As we stride into 2024, the investment world is buzzing with potential in both stocks and bonds. But amidst the excitement lie the inevitable risks. Fear not, dear reader! We’re here to be your guiding light, empowering you to make savvy decisions that sync perfectly with your financial dreams. From the thrilling highs of equities to the steady stability of bonds, and even the mysterious allure of international currency markets, we’re diving deep into every sector to uncover the hidden gems waiting to supercharge your portfolio.
Equities
As we enter 2024, equities present a tantalizing opportunity for investors. Despite facing a wall of worry, stocks are reasonably valued overall. The key is targeted exposure – focusing on specific size, style, sector, and country exposures can yield better results than broad market-weight exposure.
U.S. equities continue to play a significant role for investors. However, the concentrated rise in the so-called “Magnificent Seven″ has created opportunities to add selected value, especially in smaller, value-oriented companies. In other developed markets, we see attractive valuations with higher-than-usual return prospects, particularly in pockets of Europe.
The Risk-Reward Balance
Investing always involves a delicate balance between risk and reward. One longer-term risk in the equity market is the lack of earnings growth. This is a challenge because investors have been driving prices higher relative to earnings—a dynamic known as multiple expansion.
While stocks have not tumbled off a cliff, investors continue to feel nervy, with consumer sentiment scores still well below normal levels. At a deeper level, valuation spreads—the disparity in valuation levels between sectors—is where we see opportunity.
Bonds
For bonds, we see broad appeal across different maturity profiles. Government bonds are our preferred exposure. Corporate bonds are priced for a slowdown, but not a recession, so they could carry heightened risk.
The bond market has not provided the defensive features over the past two years that investors grew to love it for in the four decades before July 2021. However, the material increase in bond yields has improved their attractiveness versus other assets and for portfolio risk management more generally.
Undervalued Assets
Looking for undervalued assets that can help with portfolio robustness, we see defensive sectors—including healthcare and utilities—as areas of interest. They are not necessarily the cheapest sectors but can play a strong role in portfolio risk management.
Among the more economically sensitive sectors, our preference remains for communication services, despite strong returns for the year to date, as it still represents solid value and reasonable risk/reward, in our view.
The Promise of Small-Value Stocks
The biggest valuation opportunity exists in the bottom left corner—small-value stocks. However, careful asset selection is needed, and we think it’s important to focus on quality.
While small-cap stocks seem substantially cheaper than their large-cap counterparts, they generally display greater sensitivity to the broad economic environment, given the preponderance of money-losing and highly leveraged companies in the small-cap indexes.
The Opportunity Outside the U.S.
While U.S. equity returns have been dominant over recent years, we think there is a significant opportunity for investors looking outside the U.S. Our work suggests that the U.K., with a significant amount of the index consisting of a well-diversified group of global companies, represents good value.
Plus, cyclical industries such as European energy companies, which are displaying significantly improved capital allocation amid robust energy markets, look comparatively cheap. The broad opportunity in emerging markets has grown more significant during 2023, as those stocks have lagged their developed-markets peers.
AI-focused Stocks
AI-focused stocks have topped the leaderboard in 2023, with significant valuation risks embedded, in our analysis. However, second-derivative plays, including those that can improve margins by using AI capabilities in their products, offer much better valuations with earnings upside.
This could offer a way to access the emerging AI theme, with generative AI allowing companies to generate marketing content, write code, and improve efficiency, among other things. No doubt this will create winners that can harness the benefits of AI with the ability to massively scale businesses and losers that cannot.
Government Bonds
Government bonds in the developed world currently look as attractive to us as we’ve seen in at least a decade. This view holds across all durations. For this reason, our analysis leads us to favor government bonds—particularly U.S. Treasuries—on a risk-adjusted basis.
Withstanding another serious inflation run, the skew of upside to downside looks favorable to us. Of note, we do see appeal in short-term corporate bonds, where we can achieve positive real yields.
The Role of Currency Management
The U.S. dollar looks expensive, although it still acts as a flight to safety in turbulence, so prudent international currency positioning (and possibly hedging) is an attractive dimension of portfolio management.
While currencies are notoriously volatile, we tend to think of currency positioning via the lens of portfolio robustness (focusing on those currencies with defensive characteristics where sensible), but also as a potential source of upside at extremes.
Investing with Confidence
As we look ahead to 2024, the investment landscape is teeming with opportunities. By balancing these convictions into a broader diversified portfolio, we foresee a positive outlook for 2024 and beyond. Remember, the key to successful investing lies in making informed decisions, staying patient, and keeping your financial goals in sight.