Introduction
The current economic landscape is marked by higher interest rates and increased volatility, a departure from the stability observed in the decade following the global financial crisis. Unlike before, central banks face challenges in stabilizing economies due to production constraints and tougher trade-offs in addressing inflation versus supporting growth. The evolving economic environment is shaped by structural factors such as shrinking workforces, geopolitical fragmentation, and the low-carbon transition.
The prevailing uncertainty has led to a disconnect between cyclical narratives and structural realities, contributing to market volatility. Despite apparent U.S. economic growth, it reflects a recovery from the pandemic shock rather than robust expansion. The key implication is persistently higher interest rates and tighter financial conditions, prompting a need for a more active portfolio approach.
In this new regime, macro insights are expected to be valuable, with greater volatility and return dispersion creating opportunities for investment expertise.
Context is everything
In 2023, hopes for a soft landing in the U.S. economy have been fueled by robust growth in the third quarter, a significant decline in core inflation, and the creation of nearly 7 million jobs since January 2022. However, taking a broader perspective reveals that the economy is still recovering from the pandemic, with job gains largely recouping those lost during the initial impact. Despite strong job growth, overall economic activity has been below pre-pandemic expectations, averaging less than 1.8% annual growth since the pandemic.
The key insight is that a structural change has occurred, leading to a weaker growth path accompanied by higher inflation, increased interest rates, and elevated debt levels. The advice for investors is to focus on how the economy and markets are adjusting to this new regime rather than relying on a typical cyclical playbook, as the traditional approach may be misguided.
Managing Macro Risk
Investors are advised to neutralize macro exposures or, with high conviction, deliberately choose exposures. Analyst estimates for S&P 500 equity earnings show increased dispersion, emphasizing the potential rewards for macro insight.
Despite the adjustment to structurally higher inflation and policy rates, markets vary in their response. The uneven adjustment is highlighted by factors such as surging U.S. 10-year yields compared to relatively unchanged DM equity earnings yields. This adjustment is considered more critical than the possibility of a technical recession, warranting caution on broad exposures.
The long-term risk of higher inflation increases if borrowing costs remain elevated, potentially surpassing spending on Medicare in the future. A rise in term premium and expectations of increased yield volatility led to a tactical neutral stance and a strategic underweight position in long-term U.S. Treasuries. The preferred strategic overweight is in inflation-linked bonds.
Harnessing mega forces
The concept of mega forces offers a strategic approach to steering portfolios, focusing on building blocks that go beyond traditional asset classes. These forces, seen as independent drivers of corporate profits, provide potential opportunities that may be uncorrelated with macro cycles. Mega forces, such as digital disruption and artificial intelligence (AI), are already reshaping markets, as demonstrated by the outperformance of U.S. tech compared to the broader market.
The winners and losers in the mega forces landscape can influence tactical views, impacting stances on developed market equities even in less favorable macroeconomic conditions. Embracing mega forces is presented as a means for investors to outperform static allocations, leveraging the far-reaching consequences that create new investment opportunities. Examples include private credit filling the lending void due to capital pressures on banks, demographic shifts shaping production and growth limitations, and the emergence of climate resilience as an investment theme within the low-carbon transition.
AI intelligence revolution
Advances in computing hardware and deep learning have marked an inflection point for Artificial Intelligence (AI) since late 2022, with expectations of exponential progress in innovation. While tracking AI investment opportunities across geographies and sectors involves high uncertainty, a technology "stack" approach is suggested to assess these opportunities. The stack includes cloud infrastructure and chips as the foundational layer, followed by models, data, and data infrastructure, and finally, applications that harness innovation.
The tech industry, particularly led by major tech firms, is seen pivoting toward AI, indicating the potential for an intelligence revolution. The current position is perceived to be between the first and second layers of the technology stack, with the last layer anticipated to follow. This shift has implications beyond near-term productivity gains. Early research suggests a positive correlation between increased AI patents and broad earnings growth, indicating rising economic value attributed to these patents.
Despite uncertainties surrounding the future value of AI patents and their translation into profitable enterprises, there is an overweight recommendation on the AI theme in developed market stocks for the next six to twelve months. The tech sector's earnings resilience is expected to persist, serving as a significant driver of overall U.S. corporate profit growth in 2024.
