Andrew Pease
Russell Investments’ strategists believe soft-landing optimism can deliver more near-term market gains but the risks of a sharper economic slowdown later in the year are elevated.
“Although declining inflation means central banks can start easing in the second half of the year, the lagged impact of previous rate rises is yet to be fully felt,” said Andrew Pease, Chief Investment Strategist at Russell Investments. “Just as last year’s investor pessimism was overdone, we worry this year’s optimism could eventually prove to be excessive.”
With economic growth proving resilient, inflation falling, and corporate profits holding up, the team observes that investors who were fearful of recession in 2023 are being drawn into the market and positive momentum has the potential to push major market indexes to further record highs.
Scratching below the surface, the team also sees the U.S. labour market is cooling, with job openings down about 25% from their early 2022 peak, and signs that lower-income households are coming under stress. In addition, default rates on credit cards and auto loans are above pre-pandemic levels. In the corporate sector, high-yield default rates are picking up and commercial real estate delinquencies continue to rise.
“While we think it is more likely than not that the U.S. can avoid a recession in 2024, uncertainty is still elevated, and markets have priced in all, if not more than all, the positive news in recent months,” Pease said.
Russell Investments’ key asset-class views at the beginning of Q2 2024 include the following:
- The equity market outlook is constrained by expensive valuation multiples, optimistic industry consensus earnings growth expectations, and overbought sentiment. The team previously preferred Quality equities – profitable companies with strong balance sheets – however that overweight was neutralised in February following a stretch of strong performance for these stocks. The team now believes equities have limited upside.
- Non-U.S. developed equities still trade at a steep discount to U.S. equities, but there is significant uncertainty around the ability for these markets to deliver differentiated earnings.
- The team is neutral on emerging markets despite their relative cheapness due to negative sentiment. The team is neutral to slightly overweight Chinese equities across equity portfolio strategies, largely driven by where the firm’s underlying money managers are finding the best value in emerging markets.
- Government bonds, provide attractive value as yields still trade well in excess of expected inflation. U.S. Treasuries are a preferred overweight exposure, where the firm’s fixed income strategy team sees particularly good value in the five-year point of the yield curve. The team’s favorable outlook for government bonds continues to extend across most major developed sovereign markets, including Canada, Germany, Australia and the UK. The only notable outlier is Japan.
- U.S. High yield and U.S. investment grade spreads are very tight into an environment of elevated economic uncertainty, leading the team to dampen its normal strategic overweight to corporate credit.
- Real estate: The prospect of central banks cutting interest rates in 2024 should be a major tailwind for real estate, with Real Estate Investment Trust valuations continuing to look attractive.
- Infrastructure: “Given the significant uncertainty surrounding the macro-outlook, we think the defensive nature of infrastructure investments make them a useful lever for portfolio diversification – cushioning the portfolio in a market downturn, while not giving up significant upside potential should a soft landing come to pass,” said Paul Eitelman, Senior Director, Chief Investment Strategist, North America, at Russell investments.
- The U.S. dollar is expensive which suggests potential for the greenback to decline over the medium-term. However, the potential for a global recession in 2024 could result in further upside for the dollar in the short term as investors flock to the relative safety of U.S. assets. The team believes these two-sided risks warrant a neutral stance.
“On balance, our investment decision-making process leans slightly cautious, but it does not show markets at an extreme that would incline us to position portfolios markedly risk-on or risk-off. Instead, most of our portfolio strategies at the beginning of the second quarter are emphasising security selection and diversification to protect client outcomes across a wide range of potential scenarios in the year ahead,” Pease said.
Read the 2024 Global Market Outlook.