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Rethink Perspectives: 2024 – a year of economic normalisation, despite the geopolitical uncertainties
The last three years have been dominated by the pandemic, the shutdown in China, the conflicts in the Middle East and Eastern Europe, and inflation and interest rate shocks. Despite all that, economic conditions have undergone some normalisation in recent months. In this light, what are the macroeconomic prospects for the rest of the year? What impact might geopolitics have on the global economy? When will central banks start lowering interest rates?
At the same time, all have noticed the US economy’s resilience, while the rivalry between the US and China is creating a bloc mentality. What lies behind this outperformance by the US economy, and can it last? Finally, how can these views be translated into portfolio positionings, and what investment opportunities are out there?
Samy Chaar, Chief Economist at Lombard Odier and Head of our Macroeconomic Research Team, addressed these questions at our recent “Rethink Perspectives” conference in Paris, sharing his analysis.
Global trade and real estate rally
Global trade and the real estate market illustrate the return to normality that is taking place. After they had been greatly affected by the rise in interest rates, “what we have been seeing for some months, and particularly at the present moment, is a degree of stabilisation in these two sectors,” says Lombard Odier’s Chief Economist, Samy Chaar. He adds: “This is very good news, because it signals that the situation in these sectors – which had taken a hit from interest rates – has stopped deteriorating and is actually improving a little.”
Read also: Outlook 2024: Rate cuts at last
To a large extent, economic performance is being buoyed by one region: the US, which is outperforming Europe in particular. What are the reasons behind this growth gap? There are three explanations that we can explore. “Energy is the first major factor,” explains Chaar, adding that “the energy shock has been greater in Europe than in the US, which produces and exports energy products and as such has benefited from the shock.”
This outperformance by the US economy can also be linked to “a degree of fiscal velocity at present in the US, with massive investments in real estate.” This correlates with the behaviour of US consumers, who are good consumers. Rather than saving like Europeans, Americans “are spending like there's no tomorrow.” Meanwhile, the household savings rate in the US is three times weaker than on this side of the Atlantic, at around 4% of disposable income against an average of nearly 15% in Europe.1 European consumers have taken their foot off the pedal since 2020 but – despite geopolitical tensions – could start spending more again in 2024, spurred by the cyclical upturn in real incomes as inflation falls and the prospect of eurozone monetary policy easing approaches.
Read also: Taking stock of the eurozone’s challenges
Sustained growth and labour market rebalancing
While the labour markets are normalising without any major damage or shocks, unemployment rates should remain relatively low. The trend towards disinflation should gather pace in 2024, to return to something close to trend inflation levels in the US and eurozone.
In this scenario – and providing that there are no fresh shocks in the coming months – we are likely to see some relaxation of monetary policy by central banks, with interest rate cuts becoming more likely.
Sustained growth, labour market rebalancing and inflation rates back around typical levels should also support economic normalisation. “This ought to allow activity to recover a little, particularly in the real estate, retail and manufacturing sectors, while also giving a boost to European household consumption,” explains Chaar. Despite that, the geopolitical environment remains very tense, with no end in sight for the Russia-Ukraine war, no prospects of de-escalation in the Middle East and a pivotal year for presidential elections ahead. With all this going on, could the continuation or even escalation of existing conflicts alter macroeconomic forecasts for 2024?
Economic resilience in the face of geopolitical storms
There are various elements to keep track of in order to measure the impact of geopolitics on the economy, which, as Chaar explains, “include supply chains and delivery times in particular. That is what we saw when China pulled down the shutters because of Covid. Nothing worked any more, they were not producing anything, they were not transporting anything, and delivery times deteriorated.” Energy products and oil are another very important channel through which geopolitical difficulties can spread to the economy.
Read also: How should investors navigate geopolitical risks in early 2024?
But although the price of Brent crude has stabilised at around USD 80/barrel since the start of the year, global supply chains no longer appear to be disrupted by geopolitical tensions. So how is it that today’s international conflicts are having only a weak impact on the real economy and markets?
US and China face off: rival blocs are back
Samy Chaar puts forward the idea that “we are in the process of returning to a world of rival blocs, much like during the Cold War.” He draws a parallel between “the strategic competition between the USSR and US at that time, and Sino-US relations today. Which is also a form of strategic competition.” China and the US are pulling apart and disengaging from each other to reinforce their economic resilience.
“The Americans are doing all they can to de-risk in relation to the Chinese bloc, and China is trying, with a little more difficulty, to de-risk in relation to the US bloc,” describes Chaar. The US has put in place various strategies aimed at achieving this. One of these, known as “friendshoring”, involves favouring trade with politically like-minded partners, such Mexico (which became the country’s biggest trading partner in 2023, overtaking China for the first time in 20 years)2, Canada and Europe.
Read also: China’s reflation still runs second to national strategy
The upshot is that US imports of goods from China are tumbling, down 21% year on year between January and November 2023.3 “The US is seeking to enhance its economic resilience and to find often lower-cost alternatives to China,” explains Chaar, although he stresses that “interaction between the US and China will continue.” India4, Mexico, South-East Asia, North Asia, Poland and North Africa feature high up the list of more reliable alternative trading partners for the US.
