2024 Global Equity Outlook: Soldiering On

Quality Growth Boutique

Read 6 min

Dec 07 2023

Key takeaways

In our view, the economy may be heading for a recession, the US consumer faces pressure, corporate earnings are set to weaken, and geopolitics may be a more influential variable in 2024.
We believe opportunities can still be found in health care, consumer staples and technology.
We believe that high-quality, durable businesses with inflation protection and avenues for predictable earnings growth can be more attractive than even fixed income securities that now have higher yields.

Charlie Munger, legendary investor and vice chairman of Berkshire Hathaway, passed away in late November. Like his long-time friend and colleague Warren Buffett, he had insightful opinions on life and investing, which often coincided. In a recent interview with CNBC, Charlie said he believed in the “soldier on system”.

“Lots of hardship will come and you gotta handle it well by soldiering through,” he explained, adding that there will be opportunities too that you must learn to recognize.

It is a simple philosophy that nonetheless requires a vast amount of discipline and experience. Munger’s “worldly wisdom” guides us as we look to 2024. We identify three risks that will require perseverance to navigate and opportunities that will require agility to seize in the challenging landscape ahead.

Risk 1: Economy is heading for a slowdown

The much-predicted recession did not occur in the US in 2023, although long and variable lags between monetary policy actions and their effect on the economy indicate the potential for a slowdown next year, particularly when coupled with waning consumer savings and a ballooning federal budget deficit.

While the Fed – and other central banks – have paused interest rate rises, there is a risk that rates remain higher for longer than investors expect. Inflation has declined, although hitting the Federal Reserve’s 2% target rate may be more challenging. In our view, inflation may become more volatile, leading to variability in interest rates. This could impact corporate earnings as companies face wage increases and higher financing costs, combined with supply constraints, and domestic, as well as geopolitical issues. Exogenous shocks are another omnipresent risk that could lead to a more significant slowdown in the economy. Despite this, some investors appear to expect continued economic resilience and falling interest rates.

Risk 2: US consumer spending faces pressure and corporate earnings set to weaken

The US consumer has remained resilient, and given current tightness in the labor market, it is not surprising that consumer activity has been good thus far in the 2023 holiday season. However, the picture has become more complex, and it will take longer to untangle physical indicators such as traffic and instore spending from online shopping. As pressure on consumers rises further, companies may need to find new drivers for earnings growth.

Earnings were resilient in 2023, however we expect to see increased pressure on margins. US corporate earnings have been stronger than the rest of the world over the past decade thanks to accommodative monetary policy and high levels of spending and fiscal stimulus. We expect these factors will change and could impact corporate earnings after a long period of persistently high profitability.

Risk 3: Geopolitics and US elections may be more influential variables

Global geopolitical conflict did not have a negative impact on markets in 2023, but growing uncertainty and concern does eventually feed into investor sentiment, which can impact asset prices. Moreover, prolonged geopolitical events can have real consequences in terms of the functioning of businesses globally. The extent to which geopolitical events impact markets depends on factors including market valuations and the availability of risk-free returns. As we enter 2024, with equity markets and interest rates higher than a year ago, we expect that geopolitics could be a more important variable.

In the US, volatility typically present during election cycles could be exacerbated in 2024 by a contest between two polarizing lead candidates. Incumbent administrations often make tax giveaways or implement positive fiscal stimulus in election years, but such measures seem unlikely next year. The fight over the US budget and growing calls for fiscal responsibility are signs that many want large deficits to be addressed. Higher interest rates may add to pressure for greater fiscal discipline.

Technology, health care and consumer staples remain cornerstones of our portfolios

A small group of large cap stocks – the Magnificent Seven – has dominated US markets this year. Although these companies have shown good fundamentals, they are far from homogenous. Some will see continued strong growth, despite their current size and success. While we believe the select companies that we own of the Magnificent Seven are reasonably priced, we are skeptical that this group can drive broad market performance on a long-term basis. Moreover, there is tremendous value elsewhere in the market.

