New regime, New opportunities

Read details of our Q4 outlook:

Adjusting to the new regime

Market narratives have been in flux all year: from recession and sharp rate cuts earlier in the year to soft landing hopes over the summer to more recently - a higher-for-longer rates backdrop. We have long argued we don’t see central banks coming to the rescue. The recent surge in bond yields reflects markets coming around to our view, we think. Yields on benchmark 10-year U.S. Treasuries have risen to 16-year highs above 4.50%. See the chart below. Policy rates may have peaked, yet we don’t see central banks cutting rates to levels that stimulate growth any time soon.

Market playing catch-up
U.S. 10-year Treasury yields, 1985-2023

Holding tight

Inflation has been falling as pandemic mismatches unwind. We think about two-thirds of the spending shift to goods from services has unwound. Goods prices are dragging inflation down as demand normalizes. A skills mismatch is also normalizing, helping cool wage growth.

Importantly, inflation declining through 2023 has come at the cost of economic growth. In Europe, manufacturing activity has slowed sharply. Meanwhile, a stealth stagnation in the U.S. has gone under the radar. GDP data suggest activity has held up in the U.S., but on some measures, the U.S. economy hasn’t grown much in the last 18 months.

An outright recession is still in the cards. But, more importantly, we expect the economy to broadly flatline for another year, making it the weakest two-year growth stretch in the post-war era, aside from the Global Financial Crisis.

We think labor market tightness – low unemployment - has been misconstrued as a sign of economic strength. But in this new regime, the typical business cycle framing – likely does not apply.

Something more structural is at play. We’ve long said we’re in a world shaped by supply. We see constraints on supply building over time – especially from a shrinking workforce in the U.S. as the population ages. We think this demographic constraint means the U.S. economy can only add around 70K new jobs a month without stoking higher inflation, compared to 200K previously.

We think the central bank response to stagnation will be muted. Persistent inflationary pressures driven by supply constraints means central banks will have to hold policy tight, in our view.

Finding new opportunities

A challenging macro drop backdrop doesn’t mean a dearth of investment opportunities. Quite the opposite, in our view. Higher macro volatility is translating into greater divergences in security performance relative to broader markets. That calls for much greater selectivity and more granular views. Harnessing the mega forces shaping our world will also offer abundant investment opportunities. It all boils down to what’s in the price.

We see attractive opportunities for income as markets realize that central banks will have to keep a lid on activity to stem inflation.  We like short-dated U.S. government bonds and have also turned more positive on UK and euro area bonds where yields have spiked far above their pre-pandemic levels. We also like emerging market hard currency debt.

We still steer clear of long-term U.S. bonds even after their surge. Why? We think term premium – the compensation investors demand for the risk of holding long-term bonds – will rise further, pushing yields higher, as markets price in persistent inflation, higher-for-longer rates and high debt loads.

Equities have rebounded this year, led by tech. Looking ahead, surging yields and stealth stagnation may not be friendly conditions for broad equity exposures. Yet valuation dispersion within sectors has moved meaningfully higher relative to the past creating new opportunities. Benefiting from this requires getting more granular, eyeing opportunities on horizons shorter than our six- to 12-month tactical view and tilting to more active strategies that aim to deliver above-benchmark results. We turned overweight Japanese equities last month on potential earnings beats and shareholder friendly reforms. We also tap into the AI theme in developed market stocks.

Mega forces = new opportunities

Mega forces are structural changes we think are poised to create big shifts in profitability across economies and sectors. The mega forces are not in the far future – but are playing out today. The key is to identify the catalysts that can supercharge them and the likely beneficiaries – and whether all of this is priced in today.

We are tracking five mega forces: digital disruption like artificial intelligence (AI), the rewiring of global supply chains driven by geopolitical shifts and economic competition, the transition to a low-carbon economy, shifting demographics and a fast-evolving financial system. We believe granularity is key to find the sectors and companies set to benefit from mega forces.

Our investment views

Our new investment playbook – both strategic and tactical – calls for greater granularity to capture opportunities arising from greater dispersion and volatility we anticipate in coming years.

Directional views

Strategic (long-term) and tactical (6-12 month) views on broad asset classes, November 2023

Tactical granular views

Six to 12-month tactical views on selected assets vs. broad global asset classes by level of conviction, November 2023

Euro-denominated tactical granular views

Six to 12-month tactical views on selected assets vs. broad global asset classes by level of conviction, November 2023