Navigating macroeconomic fog
Key global economies—the U.S. economy in particular—have demonstrated surprising resilience to higher interest rates. But headwinds are likely to mount in 2024.

                                            

The COVID pandemic and the subsequent recovery continue to distort the economic data, forcing economists who rely on traditional recession signals to continually revise their assumptions. As a result, the most anticipated global recession in history has become the most delayed recession in history.

...the most anticipated global recession in history has become the most delayed recession in history.

To be sure, there are reasons for caution regarding the global economic outlook. Europe looks likely to endure stagnant growth in early 2024 before recovering in the second half. In Asia, China’s economic outlook remains gloomy, with few signs of improvement in the country’s property market. Commercial real estate sectors remain fragile in several other countries as well.

Meanwhile, the U.S., Japan, and Europe are at different stages in the balance between growth and inflation, meaning the Fed, the European Central Bank, and the Bank of Japan (BoJ) are likely to pursue increasingly asynchronous monetary policies in 2024, adding to the potential for increased market volatility.

Geopolitical uncertainty also could bring further volatility, particularly if conflicts in the Middle East and Ukraine cause a resurgence in energy prices. Recent election victories for far‑right populist candidates in Argentina and the Netherlands raise the question of whether further wins for populist parties could occur elsewhere, especially in the U.S., where the November 2024 election will be the most consequential currently known political event of the year.

As of late November 2023, most global economies were showing surprising resilience to higher rates (Figure 2), and the U.S. economy was performing better than expected. The unprecedented levels of cash generated by pandemic support and other fiscal stimulus measures have been a key support for U.S. household and corporate balance sheets. Excess consumer savings should continue to provide support for U.S. economic growth going forward (Figure 3).

Major global economies have shown surprising resilience

(Fig. 2) Real growth in Gross Domestic Product (GDP) at 2010 prices.

As of September 30, 2023.
Sources: U.S. Bureau of Economic Analysis, Statistical Office of the European Communities, Cabinet Office of Japan/Haver Analytics. T. Rowe Price calculations using data from FactSet Research Systems Inc. All rights reserved.

Consumer spending has been the most resilient driver of growth, due to the strength of the U.S. labor market. At the end of September 2023, there were 9.6 million open jobs available for the 6.4 million unemployed workers in the U.S. labor force.

Dealing with regime change

Even if the U.S. economy remains resilient in 2024, we believe investors will need to adapt themselves to a new market regime. To understand the implications of this shift, it is useful to examine the four historical regimes that U.S. markets have experienced since 1955, after the distortions created by World War II and the Korean War had largely dissipated.

While the post‑pandemic regime may not align perfectly with any of these prior periods, it will include some factors that prevailed during those regimes. Given the shift away from the structural forces that supported disinflation and lower rates in the wake of the 2008 global financial crisis (GFC), a return to the post‑GFC “new normal” strikes us as the least likely outcome going forward.

Heading into 2024, inflation risks are skewed to the upside. Energy prices are a concern amid supply‑side pressures. As of third quarter 2023, U.S. wages were still growing at almost a 4% annual rate. If U.S. consumer inflation changes course and reaccelerates while economic growth remains anemic, the risk of stagflation will rise considerably.

Which regime is most likely to prevail in 2024? Recent readings for the fed funds rate and inflation have been closest to the pre‑GFC “old normal.” But the regime second closest to recent conditions isn’t stagflation, it’s the postwar boom.

It remains to be seen how real (after‑inflation) interest rates above 2% will play out in the markets. But we do not believe that high rates will kill the U.S. economy. Rates are high relative to the post‑GFC period, but not relative to capital market history. The federal funds rate exceeded 5% for decades and stock markets still did well. Sticky inflation historically has been good for earnings.

Historical market regimes and their defining characteristic

 

Booming economyStagflationOld normalNew normal
1950s/1960s1970s1982 onwardPost 2008 GFC
- High GDP
- Low unemployment  
- Low inflation
- Low/unstable economic growth  
- Low stock returns
- Spiking inflation
- Secular decline in interest rates  - Slow economic growth  
- Low interest rates
- Low inflation

For illustrative purposes only.

 

Neutral on risk assets

Despite the macroeconomic uncertainties, we see no reason for investors to be excessively bearish. Market segments that don’t trade at nosebleed valuations, such as small‑ and mid‑cap stocks and real assets equities, look appealing on a relative basis. If we see a spike in volatility and a market sell‑off, it could be an opportunity to buy stocks.

...we see no reason for investors to be excessively bearish.

However, we also don’t think this is the right time to take large tactical (short-term) allocation bets. The recent “dis‑inversion” of the U.S. yield curve could augur volatility in both stocks and bonds in the months ahead. We think the best approach heading into 2024 is to have a broadly neutral view on risk assets, including equities.

