We are entering a new era. The year 2024 will be unpredictable and clouded by many uncertainties. It will be marked by geopolitical risks, the ongoing taming of the inflation beast, and how the US Presidential election will impact markets. In this structurally different world, where higher interest rates define markets, the consensus among many investors is that volatility will continue to reign supreme.
Against this backdrop, in our view active investing will take centre stage as investors seek to capitalise on opportunities to generate returns. Our investments teams are navigating the course with caution, actively uncovering pockets of opportunity, as they position portfolios for potential upside gains while managing downside risks.
First Sentier Investors’ asset class experts share their views1 on how they’re thinking about 2024.
The inflation conundrum
Throughout 2023, central banks faced tough challenges in taming inflation. While many predicted a recession, the reality is that markets may be in for a softer landing and how central banks respond is unclear.
“Near-term sentiment now favours a relatively soft landing and most major markets are priced for a material rate cut cycle in 2024. As a result, central banks are facing a conundrum – do they stand firm and focus primarily on elevated inflationary pressures? Or choose to focus on maximising growth and employment outcomes by taking a softer stance on policy settings?” said Stephen Cooper, Head of Australian and New Zealand Fixed Income.
Providing a perspective on Asia, Nigel Foo, Head of Asia Fixed Income said, “There are clear signs that inflation will continue trending lower unless food and energy inflation causes a spike. However, central banks will have more flexibility to pause rate hikes or cut rates to spur growth, should the need arise.”
“Despite short-term challenges in China, our view is that the Chinese government will remain steadfast in seeing its policies through and to push the economy into achieving higher-quality growth.”
Is there ‘Value’ in volatility?
David Walsh, Head of Investments for Realindex, said, “We expect value stocks to do well with continued inflation, but the increasingly macro-driven equity markets make the need for risk-controlled stock selection processes more important.”
“While we do not directly control explicit macro factors, they reflect strongly in risk factors we do control - sector and region performance, and in systemic-style factors like leverage and firm size. We believe, this puts us in a comparatively better position than many peers. Stock selection models will also need to reflect larger style trends, so a diversified set of stock selection factors across different horizons is needed. While we expect all stock selection factors in our models to deliver on average through the cycle, they will not all work at the same time. Macro factors can influence this,” Walsh said.
He went on to say that quality matters.
“We expect the impact of higher interest rates on poor quality names will continue to play out, if not through actual default, then in poor performance. Quality factors should continue to perform well and will be critical as a long-term driver for delivering good performance in the face of uncertainty. The broad-based set of factors we use in our Diversified Alpha strategy positions us for this,” Walsh concluded.
A market for stock pickers
A grinding slowdown is a theme that Dushko Bajic, Head of Australian Growth Equity, expects in the year ahead, “We maintain a generally positive outlook for the Australian economy. Strong economic conditions both globally and domestically have meant the slowdown hasn’t been a lightning bolt recession as we experienced in the Global Financial Crisis and COVID pandemic.”
“So what does this mean for equity markets? We believe it’s a stock pickers market, which is attractive for active fund managers like ourselves to uncover opportunities. This was evident in 2023 with company fundamentals determining stock winners rather than those particularly sensitive to interest rates.”
“We are focused on identifying companies that can ‘run their own race’ and don't need an uplift in activity or pricing from inflation in order to deliver strong top-line and earnings growth at attractive returns on invested capital,” Bajic said.
In this era of elevated interest rates and inflation, Rudi Minbatiwala, Head of Equity Income, shared a word of caution to retirees.
“Higher interest rates may appear as a boon for retirement income however retiree investors should be wary that inflationary pressures can act as a negative source of income.”
“Given the need for retirement investments to grow with inflation, we actively look for opportunities to deliver attractive income streams for retirees by looking beyond the immediate dividend yield to the long-term growth potential of stocks. In the year ahead, we expect to be favouring stocks with pricing power who can pass on their higher cost base in the form of price increases, or companies that are run efficiently and can offset cost increases with productivity gains.”
Bonds back as the great diversifier
“Fixed income now measures up more favourably against other asset classes,” said Foo.
“The income component of Asian Investment Grade Credits have strong yields relative to the last few years, making it more appealing for investors who were previously grappling with historically low coupons. We believe these will continue to perform well next year as fundamentals remain sound. Similarly, opportunities in Asian High Yield look promising as distressed names are now in more advanced stages of restructuring. We expect upsides from such recoveries to be attractive from a risk-reward perspective.”
Cooper echoed the sentiment, saying that “Value has returned to the bond market and fixed income assets now offer at least some protection against a significant downturn in other asset classes.”
