Capital Ideas^™ 
Investment insights from Capitals Express Investments

Under the weight of elevated inflation and high interest rates, the world’s major economies are diverging. Surprising resilience in the United States, Japan and India is helping to boost the global economic outlook for 2024, while ongoing signs of weakness in Europe and China are tempering expectations for the new year.

International Monetary Fund forecasts call for global growth to average 2.9% in 2024, down slightly from 3% in 2023.

U.S. economic strength may boost global growth

“The resilience of the U.S. economy, in particular, really has been remarkable when you consider how much consumer prices have gone up and how aggressively the U.S. Federal Reserve has raised interest rates,” says Capitals Express Investments U.S. economist Jared Franz.

“It’s a testament to the American consumer and labour market durability,” Franz adds. “It has certainly helped alleviate some of the worries about an impending recession. That could still happen, but I think the risk has declined substantially.”

The world’s two other largest economies, Europe and China, are expected to weigh on global growth as both struggle with an increasingly difficult environment for trade and rising geopolitical tensions.

Germany, the biggest economy in Europe, is already contracting due to a sharp slowdown in manufacturing activity and waning demand from China, its largest trading partner. Meanwhile, the full 20-member eurozone and the U.K. are flatlining and could have a more difficult time if energy prices continue to rise as drastically as they have over the past two years.

“The energy shock and higher interest rates are feeding through to weaker industrial activity,” says Robert Lind, Capitals Express Investments’s Europe economist. “That’s been made worse by a continuing slowdown in China’s economy. As a result, many European companies are sitting on large inventories.”

While Lind expects the European economy to pick up in 2024, he believes it could be a shallow recovery.

Interest rate outlook: Back to the “old normal”

While high interest rates are impacting economies in different ways, the chances of a sharp decline in rates are diminishing. That means a return to the era of near-zero rates is not likely to happen any time soon, says portfolio manager Pramod Atluri.

“I’m optimistic that consumers will continue to carry the economy, even as rates remain higher for an extended period,” Atluri explains. That’s partly because wages and home values remain above pre-pandemic levels, which has helped support consumer spending. A federal spending spree, especially on U.S. infrastructure projects, has also supported economic growth.

Looking to 2024, Atluri believes 10-year U.S. Treasury yields may remain at levels considered normal prior to the global financial crisis and hover in a range of 3.5% to 5.5%. Call it the “old normal.” Going all the way back to 1870 — or roughly 61% of the time — rates have stayed mostly in the range of 3.0% to 6.0%.

While the run-up in rates could weigh on financial markets, investors will likely adjust to that environment, Atluri adds. When 10-year rates were 4.0% to 6.0%, the average annual return since 1976 for the S&P 500 Index was 10.38%, while the Bloomberg U.S. Aggregate Bond Index returned 6.59%. (Data is from December 31, 1976 to October 31, 2023.)

Window of opportunity to move cash off the sidelines

Assuming most central banks are done — or nearly done — raising rates, that presents an opportunity for investors to get off the sidelines. The exodus from stock and bond markets into cash over the past few years was understandable, but those who remain uninvested may miss out on an opportunity to position their portfolios for long-term success.

Historically speaking, the time between the end of a rate-hiking cycle and the initial rate cut has signaled a crucial opportunity for investors to redeploy cash into stocks and bonds. In the past, that “window” has lasted an average of 10 months.

Following the last four Fed tightening cycles, stocks and bonds greatly outpaced U.S. 3-month Treasury-bill returns in the first year after the last Fed hike. Conversely, the 3-month Treasury yield, a benchmark Treasury security with a yield similar to cash-like investments, fell rapidly — declining by an average of 2.5% in the 18 months after the last Fed hike.

“I believe we’re on the cusp of a major transition where long-term investors can find attractive investment opportunities in stocks and bonds,” says Mike Gitlin, president and chief executive officer of Capitals Express Investments.

History has favoured patient investors in election years

2024 will be a pivotal election year, not only in the United States but in many other countries, including India, Russia, South Africa, Taiwan and the U.K. Globally speaking, it could be one of the most impactful election years in history.

The U.S. presidential election will take centre stage. And while it is still nearly a year away, investors may be feeling anxious about how markets will react to a potentially volatile campaign season and the possibility of a close vote, not unlike the 2020 election.

“Several key issues will certainly be top of mind for voters, including international policy, the impact of inflation and numerous key social issues," says Capitals Express Investments political economist Matt Miller. “But a lot can change between now and November. That’s a lifetime in politics.”

Although markets can be volatile in election years, for long-term investors the political party that wins the White House has had little impact on returns. Since 1936, the 10-year annualized return of U.S. stocks (as measured by the S&P 500 Index) made at the start of an election year was 11.2% when a Democrat won and 10.5% in years when a Republican prevailed.

Capitals Express Investments portfolio manager Rob Lovelace, who has invested through many election cycles in his 37-year career, says the added political uncertainty can provide attractive investment opportunities at times.

“When everyone is worried that a new government policy is going to hurt a sector, that concern is usually overblown,” says Lovelace. “High-quality companies often get caught in the political crosshairs, which can create a buying opportunity. But I aim for a long average holding period in my portfolios, so I typically try to look beyond the election cycle.”