth, higher interest rates, and bigger government deficits, put that together, it means that public debt, relative to the size of the economy, is going to be growing. It’s on an unsustainable path, and that actually raises the prospect of higher inflation in the future.
That makes us more precise in our fixed income exposures, tilting towards short and medium-term bonds, the belly of the curve, rather than very long-term bonds. So that’s one issue that needs careful navigating.
The second one that needs careful navigating is that it’s not clear that all broad asset classes have really adjusted to this regime of persistently higher policy rates than we were used to in the past. In other words, expected returns adjusted for risk are not equivalently higher on all assets as they are on cash. So, we’re careful with broad static asset class exposures, but that is where the opportunity lies to get selective and beat the benchmarks.
Oscar Pulido: Ok so those sound appreciate a few of the trickier aspects that investors need to consider as they supervise their portfolios. But on the flip side, what is making you excited? Where are the opportunities that investors can look to take advantage of?
Alex Brazier: I think the flip side of this difficulty with broad static asset class exposures is that now there’s an opportunity that we haven’t had for 20 years to really outperform those broad static exposures by being selective and agile in approach. You look back at the past 20 years, investment that was agile and selective wasn’t really rewarded because broad static exposures did about as well as anything else. But now, because we’ve got this weaker growth, higher rate, more volatile regime, we don’t expect the sustained bull markets of the past. Sure, there’ll be periods when everything goes up, but it won’t be sustained appreciate it was in the last 20 years. And so, the complexity of the macro picture means there’s much more dispersion of expectations on a pricing of assets.
And that means there are real rewards now for being very selective and precise and in this outlook that we’re publishing we highlight potential gains in portfolios from tilting allocations across asset classes depending on how they’re valued right now. For example, I’ve already mentioned that we tilt towards shorter and medium-term duration bonds rather than longer duration. We’re tilting towards hard currency emerging market bonds and mortgage-backed securities in the U. S. rather than developed market credit. That’s because we see spreads as more attractive on those. And we’re tilting towards equities in Japan versus Europe on account of the differing fundamentals not really being reflected yet in market prices.
So, opportunities from being very selective and granular across asset classes but also opportunities to get really precise and granular within asset classes too. And we highlight in the Outlook, for example, the idea of being underweight the broad U. S. equity index and using that space in portfolios to focus on U. S. equities that are set to take advantage of AI to lower costs, boost revenues, in the future. And I know you’ve talked a lot on this podcast about AI. So, it’s absolutely not the case that complex, difficult macro environment means we think we should sit and foresee. It is what it is. And we’re embracing the fact that the road ahead is windy and bumpy and interesting, and using precise, agile exposures to outperform.
Oscar Pulido: Yes, as you mentioned we’ve had some interesting conversations here on The Bid about AI, and I expect we will continue to do so in 2024. In fact when we’ve discussed AI, we’ve described it as one of five megaforces reshaping the investment landscape so tell us about the role of the other megaforces in portfolios and how those might impact markets in 2024?
Alex Brazier: Sure, and I think these are things we see as big structural shifts in economies, and we see them actually as drivers of return differences within asset classes. They’re a way in which to get selective about your exposures within asset classes. Now in addition to AI, there are four others that we’re monitoring particularly closely.
The first of those is the reshaping of the financial landscape, especially in the United States. Banks are under pressure from increasing regulation and greater competition now for deposits. And so, bank credit is likely to become more expensive, less available. That’s going to be a differentiator across banks who can adjust to this reality, but it’s also going to create opportunities, for example, in private credit where we see ongoing demand from borrowers who are looking to substitute tighter bank credit.
The second megaforce we’re looking at is demographic change. I mentioned this earlier in the context of weaker trend growth in the United States. It’s also true of other advanced economies and, importantly, China. But it’s also a potential driver of sectoral prospects in economies, for example, around healthcare.
And it’s also a driver of different growth prospects across economies, because not all economies now have ageing populations. There are some economies still with very quickly growing populations, and it’s important to take that into account.
The third megaforce we’re looking at is geopolitical fragmentation. And that’s interesting because it’s spurring industrial policy and a rewiring of supply chains. And that’s something we use to get precise within portfolios to try and find securities that will outperform.
And then finally, we’re looking, of course, at the transition to reduce carbon emissions, which, as we know, is driving a big shift in the energy mix, but it’s also now creating demands for solutions to resilience a changing climate and weather events. You talked a lot about this, I think, a couple of weeks ago with Helen on the last podcast. So, four or five in total, with AI, big mega forces that we see really reshaping economies and not in all cases yet fully reflected in market prices and therefore creating interesting investment opportunities for precise exposures within asset classes.
Oscar Pulido: So, Alex, a winding and bumpy road ahead, but exciting terrain for those agile drivers you described earlier. Maybe just one final question, which is if you had to briefly sum up your outlook for 2024, what will you be telling investors?
Alex Brazier: Well, it’s an environment where money can be put to work, but it can’t be done by putting on the autopilot on a straight highway. It’s a bumpy, windy road, as you say, so grab the wheel, drive skillfully, drive precisely, and drive in an agile way, and have a great holiday season.
Oscar Pulido: Grab your driving gloves for sure and thinking back to all your comments, it sounds appreciate in 2024, we better be ready to shift gears! Alex, thank you so much for joining us on The Bid, it’s a pleasure as always. Wishing you a great holiday season as well.
Alex Brazier: Thanks so much.
Oscar Pulido: Thanks for listening to this episode of The Bid, if you’ve enjoyed this episode check out our recent episode that Alex mentioned featuring Helen Lees-Jones entitled “Low-Carbon Transition Investing 101” and find out how investors are taking advantage of the energy transition in their portfolios.
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Spoken disclosures
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This post originally appeared on BlackRock.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
