Resilience versus risk

What a long, strange trip 2023 was! So how can investors navigate the near-term risks on the horizon and find compelling valuations in US companies?

• Where next for the US economy?
• US economic resilience 
• Considering alternatives 

As we move through 2024, investors are grappling with the end of an era – and many who came of investing age over the past 15 years may not recognise where the US economy is heading.

Since the Great Financial Crisis, we’ve been living in a world of low interest rates and easy money. Apart from the occasional market shock and risk-off retreats to safe havens, for the most part simply buying and holding stocks seemed to work.

In a stubbornly low-rate environment, bonds generally became more capital appreciation vehicles and the correlation benefits behind the classic 60/40 portfolio seemed to be fleeting at best.

The signals from the Federal Reserve have been clear—we will be in a higher-for-longer rate environment. Period, full stop. Anyone who thinks we’ll get anywhere near back to the low-rate world we’ve lived in the past many years must consider the immense number of bonds on the Fed’s balance sheet that will be rolling off to land on top of all the new issuance they must float to pay for the larger-than-ever deficits that have been run up during these easy-money times.

Certainly, we are also living in a world of aging demographics across the developed countries and all these retirees will be needing safe income alternatives – but will that demand be strong enough to match up with the supply? Best to wager that it may fall a little short. Instead, investors could consider finally buying bonds under the assumption that they will earn reasonable yields and, when we do have periods of slowing economic growth and/or market shocks – both of which could happen at any time in the next year or so – rates may retreat, leaving enticing capital gains opportunities in their wake.

Equities will remain a ballast and will likely continue to be driven by real fundamental factors such as earnings and margin expansion, as much as by unreal factors such as sentiment and human behaviour. 

It’s impossible to predict the latter but remain focused on the real fundamental drivers. Along those lines, there is reason to be optimistic that equities have a bright future. There are many companies generating steady earnings growth and the largest companies that have an outsized impact on most everyone’s portfolio – namely the big tech and communications companies that include the Magnificent Seven – may well be entering a new phase of growth and productivity gains resulting from the incorporation of AI across their revenue lines and value chains.

Be wary of areas that are susceptible to changes from recent transformations such as the shift to working from home and the ongoing emergence of onshoring supply chains and manufacturing.

Real estate investing – beyond buying a home – may be choppy for several years as work patterns resolve themselves. Any company that relies heavily on foreign suppliers may experience some obstacles. Tech and communications companies, as well as other industries that can benefit from “AI-ing” aspects of their value chain – including finance and healthcare – could do well soon.

Commodities in general could well be a roller coaster ride – not for the faint of heart. Impacted on all sides by geopolitical issues, demographic trends and climate change, predicting the future of prices for food and energy will continue to be a challenge. Energy always presents a pricing problem and everything about recent events among the world’s top energy producers points to volatility ahead. At the same time, food production is increasingly challenging in a world where droughts and floods randomly pepper major agricultural regions season in and season out.

Each new year will bring about a guessing game as to which region can grow which crop. Be prepared to see crops shift from growing region to growing region, year to year following weather patterns, with the only certainty being unpredictable price fluctuations.

Alternative investments including private investment vehicles, structured products and derivative embedded strategies producing correlation and income benefits may be worth considering weaving into a portfolio.

And, for the first time in what seems like a generation, cash is more than just a “risk-off” hiding place. Steady, respectable returns can now be had with short-term, high-quality fixed income and even boring old money market funds. There is no shame in taking advantage of 5%-plus returns that are safe and liquid.

In conclusion, the age-old adage of diversifying and staying liquid is one to hold on to. Beneficial correlations between asset classes come and go, so it may make sense to string out the old standby 60/40 approach into a 50/35/10/5 allocation incorporating quality equities and bonds alongside correlation-bolstering alternative products and cash. In a “higher-for-longer” rate environment that will resemble the way things were for many years before the Financial Crisis, it makes sense to spread out your risks and be prepared for continuous change.