We continue to find opportunities in health care and consumer staples sectors that are underappreciated by the market, and which offer visible and persistent growth rates, even in a more uncertain environment. The consumer staples sector in the US is particularly attractive. We have also been more dynamic in improving our portfolios in terms of quality and return potential across the consumer discretionary and industrials sectors. In the financials sector, we are finding potential in exchanges; and in technology, we prefer blue chip companies although we are mindful that a large swath of the tech sector will face increased regulatory challenges.

AI has been an important driver of equity returns in the tech sector this year. Investors have focused on the companies with the greatest exposure to AI (i.e., higher adoption of accelerated computing) as well as the speculative upside. While this has its logic, quantifying the medium-term AI impact at this early stage is inherently less predictable, and fluctuations in outcomes can have a meaningful impact on expectations for each company. By failing to distinguish the level of certainty around the long-term benefits of AI, markets have disproportionally rewarded some companies over others.

When assessing the impact of generative AI, we focus on readily addressable use cases versus dreaming about the long-term possibilities. Several of our technology holdings have incorporated new generative AI capabilities into their existing product portfolios, which allows them to leverage their existing strengths (e.g., traditional capabilities, distribution) to drive more sustainable earnings growth.

Enthusiasm for companies that can benefit from generative AI should be coupled with strict valuation discipline. Also, there is a difference with respect to the certainty of achieving the estimated AI-driven earnings boost for each company. Unlike other investors, we only credit companies for what is highly likely to occur, not just plausible.

China’s recovery to continue

US equities are currently priced optimistically, while emerging markets equities are cheaper but come with more risk, particularly in dominant economies like China. Its recovery from the effects of COVID has been difficult and disappointing compared to many other economies. Changing behavior and spending habits across such a large population takes time, but we expect to see that play out gradually in sectors such as retail and housing. We have conservative expectations about the evolution of China and look for companies with good visibility that are also durable and predictable.

Political and geopolitical concerns have also depressed market returns. China is now trying to project itself as a safe place for foreign businesses and capital, which is generally seen as positive. From a directional standpoint, the market has improved and there are positive drivers for future growth, although risks in China remain higher than in other markets. We scrutinize our holdings in China very closely and evaluate them against other businesses globally to ensure that we are invested in the best companies regardless of location or sector.

Challenges ahead for Europe

Europe has been facing higher policy rates, a tough energy environment, and a weak recovery in China, an important trading partner. While Europe has passed stimulus in terms of the NextGenEU, it pales in comparison to the stimulus in the US. Despite this, some governments in Europe are pushing back on the size of fiscal deficits, which were allowed to go above the set rules during the covid pandemic. Looking ahead to 2024, fiscal belt tightening mixed with the delayed effects of previous monetary tightening mean the backdrop will be tough. This is before the risk of escalation in either of the wars that could lead to higher energy prices. Added up, 2024 is likely to be another tough year for Europe in terms of GDP growth. However, valuation is starting at a low level, and while earnings growth is also likely to be weak, there should be pockets of European companies that should prove resilient, namely those with structural growth drivers that can be sustained despite the weak macroeconomy.

Finding quality: It may not be easy, but it’s not impossible

When asked to describe his approach to investing, Charlie Munger famously remarked that it was “simple, but not easy.” We fully agree with Mr. Munger that solid investment analysis is not easy, but we are armed with many tools in our arsenal to help us navigate the often clouded and uncertain investment terrain. As active investors, we constantly balance prudence in managing risks with seizing opportunities. We are satisfied with the earnings delivery and growth of our portfolio companies this year, especially as we enter a period of expected slower economic growth. We believe that high-quality, durable businesses with inflation protection and avenues for predictable earnings growth can be more attractive than even fixed income securities that now have higher yields. Further, we continue to find opportunities in the US, which remains a vibrant place for entrepreneurialism and new business formation. That dynamism is not only visible in new small businesses, but also in the growth of larger companies into global champions, particularly in the technology sector.