This article first appeared in Forum, The Edge Malaysia Weekly on December 18, 2023 - December 24, 2023

How should you allocate your portfolio assets for 2024, a year of grave uncertainty?

The good ol’ 60/40 rule of 60% equity and 40% bonds and cash portfolio allocation is alive and well in 2023, although returns have been driven solely by equities. Fixed income, traditionally 40% of such portfolios, faced a third consecutive year of losses as interest rates rose. According to JPMorgan Asset Management, overall portfolio year-to-date gains in 2023 were nearly 7%, as bonds have underperformed. Equity gains were due mostly to a narrow band of tech stocks. Will next year be better?

Portfolio performance is closely related to two fundamental factors — the state of the economy and market interest rates. Since most of the global economy is still struggling, with only the US economy holding up reasonably, the key variable now is the trajectory of US interest rates, which may signal how portfolios will perform.

The US Federal Reserve interest rate policy has been the central culprit behind the recent multi-year fixed-income losses. When interest rates rise, bond prices fall.

After forcefully raising rates 11 times from 2022 to 2023, the Fed has opted to keep rates at the 5.25% to 5.50% level since July.

The market views this positively as a sign that inflation has peaked, clearing the way for future rate cuts.

The higher interest rates have not only affected growth prospects, but also asset prices, such as real estate and the price of bonds, which then in turn affect the quality of balance sheets, since those countries and companies with excess debt may keel over, causing financial instability.

The Fed’s November Beige Book that compiles data and anecdotes on economic conditions sampled across the US revealed that price increases had “largely moderated” but “remained elevated” with expectations of further but moderate inflation. The report found that prospects had diminished over the next six to 12 months as consumers showed greater price sensitivity, while manufacturers’ outlook also weakened. Loan appetite was softer, which dampened commercial and residential real estate activity.

Governor Christopher Waller, a Republican member of the Fed Open Markets Committee, recently signalled some indication that rates may have peaked, entering a phase when data numbers on inflation and jobs will shape key decisions on whether to cut interest rates.

Given these conditions, JPMorgan forecasts that rate cuts could begin in the middle of next year, with the effect of eventually seeing 10-year Treasury yields reaching 3.75% by year end (currently 4.2%). This implies a soft landing would be achieved, with the US economy gliding down to 0.7% growth in 2024. In this orderly scenario, bond prices would rise as yields fall from the highs.

JPMorgan suggests that US corporate investment-grade bonds may achieve total returns of 12.4%. US high-yield bonds may also benefit, but to a lesser degree due to higher credit risks.

Other analysts, such as HSBC Asset Management, offer a slightly different view, noting that credit spreads often widen at the end of almost every Fed tightening cycle since 1980, as high interest rates squeeze the borrower. Profits erode and overleveraged corporations are exposed. In short, credit risks will hurt corporate bond prices. Thus, 10-year yields may fall to 3% by end-2024, but HSBC recommends buying long-dated inflation-protected Treasury bonds (TIPS), which currently offer a higher return than the projected long-term real gross domestic product (GDP) growth of 1.85%.

What about other markets? If the US is heading for a soft landing, Europe is still struggling to deal with the effects of the Ukraine war and higher inflation. China is facing deflationary pressure from the soft real estate market and declining consumer/corporate confidence. With war in Gaza and a massive devaluation in Argentina, the rest of the world worries about how overall trade will perform.

Deutsche Bank forecasts that global GDP growth will slow to 2.4% in 2024, down from 3.2% this year. This projection assumes that India and China will need to grow by 6% and 4.7% respectively. Complications remain. According to United Nations Conference on Trade and Development (UNCTAD), global trade is expected to shrink 5% to US$30.7 trillion (RM143 trillion) this year, with diminishing prospects for next year. International Monetary Fund (IMF) first deputy managing director Gita Gopinath has warned that up to 7% of global GDP is at risk from economic fragmentation and the departure from open trade.

That is not all. The year 2024 will also be an election year for many countries with implications for global geopolitics. This cycle begins with the January presidential vote in Taiwan. But the most consequential one would be the November US presidential election. Current polls suggest that if he is not indicted first, Trump may win that election, signalling four more years of controversial policies. However, the consensus view is that US antagonistic policies on China will remain unchanged.

Fear and uncertainty naturally spur a flight to safe assets, traditionally towards the US dollar and Treasuries. Yet ongoing scrutiny of American creditworthiness stemming from the government’s propensity to favour politics over fiscal responsibility is pushing the other safe-haven asset — gold. The gold price touched US$2,100 per ounce, a historical high, partly due to prospect  of lower interest rates, but also because gold does not have counterparty risks.

Small wonder that countries have brought their gold back to their own central bank vaults.

All signs point towards investor cautiousness, irrespective of preferences for bonds, gold or cash. One thing is clear — the confluence of multiple unexpected events from geopolitics, climate disasters, war and tech disruption means higher market volatility. Mind the bumps.

Tan Sri Andrew Sheng writes on global issues that affect investors. Tan Yi Kai is a Malaysian multi-asset trader based in Hong Kong.

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