Key takeaways:
- 2023 brought a welcome reprieve to investors via improved market returns vs. 2022.
- However, many investors were absent in the rebound, choosing to sit on the sidelines to wait for more certain times. We think this is the wrong approach for long-term investors as there continues to be more compelling opportunities for investors that can be accessed through diversified portfolios.
- Below we seek to uncover these opportunities and address some of the most asked questions by clients.
1.Will the US avoid a recession in 2024?
We believe there are several potential paths to consider for the US economy next year, including upside and downside scenarios. In the end, the key factors to watch will be the labor market and inflation. Without a significant spike in unemployment or reaccelerating inflation, it’s hard to see a US economy that comes to a screeching halt.
So far, the US economy has proven more resilient than most expected. Inflation has subsided without a substantial hit to the labor market that many anticipated. While some tailwinds to growth are fading, there are also reasons to believe growth will continue to hold up well. Notably, consumers remain in healthy shape evidenced by higher net worth, lower debt burdens, and positive real wage growth. A similar story of strength exists for US corporates. We also saw a substantial easing of financial conditions towards the end of the year which cuts in a positive direction for US growth.
Our bottom line: Risks remain, yet a hard landing in the US seems unlikely. Being too defensive will likely bring opportunity costs.
2.Have we seen the peak in interest rates?
Closely connected to the recession question is the future path of policy rates in the developed world. Going back to 1974, the average length of time from the last Fed rate hike to the first rate cut has been roughly five months, albeit with a lot of variability.1 It’s already been more than five months since the last Fed hike (July 2023), so clearly cuts will take longer than average this time around, although, we are inching closer as the Fed acknowledged in their December meeting.
Despite the Fed’s more dovish tone, we believe markets have too aggressively priced in easing in 2024. Markets now reflect more than a 150bps drop in the Federal Funds Rate as shown below. While the Fed has now broached the topic of recalibrating policy in 2024, that will require continued progress back towards the Fed’s 2% inflation target.
Market pricing for Fed policy rates in 2024
Source: Bloomberg as of 31 December 2023. Forward-looking estimates may not come to pass. Projected Federal Funds rate projections reflect market pricing of the 3-month Secured Overnight Financing Rate (SOFR).
Our bottom line: We believe the Fed will begin easing policy in 2024, but we think a later start and lower magnitude of easing are likely relative to what’s reflected in expectations today. We view this as a good thing for the savers of the world and multi-asset income portfolios. It means more income and diversification opportunities will be available for longer.
3.Why should I own anything other than cash?
For starters, we expect most asset classes across rates, credit, and equities to outperform cash in 2024 under our base case. It’s true the Fed and other central banks don’t appear to the be on the cusp of drastic rate cuts, but when you extend your horizon, you can clearly see the risk of holding too much cash.
To better understand this dynamic, we looked back over the last 30+ years to quantify the relationship between starting yields and future total returns. As the chart below illustrates, the link between cash yields today and future returns is weak. Why? Because there is no guarantee that prevailing yields one or three months out, when that hypothetical cash-like instrument matures, will still be as high as the initial investment rate. In other words, the durability of cash investments’ return stream is unpredictable. In contrast, for a blended multi-asset portfolio comprised of global dividend stocks, investment grade bonds and high yield, starting yields had a much more positive predictive relationship with ensuing three-year returns. This is due to reduced sensitivity to short-term rate policy, brought about by owning fixed-rate investment grade and high yield bonds, which allow investors to “lock-in” higher starting yields for a longer period. This can be a powerful return driver especially when combined with the greater upside potential of equities.
Initial yields vs. subsequent 3-year total returns
Past performance is not an indication of future results. Index performance is for illustrative purpose only. Investors cannot directly invest into an index. Source: BlackRock, Bloomberg as of 12/31/2023. Cash represented by Bloomberg US Treasury Bill Index. Multi-Asset Income Index Blend is comprised of 33.34% MSCI World High Dividend Index, 33.33% Bloomberg US Corporate Bond Index, and 33.33% Bloomberg US High Yield Bond Index. For illustration purposes only. Yield reflects yield-to-worst (%) for fixed income and dividend yield (%) for equity.
Our bottom line: Investors can achieve attractive income and total return using a multi-asset approach with the added benefit of portfolio diversification again.
4.Should I continue to hold high quality bonds over high yield?
The question for investors today is should they stick with the higher quality bond theme. We agree the yield available in high quality bond markets is much more attractive today and these areas should represent a larger allocation in portfolios versus years past. For instance, the average yield across short-term investment grade bonds, investment grade collateralized loan obligations (CLOs), and agency mortgage-backed securities (MBS) is 5.2% today vs. 1.8% at the end of 2021.2 That said, longer-term investors that are avoiding high yield entirely may be leaving some income and return on the table. Consider that the current 7.6% yield of the US high yield index is ~0.5% above that of the average annualized return of US equities since 2000.2 Said another way, there are pockets of credit markets that we think can provide equity-like returns given the dynamics mentioned in question 3.
