Global equities

Hans Slomp, Senior Portfolio Manager Equities, Cardano NL

After a year when equity markets defied expectations to hold up well, the jury is out on 2024. Companies are increasingly facing rising input costs from tight labour markets, which puts pressure on operating margins. The ‘higher for longer’ interest rate backdrop that we expect, and its lagging effect upon the real economy, is set to slow economic growth across most major developed economies. This is increasingly weighing on both corporate and consumer sentiment and presents a challenge to equity market performance.

Amidst economic slowdown and the heightened probability of recession, cyclical sectors will likely suffer. Even if we were to assume that interest rates have peaked it will be equities that are most exposed to the economic cycle that will likely underperform. The first signs of this risk became evident during late-2023’s reporting season; cyclicals across many different industrial sectors had the most profit warnings, whilst utilities had the least.

We expect that defensive sectors should fare better in 2024, alongside rate sensitive sectors, both of which struggled in 2023. The relative performance of cyclicals versus defensives shows a very close relationship to the direction of bond yields. Defensive sectors are now moving into favour and accordingly we are defensively positioned as we start the New Year.

Government bonds

Mehdi Abdi, Head of Government Bonds, Cardano NL

From a global perspective, the outlook for government bonds looks brighter in 2024. The most aggressive interest rate hiking cycle of recent economic history has probably run its course. As growth starts to slow, bond market returns are set to improve.

That said, inflation is likely to prove stickier than is usual during an economic slowdown and that will prevent central banks from cutting interest rates until well into the New Year. Also acting as a headwind will be supply; governments are likely to have to maintain issuance at high levels. This year, structural factors (energy related transition finance, demographics / higher social care provision etc.) will converge with cyclical factors (weaker growth and lower tax receipts) to add to supply pressure.

Regional differences will remain. For example, the euro-area is more vulnerable to energy related shocks or stagflation risks than the United States and, Japanese government bonds will remain exposed to the effects of the Bank of Japan continuing to exit from its yield curve control policies. We see the strongest government bond market performance (in local currency terms) to be amongst the more cyclical economies; Australia and UK for instance. In these markets, starting yields are generally higher and the potential to see yields fall is more pronounced.

In the euro-area we expect that Bund yields will slowly trend lower over the coming 12 months but there are conflicting forces in play for intra-regional spreads. Support from the European Central Bank is set to weaken but reinvestments under the Pandemic Emergency Purchase Programme is continuing throughout 2024. The risk of very much wider spreads is contained. However, further into the future we still see ongoing pressure due to weaker growth and higher funding needs amongst peripheral euro-area nations.

Credit

Justin Hatch, Head of Credit, Cardano UK

Credit markets enter 2024 in good shape. Corporate credit quality is stable and the excess yield above government bonds appears to be attractive. However, as growth slows into the New Year, we do expect default rates to rise. Higher defaults will be challenging for High Yield and Emerging Markets Debt (performance of the two are quite closely related albeit Emerging Markets enjoyed a relative valuation advantage). Investment grade market valuations look adequate to compensate for the tougher environment ahead.

Primary issuance in the UK has been growing more slowly than has been seen in the US and in the euro-area assisting the Bank of England’s corporate bond buying programme to be successfully wound down. Demand from sterling investors remains robust and we expect this to continue into 2024. Nevertheless, despite high demand, we judge sterling and euro corporate bonds to represent better value than comparative securities issues in US dollars.