The ubiquity of uncertainty and long-term investment opportunities

Sluggish economic growth, a volatile geopolitical backdrop, and apprehension over the eventual outcome of the looming US Presidential election, have collectively conspired to give investors much pause for thought.

The World Bank recently added to the anxiety when it forecast that the global economy is on track to deliver its weakest half-decade performance in 30 years, with trade growth predicted to be half the average in the decade prior to the pandemic.¹

Despite the myriad of issues the world presently faces, we believe there is plenty investors can take solace from. Interest rates look like they have peaked, bond markets are in better shape, and equities continue to roar ahead. Even the World Bank has acknowledged the global economy – despite its challenges – is in a better place than it was a year ago as the risk of recession has at least receded. Many indicators suggest that 2023 saw the trough in the global cycle. Investors are looking forward, and there are some encouraging signs.

While past performance is not a guide to future returns, it’s still worth noting what we’ve witnessed in the first quarter (Q1) of 2024 where a multitude of equity indices have powered ahead. The S&P 500, Nasdaq, Dow Jones, Japan’s Nikkei, and Europe Stoxx 600 have all hit fresh highs.²

Within the fixed income space, bond yields have risen and as such there continues to be income opportunities in credit, and there is even the potential for bonds to rally when central banks do cut interest rates or if the equity bull market stalls. In addition, high yield continues to enjoy the structural appeal of delivering equity-like total returns but with much less volatility.

Joy driver

While we expect softer global growth in 2024 – before picking up in 2025 – vitally, the global economic engine is still moving ahead. The Organisation for Economic Co-operation and Development (OECD) has hiked its 2024 global growth forecast to 2.9%, up from the 2.7% it forecast in November.³

For now, we also predict growth of 2.9% in 2024, rising to 3.1% in 2025. Certainly, there are issues; in the final three months of 2023, the UK slipped into technical recession, while the Eurozone and Japan just avoided it.

In contrast, across Asia, many nations have posted solid GDP numbers, while China, which has its own issues to contend with, still achieved its 2023 target of “around 5.0%” growth. Meanwhile India continues to be a key GDP driver – in 2023 it contributed 16% of the global growth.⁴

Central to growth, of course, has been the US which has continued its exceptional run, achieving Q4 economic growth of 3.2% – revised down from an initial estimate of 3.3% – compared to Q3’s 4.9%  – but still well ahead of the 2% analysts had predicted.

Grounding the macroeconomic optimism – at least where it has manifested itself – is the prospect of lower interest rates, on the back of broadly easing inflationary pressure, which continues to fall in most economies.

We expect a stickier period to emerge in several economies over the coming quarters, with some upside risks emanating from the continuing conflict in the Middle East, but overall, we anticipate that developed central banks will start easing policy from around mid-year. Emerging market central banks have largely started easing but as inflation falls back in line with central bank targets over 2024, this should allow further easing to continue.

Tech boom

While the prospect of looser monetary policy is undoubtedly bolstering equity markets returns, it is the technology sector which has dominated recent market performance  – chiefly because of the wave of optimism over the long-term potential of generative artificial intelligence (AI).

One analysis believes generative AI could add trillions in value to the worldwide economy as it automates activities that presently take up much of workers’ time.⁵  Higher productivity should mean better economic growth and living standards, which in turn should boost returns across a wide range of industries.

Unlike the tech boom and bust endured at the turn of the century, in our view the present bull market reflects the industry’s superior growth rate alongside profits and revenues, characteristics which were largely absent during the previous boom. The sector will naturally endure wobbles and markets are unlikely to hold their current pace, but we expect this secular trend to continue to be a powerful influence on markets and investors. Returns from US technology stocks have consistently outpaced those from the broader market and from more cyclical equity sectors. We expect that to continue as a secular trend.

ESG is here to stay

Sustainability has fallen out of focus over the past year, in part because of 2023’s difficult market backdrop but undoubtedly regulatory fatigue has also set in. But ultimately environmental, social, and governance (ESG) considerations are part of a secular trend. Just look at the how the green bond sector has expanded in recent times – its value has risen by 500% in the last five years alone.

New technologies advancing decarbonization and reducing biodiversity loss are being developed all the time – giving equity investors new business models to gain exposure to. Just like AI, going green is here to stay  – it is, and will continue to be, one of the key investment themes of the age.

And it needs to be as global temperatures are still rising, climatic events are becoming more serious and natural habitats are deteriorating. The need to support and finance the transition to a more sustainable future is greater than ever and the investment opportunities are multiplying. The cost of renewable energy is falling – between 2010 and 2021, the global average cost of electricity generation for a renewable generator over its lifetime (including building and operating costs) fell by 88% for solar panels, and 68% and 60% for onshore and offshore wind respectively.⁶  One report forecasts that the cost of solar power will be cut in half and the cost of wind energy by a quarter by the end of this decade.⁷  Moreover, technology is addressing the challenge of reducing emissions in sectors such as steel making, chemicals, and agriculture.

ESG no longer operates at the fringes, it is the mainstream. The world needs to adapt. Last year global clean energy spending surged 17% to a record $1.8trn according to BloombergNEF, including renewable energy installations, electric vehicles (EVs) and hydrogen production systems.⁸  But more than twice this amount is needed to reach net-zero targets by 2050 – this backdrop could provide  investment opportunities.

The institutional perspective

For institutional investors, those focused on managing assets against pension or insurance liabilities, what happens with interest rates and credit spreads is key. As central banks begin to reduce policy rates, yields curves should steepen, which means that the scope for longer-term rates to move down is limited. Indeed, the inflation shock of 2021-2023 and concerns about shifts in the global savings-investment balance will likely mean a higher risk premium in long-term bond yields. This is positive for cashflows in a bond portfolio, and at the same time we do not expect big duration moves in bond markets.

Opportunities for allocating long-term capital to meet sustainability targets should continue to grow. Low or net-zero carbon strategies are widespread in the fixed income world now, and as the capital spending requirements to meet net-zero ambitions continue to run high, green bond issuance could expand further. Credit markets are very healthy and this should facilitate ongoing issuance of bonds linked to environmental and other sustainable development goals.

All data sourced from FactSet, AXA Investment Managers, March 2024.