2024: a diversified and agile allocation
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Each month, LBP AM deciphers market news in video. To kick off 2024, LBP AM strategist Xavier Chapard shares his views on asset allocation at the start of the year in our "Market Insights" feature.
The macro backdrop should gradually improve in 2024. Global growth is slowing down at the beginning of the year, but it is expected to start picking up again from the middle of the year. Inflation is slowing down towards more reasonable levels, which should allow central banks to stop tightening and most likely begin lowering their interest rates during this year.
That being said, after a strong performance in late 2023, markets are positioned for a near-perfect scenario. Contrary to us, the consensus no longer anticipates a slowdown in the US at the beginning of the year, and sees inflation returning to the 2% target before the end of the year. This seems optimistic for the US given that domestic pressures remain significant. And after the Fed's surprisingly dovish pivot in December, markets are pricing in substantial interest rate cuts. With a relatively positive outlook but with very limited margins for error, how should one approach markets?
Asset allocation
The key principle of our asset allocation strategy for the start of the year is diversification among asset classes. We are relatively constructive on risky assets for this year, but we do believe the market is a bit too optimistic in the short term, even though investor positioning is not excessive at present. Geopolitical uncertainties also remain high, and the electoral calendar is busy. The potential for both positive and negative surprises being significant, high volatility ought to continue.
Fixed Income
Interest rates on government bonds significantly declined at the end of 2023. They remain relatively high but have already returned to their levels from a year ago. This decrease in rates is expected to continue as inflation normalizes, and the shift from a cycle of interest rate hikes to a cycle of rate cuts progresses. That being said, the markets are already anticipating a lot of interest rate cuts. However, we believe that central banks will remain cautious at least until the spring. Furthermore, the market will still have to absorb a significant amount of debt issuance this year, given the substantial public deficits and the continued reduction of central bank balance sheets. All in all, we expect interest rates to remain volatile and without a clear direction in the short term. We are neutral on sovereign debt, favoring shorter maturites and diversifying our exposure across different countries in the Eurozone.
Credit
We maintain exposure to European corporate bonds to capture still attractive yields, especially as the end of monetary tightening limits the risks. This is particularly the case for financial companies. However, regarding the riskiest issuers, we remain highly selective given defaults are expected to continue increasing somewhat. Especially considering that credit spreads have returned to relatively low levels.
Equity
For equities, our positioning at the beginning of the year is at a neutral positionings, with a preference for European and emerging market stocks over U.S. stocks. On one hand, stock valuations are reasonable in a context where interest rates are expected to decline, and the risks of an economic recession are limited. This is especially the case in Europe, where stocks are trading at 12 times earnings, which is 10% below the historical average. On the other hand, earnings expectations seem a bit too high, especially in the United States, where the markets anticipate over 10% earnings growth this year. However, there is a significant risk of margin compression in a context of reduced pricing power while wage and financial costs remain dynamic.
Overall, the relatively positive scenario for markets suggests a less defensive allocation. But the fact that the market is already optimistic and the risk of geopolitical shocks persists leads us to prioritize diversification and agility in our market positioning.