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Multi-Asset Strategies Outlook

Q1 2024

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Multi-colored piles of spices.

Diversification Strikes Back

Macroeconomic, geopolitical and financial market uncertainty is high heading into 2024. Although the forecast is cloudy, there are some things we believe we can say with confidence.

First, bond yields are higher than they’ve been in more than a decade. As a result, the fixed-income market looks well-positioned after a few challenging years. Second, the math behind diversification still holds. We think mixing stocks, bonds and other asset classes is the most prudent way to address market uncertainty.

Markets and the global economy will face five critical issues in 2024:

1. Is Recession Still in the Cards?

We said a recession was likely throughout 2023. We were wrong then, so what’s different now? We expect the federal government to spend less, banks to lend less, tight monetary policy to bite at last, global growth to slow, and U.S. consumers to retrench, having depleted their pandemic-era savings.

Regardless of the economic outcome, we think these conditions create a solid backdrop for high-quality bonds. Our outlook for stocks is less upbeat. We believe a weak economy and higher rates will limit corporate earnings growth. The stock market’s November 2023 rally partially reflected the notion that corporate earnings are set to rebound in 2024. We’re not so sure because, in the modern era, earnings recessions have almost always followed Federal Reserve (Fed) tightening cycles.

2. Rate Cuts Are Unlikely Without a Recession

The second leg of the recent rally is the notion that the Fed will soon switch to aggressively cutting interest rates. To be sure, the Fed’s own dot plot forecast suggests two or three rate cuts in 2024. But financial markets are forecasting four or even five moves before year-end.

Everything the Fed has said about keeping rates higher for longer argues against the idea that it will quickly pivot to aggressive cuts. To us, that’s the most significant disconnect in financial markets today.

3. Geopolitics Will Be a Major Cause of Uncertainty in 2024

There’s a war in Europe, another in the Middle East and fear of a third in Asia. The U.S. faces a consequential election year and threats of political violence; the House of Representatives appears to be persistently on the edge of chaos, and we keep barely avoiding government shutdowns, one temporary spending bill at a time.

We don’t try to forecast political outcomes, and we certainly don’t try to invest based on the likelihood of this or that geopolitical occurrence. But we think it’s important to understand the policy backdrop in which economic and market outcomes play out. That’s particularly true in 2024, when politics are likely to be a recurring source of market volatility.

4. Federal Debt and Deficit Will Remain Challenging

The U.S. budget deficit and national debt are high relative to history and the rest of the world. High debt levels are important in 2024 for several reasons, including:

  • The debt burden could constrain the federal government’s ability to borrow and spend to counterbalance a potential economic downturn.

  • Credit rating agency Fitch caused a bond market sell-off in 2023, putting U.S. Treasury debt on negative credit watch for a potential downgrade. Fitch specifically cited “increased political partisanship and a growing debt burden” in its decision.

5. Rebound for Small-Cap Stocks Incoming? Not So Fast.

Long-standing academic research argues that small-cap stocks should outperform large-company stocks over time. But the reality has been quite different for many years now. Given relative valuations and interest rates, there’s an argument that it’s time for small-caps to reassert themselves.

Small-cap valuations are attractive. As of October 31, 2023, small-cap value stock valuations were 25% below their average of the last 20 years, and small growth stocks were 10% below. And if it’s true that we’re in for a soft landing, then we’re likely to see better-than-expected corporate earnings. Better economic and earnings growth would be significant positives for small stocks of all stripes.

Unfortunately, that’s not our base case, which continues to see economic and earnings recessions ahead. So, we can see reasons to favor small-caps, but we’re not prepared to overweight the asset class yet.

Asset Class

U.S. Equity vs. U.S. Fixed Income & Cash
We maintain our overweight to cash versus stocks because relative valuations remain unfavorable for equities. With the Fed keeping short rates in the neighborhood of 5.5%, cash yields are attractive compared to earnings yields on stocks. Within equities, we continue to express this position primarily through an underweight to real estate investment trusts (REITs), which have remained under pressure for some time.

U.S. Fixed Income & Cash favored over U.S. Equity.

Equity Region

U.S. vs. Developed Markets
The picture in developed and emerging markets (EM) equities is colored by the same brush — relatively high U.S. interest rates and dollar strength. Arguably, the slowdown in inflation, Fed pause and expected U.S. recession all argue against a strong dollar throughout 2024. But our tactical models have a much shorter horizon, so we remain neutral on U.S. versus developed market equities for now.

U.S. and Non-U.S. Developed Markets Favored Equally.

U.S. vs. Emerging Markets
High U.S. short-term interest rates continue to support the greenback and create a hurdle for select EM economies. Nevertheless, we view economic fundamentals and corporate earnings growth as generally favoring emerging markets. We’re happy to remain neutral while allowing our EM equity managers to identify opportunities that result from country-by-country differences in growth, inflation, interest rates and currencies.

U.S. and Emerging Markets Favored Equally.

U.S. Equity Size & Style

Large Cap vs. Small Cap
Market participants are calling for a small-cap stock rebound after years of underperformance. However, we’re not there yet. Historically, small-cap stocks have tended to do better coming out of recessions than going in. So, if there’s a downturn ahead, the time to overweight small-cap stocks may be on the horizon. Meanwhile, our short-term quantitative models continue to be neutral.

Large Cap and Small Cap favored equally

Growth vs. Value
The headline is bland — “neutral” by style. But the underlying story is far more interesting. Growth has significantly outperformed value in 2023, so value should be preferred from a high-level relative risk and valuation point of view. However, growth style performance has been massively skewed to Apple, Alphabet, Microsoft, Amazon, Meta, Tesla and Nvidia — the so-called “Magnificent Seven.”

Value has also had performance challenges resulting from a handful of interest rate-sensitive sectors, including financials, utilities and real estate. As a result, we’re less inclined to make a broad style call on such narrow bases. Instead, we prefer to allow our managers to navigate the opportunities in their respective markets.

Growth and Value favored equally.

Fixed Income

U.S. vs. Non-U.S.
Our fixed-income team continues to position for recession in the U.S. and eurozone. They believe central banks have finished hiking rates, and a growth slowdown will prompt rate cuts in 2024. As a result, they have extended duration to capture an anticipated decline in yields. In terms of credit quality, they continue to favor high-quality over high-yield bonds, believing that slower growth in the near term will create better opportunities to add yield and credit risk in the future.

U.S. and Non-U.S. favored equally.

Alternatives

REITs vs. Core Assets
We retain a negative outlook for REITs due to high mortgage rates. However, valuations and credit spreads have indeed improved for REITs. It’s also worth pointing out that we continue to benefit from the active management of our allocation. This supports our argument that the space has attractive relative values despite the challenging overall conditions.

Core Assets favored over REITs
Richard Weiss
Richard Weiss

Chief Investment Officer

Multi-Asset Strategies

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References to specific securities are for illustrative purposes only, and are not intended as recommendations to purchase or sell securities. Opinions and estimates offered constitute our judgment and, along with other portfolio data, are subject to change without notice.

International investing involves special risk considerations, including economic and political conditions, inflation rates and currency fluctuations.

Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.

Historically, small- and/or mid-cap stocks have been more volatile than the stock of larger, more-established companies. Smaller companies may have limited resources, product lines and markets, and their securities may trade less frequently and in more limited volumes than the securities of larger companies.

Diversification does not assure a profit nor does it protect against loss of principal.

Generally, as interest rates rise, bond prices fall. The opposite is true when interest rates decline.

Past performance is no guarantee of future results. Investment returns will fluctuate and it is possible to lose money.

The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.