Investing in climate resilience
The emphasis of this chapter is on helping investors navigate the risks and opportunities associated with the energy transition. Beyond renewables, traditional energy companies can also outperform, especially during supply-demand mismatches.
While the energy transition often dominates headlines, a related and crucial investment theme is climate resilience. This involves preparing for, adapting to, and withstanding climate hazards, as well as rebuilding after climate damage. Climate resilience encompasses various solutions like early monitoring systems, air conditioning to address heatwaves, and retrofitting buildings for better weather resistance. Given the anticipated increase in climate damages, significant investment is required to enhance society's resilience.
The economic impact of climate damages is growing rapidly, and there is a rising demand for products and services that contribute to climate resilience. This theme is identified as potentially becoming a mainstream investment theme over time. The three sub-themes within climate resilience—assessing and quantifying risks, managing risk, and rebuilding physical infrastructure—create a framework to identify opportunities across sectors (such as industrials and technology) and asset classes.
Deepening fragmentation
Cascading crises have accelerated global fragmentation and the emergence of competing geopolitical and economic blocs. Countries like Vietnam, Mexico, the Gulf states, India, and Brazil are seen as potential beneficiaries of supply chain diversification, establishing ties with multiple blocs, and possessing valuable resources. In this more competitive global landscape, a surge of investment in strategic sectors such as technology, energy, defense, and infrastructure is expected. Opportunities also exist in firms specializing in managing and reducing cybersecurity risks.
Increased geopolitical risks stemming from conflicts in the Middle East, Russia-Ukraine tensions, and structural competition between the U.S. and China are acknowledged. The current global situation is characterized by the highest number of volatile situations in decades, according to the UN. The year 2024 is anticipated to be the biggest election year in history, with the U.S. and Taiwan elections deemed particularly significant. Navigating this new world order requires holistic portfolio strategies that aim to both seize opportunities and mitigate risks, rather than focusing solely on avoiding risks or positioning for specific events.
Conclusion
Our core conviction is that investors need to be more dynamic with portfolios in the new regime. The outlook for 2024 suggests that investors should take a proactive stance, avoiding autopilot investing. The advice is to be intentional in managing portfolio risk, with an expectation of deploying more risk over the next year.
The current economic landscape is marked by higher interest rates and increased volatility, a departure from the stability observed in the decade following the global financial crisis. Unlike before, central banks face challenges in stabilizing economies due to production constraints and tougher trade-offs in addressing inflation versus supporting growth. The evolving economic environment is shaped by structural factors such as shrinking workforces, geopolitical fragmentation, and the low-carbon transition.
The prevailing uncertainty has led to a disconnect between cyclical narratives and structural realities, contributing to market volatility. Despite apparent U.S. economic growth, it reflects a recovery from the pandemic shock rather than robust expansion. The key implication is persistently higher interest rates and tighter financial conditions, prompting a need for a more active portfolio approach.
In this new regime, macro insights are expected to be valuable, with greater volatility and return dispersion creating opportunities for investment expertise.
Context is everything
In 2023, hopes for a soft landing in the U.S. economy have been fueled by robust growth in the third quarter, a significant decline in core inflation, and the creation of nearly 7 million jobs since January 2022. However, taking a broader perspective reveals that the economy is still recovering from the pandemic, with job gains largely recouping those lost during the initial impact. Despite strong job growth, overall economic activity has been below pre-pandemic expectations, averaging less than 1.8% annual growth since the pandemic.
The key insight is that a structural change has occurred, leading to a weaker growth path accompanied by higher inflation, increased interest rates, and elevated debt levels. The advice for investors is to focus on how the economy and markets are adjusting to this new regime rather than relying on a typical cyclical playbook, as the traditional approach may be misguided.
Managing Macro Risk
Investors are advised to neutralize macro exposures or, with high conviction, deliberately choose exposures. Analyst estimates for S&P 500 equity earnings show increased dispersion, emphasizing the potential rewards for macro insight.
Despite the adjustment to structurally higher inflation and policy rates, markets vary in their response. The uneven adjustment is highlighted by factors such as surging U.S. 10-year yields compared to relatively unchanged DM equity earnings yields. This adjustment is considered more critical than the possibility of a technical recession, warranting caution on broad exposures.