The fragmentation of trade at China’s expense is also reflected in various large-scale legislative packages put in place by the Biden administration, which pave the way for massive investment on US soil. They include the CHIPS Act (aimed at strengthening US sovereignty in the semiconductor industry), the Inflation Reduction Act (IRA, providing tax credits and subsidies for green energy production in the US) and the Infrastructure and Jobs Act (which seeks to modernise the country’s public transport systems and infrastructure). The IRA alone represents more than USD 3 trillion in public and private investment over a ten-year period.5
These three pieces of US legislation are aimed at preserving the country’s technological lead over China in the years to come, supporting growth and contributing to the transition towards cleaner industry. Chaar believes that the upshot of all this will be much more favourable for the US economy: “China is linked to the US because that’s where it sells its products; the US is linked to China because that’s where its products are made. While it's possible to have your products made elsewhere, it’s much harder to replace the US consumer.”
Read also: US shoppers are still at the wheel of the world economy
The bloc mindset is likely to consolidate further in 2024, with the US-led bloc followed by Europe on one side and the Chinese bloc on the other “set to disengage from one another while seeking to shield themselves against local geopolitical conflicts, as they have successfully done until now,” describes Chaar. There is one further parameter to be taken into consideration: the influence of domestic policy over the global economy. More than 60 countries around the world will be holding elections or referendums in 2024, with nearly half the global population eligible to vote. The election of the next president of the United States will be more closely watched than any other. If recent polls putting Donald Trump in pole position to return to the White House6 are borne out at the ballot box, various measures expected of the Republican candidate could impact the global economy, such as the cancellation of the IRA, a return to the “America first” policy and the application of restrictive migration policies, and “run the risk of the US labour market overheating in 2025–26,” declares Chaar.
Given these circumstances, what global portfolio positioning should be adopted in 2024? If geopolitical risks persist, does it make sense to favour equities? Or would it be wiser to increase exposure to cash and fixed income?
What are the implications for portfolio positioning?
As Samy Chaar warns, “We need to keep a very close eye on the political and geopolitical realities. Above all, however, we should pay particular attention to interest rate trends.” He explains that “an environment where central banks will cut rates is more favourable to equities. When we look at previous economic cycles, we see that in the absence of a recession – and there are currently no signs of a major slowdown, though we will remain agile and vigilant – falls in interest rates can propel equities higher.” Nevertheless, he adds, “This conviction needs to be taken with a pinch of salt. Up until 2021, there were no alternatives to equities. Today they do have some competition, as fixed-income securities can offer returns. A more balanced approach to portfolios is called for.”
Read also: 2024, a pivotal year for investors
Average returns of 7–8% for equities over a ten-year horizon
“Our analysis of expected returns over ten years indicates that equities should be capable of generating an average annual return of 7–8%,” says Chaar. He goes on to temper this upbeat outlook: “Equities should generate 7–8% returns on average over the ten years from 2024 to 2034, including good years and bad,” whereby the probability of realising 8% in one year stands at 80%7. That is, for every one year in five, this return is unlikely to be achieved – a risk factor that must be given due heed.
Dollar-denominated bonds, meanwhile, “offer the same promise of an 8% return, if you opt for the upper end of the high-yield segment (single B or double B),” explains Chaar. He points out one key difference compared with equities: “The likelihood of achieving this objective increases to 90%, i.e. one year in ten would be bad. So when constructing a portfolio, the equity allocation must be balanced against a fixed-income component offering a projected return that it did not have two to three years ago.”
Read also: Ten investment convictions for 2024
Chaar goes on to explain: “This means that the efficient frontier is much flatter than it was pre-2021, when there was no other choice but to take risks. Now, when we allocate assets, we are operating within an environment that is much more conducive to building balanced portfolios.” As such, it is possible to counter equity risk with a more robust fixed-income proposition.
“We therefore recommend remaining at the strategic level, so for example 45% in equities for a balanced portfolio, less for a conservative portfolio and a little more for a higher-risk portfolio,” specifies Chaar. On the question of whether bonds are an essential element of a portfolio, he gives an unequivocal response: “Yes. Prior to 2020 and 2021, we had fixed-income allocations in our accounts of around 25% to 30%. Today, that figure is 40%. A paradigm shift has taken place. Structurally, you need more high-yielding products, and in particular corporate bonds.” And how should a balanced portfolio be positioned with regard to risk? “Exposure should be neither too conservative nor too risky, with a little cash and some alternative investments for eligible investors.”
1 https://www.euronews.com/business/2023/11/27/how-much-are-europeans-left-with-at-the-end-of-the-month
2 US imports from Mexico surpass China (qz.com)
3 US imports from Mexico surpass China (qz.com)
4 L'Inde et les Etats-Unis scellent leur rapprochement commercial et stratégique | Les Echos (India and the US seal their commercial and strategic convergence; available in French only)
5 Etats-Unis: le coût des mesures écologiques de Joe Biden s’envole – l'Opinion (lopinion.fr) (US: the cost of Joe Biden's environmental measures soars; available in French only)
6 Graph: Présidentielle 2024: Biden au coude-à-coude avec Trump dans les sondages | Statista (2024 presidential elections: Biden neck and neck with Trump in the polls; available in French only)
7 Bloomberg
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