“Even if inflation proves stubborn and rates move higher from here, we are likely to still see positive returns as running yields are higher and the scope for further increases is somewhat more limited. We expect inflation to prove persistent” in the coming years, resulting in higher average interest rates relative to the past decade or more. That said, we still expect interest rates to experience meaningful cycles as economic fortunes fluctuate, and bonds can again play their part as a diversifier in portfolios, moderating volatility of risk assets.”
Credit could surprise
Craig Morabito, Senior Portfolio Manager, Global Credit, said, “The return volatility of traditional aggregate-style fixed income funds was unpalatable last year, especially for investors seeking stability and capital preservation from this defensive component of their investment portfolio. Although the movement of interest rates remains uncertain as we move into the New Year, it will continue to drive the performance of these funds.”
“But credit may surprise. Our flagship global credit strategy enjoyed positive returns over the year. It’s very short duration profile makes it substantially less sensitive to changes in interest rates and the regular receipt of income from bond coupon payments suggests short-dated global credit should continue delivering positive returns in the year ahead, including to comfortably beat returns currently on offer from cash and term deposits,” he said.
Infrastructure: a story of structural growth
Peter Meany, Head of Global Listed Infrastructure, said the outlook for the sector was positive, “Earnings growth for critical infrastructure assets are likely to be underpinned by several growth drivers in 2024 and beyond. We are optimistic about the substantial investment opportunities associated with the energy transition but there are also themes like solving for urban congestion, and digitalisation, which we expect will add value long into the future.”
“Currently, we see real value in sectors like US utilities and toll roads, where the market has underestimated the potential of these assets. We see opportunities to buy into long-term structural themes at an attractive price point and with many governments hamstrung by debt following the pandemic, we expect that the private sector will be called upon to drive further investment in this area in the years ahead,” Meany said.
These structural growth drivers extend to direct infrastructure.
Danny Latham, Partner and Head of Igneo Infrastructure Partners, Australia and New Zealand, said, “In 2024 and beyond, we see significant potential in mid-market investments, especially within the renewables and digital infrastructure sectors given both the demand for, and associated investment deployment, for those assets.”
“Macro tailwinds driven by the decarbonisation story and the net zero targets set by many governments, including Australia, will contribute to our ability to create long-term value for our investors while contributing to a more sustainable future. However, there are also structural challenges such as the transmission connection challenges which pose a threat. Government policies will be critical in unlocking the next phase of renewable development,” Latham said.
A convergence of responsible investment issues
“We are increasingly seeing how responsible investment areas are converging,” said Kate Turner, Global Head of Responsible Investment.
“We cannot look at climate change as a standalone issue. As droughts, floods and other extreme weather batter the globe, thousands of the poorest populations are being forced to flee their homes and livelihoods. A key risk for displaced people is falling victim to modern slavery situations such as forced labour. Human rights are also bound up in the decarbonisation of the global economy.”
“The transition to a low-carbon economy is urgent and important, but we must also ensure it is a just transition. Governments, companies and investors must aim to ensure there is decent and fair work for everyone, as we decarbonise the world,” Turner said.
Kristen Le Mesurier, Head of ESG2 in the Australian Equities Growth team said, “Climate change and the climate transition is likely to remain the most prominent ESG issue in 2024. There are clear gaps in the emissions reductions needed to keep temperature at or below 1.5 degrees Celsius and a notable divergence between country-level and company-level commitments. For investors, the question is whether these gaps present an investment risk, and over which time horizon.”
“Nature and biodiversity is rising to the fore as an investment issue and companies are starting to think about their impact on nature and their reliance on nature. Both have the potential to present investment risks. Several reporting frameworks were finalised in 2023 and we expect companies to report on their efforts under the Taskforce for Nature-related Financial Disclosures next year.”
“Modern slavery also remains a challenge for companies and investors. Recent data suggests that modern slavery is systemic3 yet most companies aren't detecting instances of modern slavery in their supply chains, suggesting that most detection mechanisms aren't effective. As investors, we are encouraging companies to use the full range of detection mechanisms at their disposal, including talking to unions and worker groups on the ground in high-risk countries. We hope to see more instances detected and reported by companies in 2024.”
1 Please note, certain investment strategies are not available in all regions or to all investors.
2 Environmental, Social and Governance.
3 The 2021 Global Estimates of Modern Slavery indicate that there are 49.6 million people living in situations of modern slavery on any given day, which is 10 million more than the previous estimates in 2017. Of these people, approximately 27.6 million were in forced labour.
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