Whether the U.S. economy will tip into recession and with the return of bonds as an attractive complement to stocks, investors have much to consider in 2024.
January 9, 2024
Managing Director, Head of Investment StrategyRBC Europe Limited
We think a U.S. recession is the most probable outcome in the coming
quarters. In the past, the combination of high interest rates and
restrictive bank lending standards—what is in place today—has been a
recipe for recession. Soft landings, on the other hand, have historically
featured rising interest rates but no overt tightening of lending
standards. The presence of similar conditions, i.e., high rates and
restrictive lending, is already taking a toll in Canada, the UK, and the
However, it could be that the big, decisive shifts in fiscal and monetary
policy over the past few years continue to have lingering effects on the
course of the U.S. economy, and that instead of a decline in GDP, growth
is merely on the slow side in 2024.
Regardless of the outcome, the economic headwinds which have been
gathering will likely run their course and probably fully dissipate later
in the year.
That could be enough to keep S&P 500 earnings growing, and we believe
any growth in earnings would leave room for share prices to advance
between now and the end of 2024, even if the path for getting there is
We recommend a Market Weight position in global equities, but we believe
investors should consider limiting individual stock selections to
high-quality businesses, i.e., those with resilient balance sheets,
sustainable dividends, and business models that are not intensely
sensitive to the economic cycle.
In our opinion, portfolios that have held their value to a
better-than-average degree will be best-equipped to take advantage of the
opportunities that are bound to present themselves when a stronger pace of
economic growth reasserts itself.
The stock market will need to adjust to the new competition from bonds for
investment dollars. For the first time in more than a decade, bond yields
have moved back up to levels that make fixed income a fully useable and
attractive adjunct to equities in a balanced portfolio. Bonds provide, as
they have traditionally done, a combination of reduced volatility, more
predictable returns, and the comfort of a maturity value.
If at some point a more defensive structuring for a balanced portfolio is
called for, having bonds as a reasonable alternative for an investor
looking to take some risk out is a welcome development.
Nimble positioning in equities; bonds could post strong returns
U.S. equities face an unusually high number of crosscurrents in 2024.
There is a wide range of potential economic outcomes possible, as
The market seems positioned for a rosy scenario. Industry analysts’ S&P 500 consensus earnings forecast of $244 per share in 2024 represents 11.1 percent year-over-year growth. This forecast, combined with the market’s 19.3x above-average price-to-earnings ratio, leaves little wiggle room for economic disappointments.
The U.S. presidential election will inevitably generate noise. Investors
should remember that since 1928, the S&P 500 rose 7.5 percent on
average during presidential election years and ended the year in positive
territory almost 75 percent of the time. We believe Fed policy and the
economic cycle play greater roles in shaping market returns than political
party control in Washington.
Overall, we think S&P 500 returns for the next 12–18 months will
largely depend on whether a U.S. recession materializes. But even if one
does and the stock market corrects, the market typically establishes a new
uptrend partway through the recession period.
The column chart shows average and median S&P 500 performance during
the four-year U.S. election cycle from 1928 through 2022. The
respective average and median returns are as follows: 7.5% average and
10.7% median return in the election year; 6.6% and 8.1% in year one of
the presidential term; 3.3% and 0.6% in year two of the presidential
term (this is also the midterm election year); 13.5% and 17.3% in year
three of the presidential term.
Source – RBC Wealth Management, Bloomberg; based on annual data
To start the year, we recommend maintaining U.S. equities at the Market
Weight level to take advantage of the distinct possibility of the S&P
500 reaching new all-time highs in the coming few months. This allocation
is also intended to balance the risk of a recession against the
possibility that one may be averted.
We anticipate market performance will broaden out beyond the “Magnificent
7” technology-oriented stocks that led by a wide margin for much of 2023.
Investors should consider limiting individual stock selections to
companies they would be content to own through a recession—those with
strong management teams, robust cash flow generation, and healthy balance
sheets. We would tilt portfolio holdings toward reasonably valued stocks
of high-quality companies. The valuations of small-capitalization stocks
in particular seem to already price in a recession.