Overall, we are constructive on high yield with one important caveat - owning the lowest quality bonds in a slowing environment requires caution. A higher cost of capital backdrop will likely lead to an uptick in defaults in 2024 with lower quality exposures being most exposed.
Our bottom line: We think investors should have an allocation to both investment grade and high yield bonds due to the attractive yield levels available today and lean more into the latter the longer your time horizon is.
5.Can dividend stocks outperform?
One of the most notable trends of 2023 was the AI led outperformance of the Magnificent 7 versus everything else. As a result, we saw a significant divergence in returns between market cap and equally weighted indices (e.g., +26.3% vs. +13.8% for the S&P 500, respectively). Dividend stocks significantly lagged broad markets in 2023, with the S&P High Dividend Index returning +3.9% and the Morningstar US Dividend Growth Index returning +9.6%. As a result, dividend stocks continue to screen as cheap relative to their own history and relative to broad markets which are increasingly dominated by growth stocks. This means the bar for future gains is lower for dividend stocks and these stocks stand to benefit more should the equity rally broaden out.
We continue to favor those stocks that are higher quality with a history of growing dividends. We think this approach makes sense in a more uncertain macro backdrop like today and has proven effective over time. Take the example of Mondelez International (manufacturer of snacks and beverage products). Looking at just its dividend yield of 2.3% wouldn’t tell the full story of its potential. The stock has an equity beta of 0.72, has doubled in price over the last ten years, and grown its dividend by an annualized rate of 11.7%.2 Those are powerful attributes for income investors!
Past performance is not an indication of future results. Reference to the company name mentioned herein is for illustrative purpose only and should not be construed as investment advice or investment recommendation of those companies. Source: Bloomberg as of December 31, 2023. Equity beta based on weekly returns. Dividends on $10K assumes initial investment in December 2013 with dividends reinvested.
Importantly, income investors shouldn’t abandon growth stocks altogether just because they trade at higher multiples. Those portfolios that were underexposed to such sectors and themes in 2023 significantly lagged, and the trends around technology have staying power in our view. Rather, one consideration for income investors is to gain some of this growth equity exposure through covered calls. By selling calls on growth stocks investors can diversify their sector exposures beyond traditional dividend sectors like consumer staples, generate additional income in their portfolios, and allow for some equity upside participation.
Our bottom line: Dividend stocks remain cheaply priced and have proven a powerful asset to own over time. A Fed on hold and a soft landing in the US should allow the equity rally to broaden out beyond just mega-cap tech.
Looking ahead
As we start the year off, we are cautiously optimistic on the year ahead. We are positioned for a backdrop that will show a slowdown but no hard landing, moderating inflation, and a Fed that is likely done with its hiking campaign. Within our Multi-Asset Income model portfolios and Multi-Asset Income Fund, we have added to equity risk and been tactical with duration and credit quality management on the back of a more favorable macro backdrop and the strength of the recent rate rally.
Performance data represents past performance and does not guarantee future results. Investment return and principal value will fluctuate with market conditions and may be lower or higher when you sell your shares. Current performance may differ from the performance shown. All returns assume reinvestment of all dividend and capital gain distributions. Refer to blackrock.com for current month end performance.
To obtain more information on the fund(s) including the Morningstar time period ratings and standardized average annual total returns as of the most recent calendar quarter and current month-end, please click on the fund tile. The Morningstar Rating for funds, or "star rating," is calculated for managed products (including mutual funds, variable annuity and variable life subaccounts, exchange-traded funds, closed-end funds, and separate accounts) with at least a three-year history. Exchange-traded funds and open-ended mutual funds are considered a single population for comparative purposes. It is calculated based on a Morningstar Risk-Adjusted Return measure that accounts for variation in a managed product's monthly excess performance, placing more emphasis on downward variations and rewarding consistent performance. The top 10% of products in each product category receive 5 stars, the next 22.5% receive 4 stars, the next 35% receive 3 stars, the next 22.5% receive 2 stars, and the bottom 10% receive 1 star. The Overall Morningstar Rating for a managed product is derived from a weighted average of the performance figures associated with its three-, five-, and 10-year (if applicable) Morningstar Rating metrics. The weights are: 100% three-year rating for 36-59 months of total returns, 60% five-year rating/40% three-year rating for 60-119 months of total returns, and 50% 10-year rating/30% five-year rating/20% three-year rating for 120 or more months of total returns. While the 10-year overall star rating formula seems to give the most weight to the 10-year period, the most recent three-year period actually has the greatest impact because it is included in all three rating periods.
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