With U.S. interest rates closer to their historical averages, a balanced portfolio could offer diversification benefits1 as bonds now provide higher income and ballast to stocks. However, interest rates are likely to remain volatile in 2024, which could favor cash or short‑term bonds. These assets currently offer attractive yields with minimal duration2 exposure and could be potential sources of liquidity if market opportunities arise.

Looking beyond the traditional 60/40 stock/bond portfolio, investors willing to take on more risk could consider alternatives with lower correlations to traditional assets and areas of the market that could benefit from market dislocations and higher yields, such as private credit.

 

Navigating macroeconomic fog
Investment IdeaRationaleExamples
Focus on areas with attractive income.The global economy has been resilient despite higher rates, but strong growth is unlikely in 2024. This should limit the upside in asset prices, so income from higher yields is likely to be an important driver of returns in 2024.- Short‑term fixed income
Consider tilting toward asset classes where valuations are undemanding.Small‑cap equities trade at historically low valuations, reflecting economic growth concerns and the potential impact of higher rates. Small‑caps could provide significant upside if the economy remains resilient.- U.S. small‑cap stocks
- International small‑cap stocks

For illustrative purposes only. This is not intended to be investment advice or a recommendation to take any particular investment action.

 


 

On the Horizon

Rethinking Fixed Income

We think the Fed will be slower to cut rates in 2024 than markets seem to expect. High yield and shorter‑term investment‑grade corporate bonds could offer opportunities.

1Diversification cannot assure a profit or protect against loss in a declining market.               

2Duration measures a bond price’s sensitivity to changes in interest rates. The longer a bond’s duration, the higher its sensitivity to changes in interest rates and vice versa.

T. Rowe Price cautions that economic estimates and forward-looking statements are subject to numerous assumptions, risks, and uncertainties, which change over time. Actual outcomes could differ materially from those anticipated in estimates and forward-looking statements, and future results could differ materially from any historical performance. The information presented herein is shown for illustrative, informational purposes only. Forecasts are based on subjective estimates about market environments that may never occur. Any historical data used as a basis for this analysis are based on information gathered by T. Rowe Price and from third-party sources and have not been independently verified. Forward-looking statements speak only as of the date they are made, and T. Rowe Price assumes no duty to and does not undertake to update forward-looking statements.

Investment Risks 

Fixed-income securities are subject to credit risk, liquidity risk, call risk, and interest-rate risk. As interest rates rise, bond prices generally fall. Investments in high-yield bonds involve greater risk of price volatility, illiquidity, and default than higher-rated debt securities. Because of the nature of private credit there may be heightened risks for investors, such as liquidity risk and credit risk to the underlying borrower and investments involve greater risk of price volatility, illiquidity, and default than higher-rated debt securities. International investments can be riskier than U.S. investments due to the adverse effects of currency exchange rates, differences in market structure and liquidity, as well as specific country, regional, and economic developments. These risks are generally greater for investments in emerging markets. Small-cap stocks have generally been more volatile in price than large-cap stocks. Mid-caps generally have been more volatile than stocks of large, well-established companies. Investing in technology stocks entails specific risks, including the potential for wide variations in performance and usually wide price swings, up and down. Technology companies can be affected by, among other things, intense competition, government regulation, earnings disappointments, dependency on patent protection and rapid obsolescence of products and services due to technological innovations or changing consumer preferences. Health sciences firms are often dependent on government funding and regulation and are vulnerable to product liability lawsuits and competition from low‑cost generic product. Commodities are subject to increased risks such as higher price volatility, geopolitical and other risks.  There is no assurance that any investment objective will be achieved. Alternative investments typically involve a high degree of risk, may be illiquid, may undertake more use of leverage and derivatives, and are not suitable for all investors. Diversification cannot assure a profit or protect against loss in a declining market.

Additional Disclosure

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Important Information

This material is provided for informational purposes only and is not intended to be investment advice or a recommendation to take any particular investment action.

The views contained herein are those of the authors as of December 2023 and are subject to change without notice; these views may differ from those of other T. Rowe Price associates.

This information is not intended to reflect a current or past recommendation concerning investments, investment strategies, or account types, advice of any kind, or a solicitation of an offer to buy or sell any securities or investment services. The opinions and commentary provided do not take into account the investment objectives or financial situation of any particular investor or class of investor. Please consider your own circumstances before making an investment decision.

Information contained herein is based upon sources we consider to be reliable; we do not, however, guarantee its accuracy.

Past performance is not a reliable indicator of future performance. All investments are subject to market risk, including the possible loss of principal. All charts and tables are shown for illustrative purposes only.

T. Rowe Price Investment Services, Inc., broker/dealer and T. Rowe Price Associates, Inc., investment adviser. 

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