The long-term risk of higher inflation increases if borrowing costs remain elevated, potentially surpassing spending on Medicare in the future. A rise in term premium and expectations of increased yield volatility led to a tactical neutral stance and a strategic underweight position in long-term U.S. Treasuries. The preferred strategic overweight is in inflation-linked bonds.
Harnessing mega forces
The concept of mega forces offers a strategic approach to steering portfolios, focusing on building blocks that go beyond traditional asset classes. These forces, seen as independent drivers of corporate profits, provide potential opportunities that may be uncorrelated with macro cycles. Mega forces, such as digital disruption and artificial intelligence (AI), are already reshaping markets, as demonstrated by the outperformance of U.S. tech compared to the broader market.
The winners and losers in the mega forces landscape can influence tactical views, impacting stances on developed market equities even in less favorable macroeconomic conditions. Embracing mega forces is presented as a means for investors to outperform static allocations, leveraging the far-reaching consequences that create new investment opportunities. Examples include private credit filling the lending void due to capital pressures on banks, demographic shifts shaping production and growth limitations, and the emergence of climate resilience as an investment theme within the low-carbon transition.
AI intelligence revolution
Advances in computing hardware and deep learning have marked an inflection point for Artificial Intelligence (AI) since late 2022, with expectations of exponential progress in innovation. While tracking AI investment opportunities across geographies and sectors involves high uncertainty, a technology "stack" approach is suggested to assess these opportunities. The stack includes cloud infrastructure and chips as the foundational layer, followed by models, data, and data infrastructure, and finally, applications that harness innovation.
The tech industry, particularly led by major tech firms, is seen pivoting toward AI, indicating the potential for an intelligence revolution. The current position is perceived to be between the first and second layers of the technology stack, with the last layer anticipated to follow. This shift has implications beyond near-term productivity gains. Early research suggests a positive correlation between increased AI patents and broad earnings growth, indicating rising economic value attributed to these patents.
Despite uncertainties surrounding the future value of AI patents and their translation into profitable enterprises, there is an overweight recommendation on the AI theme in developed market stocks for the next six to twelve months. The tech sector's earnings resilience is expected to persist, serving as a significant driver of overall U.S. corporate profit growth in 2024.
Investing in climate resilience
The emphasis of this chapter is on helping investors navigate the risks and opportunities associated with the energy transition. Beyond renewables, traditional energy companies can also outperform, especially during supply-demand mismatches.
While the energy transition often dominates headlines, a related and crucial investment theme is climate resilience. This involves preparing for, adapting to, and withstanding climate hazards, as well as rebuilding after climate damage. Climate resilience encompasses various solutions like early monitoring systems, air conditioning to address heatwaves, and retrofitting buildings for better weather resistance. Given the anticipated increase in climate damages, significant investment is required to enhance society's resilience.
The economic impact of climate damages is growing rapidly, and there is a rising demand for products and services that contribute to climate resilience. This theme is identified as potentially becoming a mainstream investment theme over time. The three sub-themes within climate resilience—assessing and quantifying risks, managing risk, and rebuilding physical infrastructure—create a framework to identify opportunities across sectors (such as industrials and technology) and asset classes.
Deepening fragmentation
Cascading crises have accelerated global fragmentation and the emergence of competing geopolitical and economic blocs. Countries like Vietnam, Mexico, the Gulf states, India, and Brazil are seen as potential beneficiaries of supply chain diversification, establishing ties with multiple blocs, and possessing valuable resources. In this more competitive global landscape, a surge of investment in strategic sectors such as technology, energy, defense, and infrastructure is expected. Opportunities also exist in firms specializing in managing and reducing cybersecurity risks.
Increased geopolitical risks stemming from conflicts in the Middle East, Russia-Ukraine tensions, and structural competition between the U.S. and China are acknowledged. The current global situation is characterized by the highest number of volatile situations in decades, according to the UN. The year 2024 is anticipated to be the biggest election year in history, with the U.S. and Taiwan elections deemed particularly significant. Navigating this new world order requires holistic portfolio strategies that aim to both seize opportunities and mitigate risks, rather than focusing solely on avoiding risks or positioning for specific events.
Conclusion
Our core conviction is that investors need to be more dynamic with portfolios in the new regime. The outlook for 2024 suggests that investors should take a proactive stance, avoiding autopilot investing. The advice is to be intentional in managing portfolio risk, with an expectation of deploying more risk over the next year.