As for fixed income, we expect a strong bounce-back year to play out over
the course of 2024. When bond yields are high, the income earned is often
enough to offset most price fluctuations. In fact, for the 10-year
Treasury to deliver a negative return in 2024, the yield would have to
rise to 5.3 percent. This is relatively unlikely, in our view, as we
expect the Fed to embark on a series of modest rate cuts beginning this
summer as the economy loses steam.
The bond market’s repricing of rate cut expectations will likely be most
dramatic at the short end of yield curves. Thus, investors should
proactively rotate out of cash and/or cash equivalent products and into
longer-dated securities, in order to lock in yields for longer—and before
they fade away, in our opinion.
Interest rate risks becoming more two-sided
Restrictive monetary policy continues to work its way through the Canadian
economy, weakening it. Meanwhile, inflation risks seem to be easing and
additional rate hikes from the Bank of Canada (BoC) are likely on hold, in
For equities, the trajectory of interest rates and the ultimate impact on
the consumer will have clear implications for the Canadian banks, in our
view. Bank valuations reflect the uncertain environment, and the group
trades close to trough levels.
We expect Energy sector stock performance to be largely influenced by
commodity prices and note the Canadian energy companies’ fortified balance
sheets and reasonable capital expenditure needs.
As for fixed income, historically, adding duration following the last BoC
rate hike has led to higher total returns relative to short-duration
strategies. We suggest extending maturities through laddering, exposing
portfolios to a higher degree of rate sensitivity while minimizing return
volatility, which should lead to a smoother path of returns.
Opportunities despite the subdued economy
Economic data is likely to slip further as the full impact of much higher
interest rates increasingly filters through the economy. We think the Bank
of England will likely keep the Bank Rate elevated for much of 2024 as
core inflation remains sticky and above five percent. We see a risk of
stagflation in the UK.
Despite these challenging prospects, we continue to recommend a Market
Weight position in UK equities. Their defensive qualities and attractive
valuations should be assets given the more volatile backdrop we are
expecting in 2024. The Energy sector currently enjoys a favourable
risk-reward profile, in our view.
For fixed income, we would add further to Gilts and increase duration.
Credit spreads could widen as credit fundamentals worsen. There are
pockets of opportunities in non-cyclical issuers and in senior-ranking
Remain cautious but on the lookout for the next economic upturn
Europe will also likely grapple with anemic economic growth in 2024. The pandemic
and the war in Ukraine have compounded the bloc’s long-standing structural
issues, such as a lack of competitiveness, which conspire to undermine the
effectiveness of the EU single market. European Commission task force
recommendations to remedy the situation are due in March 2024.
We continue to recommend an Underweight position in European equities as
weakening macro and earnings momentum remain headwinds for the region’s
ability to outperform. However, we are watchful for any green shoots and
signs that the euro area’s relative economic growth momentum may be
improving. This would be a key catalyst to increase allocations given
In fixed income, we would add to sovereign bond positions and duration as
the economic outlook looks set to deteriorate further, thus benefiting
longer-duration and sovereign positions.
Overweight Japan equities; prefer Asian investment-grade credit
We suggest an Overweight stance in Japanese equities, where the outlook
appears bright thanks to the launch of a revamped tax-exempt investment
scheme for residents, corporate pension reforms, onshoring trends, and
efforts at improving corporate governance. Relative economic and political
stability combines with low valuations to further enhance this market’s
Given that China’s economic recovery and investor sentiment remain
fragile, Chinese equities may continue to trade within a limited range. We
would focus on opportunities in industries where China has competitive
advantages or which can benefit from policy tailwinds, such as advanced
manufacturing and health care.
In Asian fixed income, we continue to prefer investment-grade credit for
2024. The lower U.S. Treasury yields that we expect into 2024 should
provide an overall tailwind for Asian credit. We prefer to keep duration
short for Asian investment-grade credit due to spread valuations. We like
the attractive coupon carry for this resilient segment, but also seek to
limit the potential performance impact should valuations reverse.
For more details on these views, as well as forecasts for commodities and
currencies, please have a look at our complete
Global Insight 2024 Outlook
or the individual articles:
Investing for a new reality
(feature article), as well as the regional focus commentaries on
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