RBC Favours Quality Bonds; US, UK, Japanese Equities In 2024

Amanda Cheesley Deputy Editor 22 January 2024

RBC Favours Quality Bonds; US, UK, Japanese Equities In 2024

Frédérique Carrier, head of investment strategy in the British Isles and Asia at RBC Wealth Management, examines the challenges and opportunities facing markets and asset classes in 2024 in the US, UK, Europe, Asia and Canada. She also shares RBC Wealth Management’s recommendations given the new market reality.

Whether the US economy will finally tip into recession and with the return of bonds as an attractive complement to stocks in a portfolio, investors have much to look at this year, according to Frédérique Carrier, head of investment strategy in the British Isles and Asia at RBC Wealth Management.

Carrier thinks that a US recession is the most probable outcome in the coming quarters. In the past, the combination of high interest rates and restrictive bank lending standards – which is 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, such as high rates and restrictive lending, is already taking a toll in Canada, the UK, and the eurozone,” Carrier said.

“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 US economy, and that instead of a decline in GDP, growth is merely on the slow side in 2024,” Carrier added. “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. She believes that 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 uncertain.

Carrier recommends a market weight position in global equities, but believes that investors should consider limiting individual stock selections to high-quality businesses, namely those with resilient balance sheets, sustainable dividends, and business models that are not intensely sensitive to the economic cycle.

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,” Carrier said. “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.” 

US equities face an unusually high number of crosscurrents in 2024, according to Carrier. There is a wide range of potential economic outcomes possible. 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 per cent 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 US presidential election will inevitably generate noise. Investors should remember that since 1928, the S&P 500 rose 7.5 per cent on average during presidential election years and ended the year in positive territory almost 75 per cent of the time. Carrier believes that Fed policy and the economic cycle play greater roles in shaping market returns than political party control in Washington.

Overall, she thinks S&P 500 returns for the next 12 to 18 months will largely depend on whether a US recession materialises. But even if one does and the stock market corrects, the market typically will establish a new uptrend parthway through the recession period.

To start the year, Carrier recommends maintaining US 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.

Carrier believes that investors should consider limiting individual stock selections to companies which they would be content to own through a recession – those with strong management teams, robust cash flow generation, and healthy balance sheets. She would tilt portfolio holdings towards reasonably valued stocks of high-quality companies, adding that the valuations of small-capitalisation stocks, in particular, seem to already price in a recession.

As for fixed income, Carrier expects 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 per cent. This is relatively unlikely, as she expects 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. Investors should therefore 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 Carrier's opinion.

Interest rate risks are becoming more two-sided, Carrier continued. 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.

For equities, the trajectory of interest rates and the ultimate impact on the consumer will have clear implications for the Canadian banks, in her view. Bank valuations reflect the uncertain environment, and the group trades close to trough levels.

Carrier expects energy sector stock performance to be largely influenced by commodity prices. As for fixed income, historically, adding duration following the last BoC rate hike has led to higher total returns relative to short-duration strategies. She suggests extending maturities through laddering, exposing portfolios to a higher degree of rate sensitivity while minimising return volatility, which should lead to a smoother path of returns.

Carrier believes that there are 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.The Bank of England is likely to keep the bank rate elevated for much of 2024 as core inflation remains sticky and above 5 per cent. She sees a risk of stagflation in the UK.

Despite these challenging prospects, Carrier recommends a market weight position in UK equities. Their defensive qualities and attractive valuations should be assets given the more volatile backdrop she is expecting in 2024. The energy sector currently enjoys a favourable risk-reward profile.

For fixed income, Carrier 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 bank bonds.

Carrier remains cautious but on the lookout for the next economic upturn. Europe will also likely grapple with anaemic economic growth in 2024, she said. The pandemic and the war in Ukraine have compounded the bloc’s longstanding structural problems, such as a lack of competitiveness, which conspire to undermine the effectiveness of the EU single market. However, the European Commission task force recommendations to remedy the situation are due in March 2024.

Carrier recommends an underweight position in European equities as weakening macro and earnings momentum remain headwinds for the region’s ability to outperform. However, she is watchful for any signs that the eurozone’s relative economic growth momentum may be improving. This would be a key catalyst to increase allocations given inexpensive valuations.

In fixed income, Carrier would add to sovereign bond positions and duration as the economic outlook looks set to deteriorate further, benefiting longer-duration and sovereign positions.

Asia Pacific
RBC is overweight in Japanese equities, preferring Asian investment-grade credit. Carrier suggests 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 combine with low valuations to enhance this market’s attractiveness.

Given that China’s economic recovery and investor sentiment remain fragile, Chinese equities may continue to trade within a limited range. Carrier would focus on opportunities in industries where China has competitive advantages or which can benefit from policy tailwinds, such as advanced manufacturing and healthcare.

In Asian fixed income, Carrier prefers investment-grade credit for 2024. The lower US Treasury yields that she expects to continue into 2024 should provide an overall tailwind for Asian credit. She prefers to keep duration short for Asian investment-grade credit due to spread valuations. Carrier likes the attractive coupon carry for this resilient segment, but also seeks to limit the potential performance impact should valuations reverse.

Other wealth managers also favour quality bonds in 2024, as well as US, UK and Japanese equities. See more here.

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