It's time for the February edition of "Adding Alpha." And in the style of David Letterman, we're counting down the Top 10 Most Important Investor Themes for 2024.
Number 10 is China.
China's GDP growth, retail sales, and real household income are healthy. But the property sector is undergoing a painful de-leveraging process, causing consumer demand and consumer confidence to weaken. It leads us to believe China's economy is cyclically weak but not in structural crisis. However, investor sentiment is very negative. The next 12 months' P/E multiple of the MSCI China Index is trading at a massive 25% discount to its 20-year average, despite strong earnings growth prospects.
Number 9: The D-word, deficits and debt levels.
The cost of refinancing US debt gets more expensive with higher interest rates, and 2023 hit $2 trillion. On a cash basis, the deficit doubled in a year in which we had full employment. We already saw two of the three credit rating agencies downgrade US debt, with a third on negative outlook. With 2024 being an election year, we don't expect much of a resolution on this front. So this issue will likely continue to be a thorn in the side of investors.
Number 8: AI.
It's only been a little over a year since ChatGPT launched, but it's led to an explosion in AI innovation. We expect to see productivity enhancements for the users and earnings growth and profit margin expansion for the firms adapting to this technological paradigm throughout the course of the year.
Number 7: Global election cycles.
Over 35% of the world's GDP and nearly 80% of the world's market cap will face major election cycles in 2024. Despite election noise, the S&P 500 has generally posted positive results during US election years. In fact, the last 16 presidential reelection years have shown positive S&P 500 total returns, no matter who ends up winning.
Number 6: Yield curve normalization.
The question is not if, but when the Fed begins to cut rates. This inversion of the yield curve is likely to come as a result of natural upward pressure on the long end of the curve -- that is, for economic growth and inflation -- and rate cuts on the short end, which should create a much-needed tailwind for sectors like financials and real estate.
Number 5 is Inflation.
Although inflation has moderated from peak levels in 2022, driven by falling goods, food, and energy prices, it continues to be offset by stickier services inflation. Given consumers' resilience in 2023, we expect inflation to continue to moderate toward the Fed's 2% target.
Number 4: The "beast of burden" is the US consumer.
Labor market strength has supported consumer spending, powering the economy. With nearly 70% of GDP tied to consumption in some way, shape, or form, the outcome for the economy and earnings relies heavily on consumers' ability to withstand the cumulative effects of inflation, tighter lending standards, dwindling savings rates, and rising credit balances.
Number 3: Diverging global central bank policies.
In 2024, the Fed is turning dovish. The European Central Bank and the Bank of England are maintaining their tightening bias. China remains accommodative. And the Bank of Japan is keeping everyone guessing about if or when it will pivot away from ultra-loose policy. Divergence creates opportunities for investors.
Number 2 is Earnings.
Approximately 75% of the return in the markets last year was driven by multiple expansion. With the S&P 500 starting 2024 trading at a 19 1/2 times forward PE, there's a lot of pressure to deliver results against a backdrop of already very high expectations. And Q4 earnings season has been underwhelming so far.
And the number 1 most important investor theme for 2024 is #SlowYourRoll economic growth.
We expect economic growth to continue to decelerate but not tip into recession by getting support from the Fed's monetary policy pivot. The key point is the business cycle is not moving back to an accelerating expansion. The slowing expansion phase simply lasts longer due to the shift in monetary policy. That has important implications for portfolio positioning, because without that all-important inflection point in the cycle, aggressive allocation changes feel premature.