2Q:2024 Capital Markets Outlook Video

Following last year's strong close, first quarter returns for the capital markets were driven by hope and a measure of fear. Hope was manifested in equity returns, which were positive across the board, despite the fact that interest rates and inflation ticked a little bit higher. Bonds had more of a mixed picture, with credit markets holding up fairly well. But the U.S. government bond market in particular lagged in the face of higher interest rates. Whether it was inflation reports, continued strong labor markets, or confirmation that the economy was doing well, investors looked for the prospect of higher profit growth that often accompanies the stronger economy.

Conversely, the bond market did not fare as well, beginning first with the Fed urging caution about the timing and magnitude of rate cuts versus market participants' expectations. The Fed's position was confirmed by continued indications of a strong labor market and inflation that has remained above their target.

However, we've seen some components of inflation meaningfully moderate, in particular goods and food, and to a lesser extent, energy, but services inflation has remained stubbornly high. A prominent example is transportation costs, which includes key components such as automobile insurance and car repairs.

The other tricky constituent has been that of a tight labor market. While the unemployment rate remains low, we've seen job openings measurably decline. As the economy approaches normalization. We expect this trend to continue.

Another trend we would expect to persist as moderation and consumer spending. In fact, consumer savings level has fallen below the long-term trend for the first time in several years. Forecasting what lies ahead for the world's major economies, we expect normalization to continue, be it on inflation or economic growth, but investors should not expect the path of normalization to always be smooth.

Turning to equities, concentration has remained a headline for many popular indices, such as the S&P 500. But encouragingly, as we move from early February until the quarter's close, we saw other areas of the stock market, such as value in small caps, actually outperform the S&P 500.

Also, a reversal of fortune occurred for more speculative areas of the stock market, such as non-profitable technology companies and those that are most highly shorted, those being stocks investors are betting on to have a lower share price. While these stocks did quite well in 2023, they have lagged year to date.

But now, let's highlight some areas we believe offer favorable opportunities. We expect continued capital spending in the area of artificial intelligence to hold promise, but this isn't just confined to one semiconductor company. It also includes areas such as software and IT consulting, where the growth rates are expected to be quite strong.

Within the value universe, there's also opportunities for dramatic growth due to the continued trend of on-shoring. In fact, some of the annual spending as a percentage of global GDP in areas such as cybersecurity, supply chains, and energy security are expected to match those attained in cloud computing over the past decade. For more risk-averse investors, low-volatility stocks are certainly an option.

Areas we deem fertile ground from a valuation perspective here are defensive sectors such as utilities, healthcare, and consumer staples. But return opportunities are not exclusive to equities, considering the higher-yield environment that has enhanced the return potential for fixed-income investors. We continue to emphasize high-yield bonds, considering their attractive yields and their underlying fundamental strength as indicated by lower debt levels versus history and strong cash flow margins.

But one needs to be selective. That's particularly true with CCC or lower-rated bonds, which tend to have the highest incidence of default. We think there's better risk-adjusted opportunities among single-B and BB rated bonds. Beyond U.S. high-yield, other sectors that we favor are a global high-yield, emerging-market, U.S. dollar-denominated corporate bonds, and select mortgage-backed securities.

So, at this intersection of hope and fear, opportunities do remain. And as we approach normalization, one doesn't want to wait for that clarion bell to ring. You want to take advantage of those areas of the stock market where valuations are compelling and the prospects appear attractive. That's also true in the fixed-income markets, where you're getting paid handsomely now before central banks start cutting rates in earnest.

Thanks so much and we'll see you next quarter.

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