iShares Spring 2024 Investment Directions

• Our base case is that the Fed engineers a soft landing and starts to cut rates in the second half of the year. The downside risks to economic growth have diminished, so the risk of only two Fed rate cuts now appears higher than the risk of four cuts.
• Solid economic growth, normalizing inflation, and a strong labor market may reward fixed-income investors for owning bonds with duration around the five-year part of the curve.
• With rates likely to remain in restrictive territory, we are staying focused on the quality factor. We believe the resilience of the quality factor is not limited to equities. In other asset classes, such as corporate credit, we believe companies with resilient balance sheets and strong fundamentals are likely to continue outperforming their unprofitable counterparts.
• International election uncertainty, monetary policy disparity and gradual impact of structural trends such as near-shoring all point to a year of elevated global dispersion. We think this presents investors with distinct opportunities by evaluating their options in both international equities and fixed income.

The U.S. economy has evolved largely as we anticipated in our 2024 Year Ahead Outlook, with inflation remaining stubbornly above the Fed’s target while economic growth is slowing but still solid. What has changed since our last report is that downside risks to growth have largely diminished.

We maintain our long-held view that the Fed will deliver three policy rate cuts in 2024. However, the risk of only two cuts now appears higher than the risk of four. We believe advisors should remain nimble and focus on actively managing portions of client portfolios to take advantage of potential opportunities that may arise over the next few months.

Consistent with higher short-term rates, money market fund assets surged last year and hit a record $6.1 trillion in February.¹ However, cash alternative returns appear set to decline as the Fed is likely to begin cutting in the second half of this year.

Similarly, investors are not being compensated much at all for taking credit risk in high yield. Advisors may seek out strategies that screen out the riskiest borrowers.

Advisors may also pursue opportunities away from major U.S. fixed income sectors. Experienced active managers can build a high-income seeking portfolio that manages risk and is well-diversified across multiple sources of return in markets like European credit, emerging markets (EM) and securitized credit.

With our view of rates likely to remain in restrictive territory, we believe the outperformance of the quality factor will persist on the back of balance sheet resilience and strong earnings fundamentals while their unprofitable counterparts continue to feel pressure.

At the sector level, we see tactical opportunities in the following:

• Communication services: Between 2021 and 2024, revenue per share for the sector increased at an annualized rate of 10%.² In the first quarter of 2024, we saw that revenue growth jump to 15%. We believe this spend will continue to show up in earnings for the sector over the next quarter.
• Financials face broader headwinds, but we are turning constructive on the broker-dealers. Trading revenue remains robust, driving a sizable portion of earnings beats over the past few quarters. Furthermore, with markets flirting with all-time highs, and a robust quarter of investment grade issuance, we see the prospect of an acceleration in capital market activity.

In emerging markets, investors could continue to separate China from broad exposures. Poor investor sentiment towards China creates opportunities for other Asian countries such as Japan and India to fill the gap.

While Japan is slightly more expensive than last year, supportive policies for international investors and increased dividends and buybacks, make Japan a strong international opportunity. This is especially true as the Bank of Japan exits negative interest rate territory on the heels of positive inflation.

Elsewhere in EM, we like small cap equities and hard currency debt. Emerging market small caps, which boast higher allocations to sectors like industrials and manufacturing, could provide more direct exposure to secular growth themes such as reshoring and infrastructure, especially in India and Brazil. Our optimism for emerging markets is equally strong for fixed income.