2024 Midyear Outlook: Allview Face-Off Roundtable

Travis Keshemberg: I'm Travis Keshemberg, senior portfolio manager on Allspring’s Systematic Edge Multi-Asset team, and welcome to SpringTalk. Joining me today are Allspring's very own Bryant VanCronkhite, senior portfolio manager and co-head of the Special Global Equity team, and Noah Wise, senior portfolio manager on the Plus Fixed Income team. We will be talking about our mid-year predictions for markets and beyond for 2024. Bryant, Noah, thank you very much for joining us today.

Bryant VanCronkhite: It's great to be here.

Noah Wise: Thank you for having us.

Travis: So, why don't we jump into it and see what we think is going to happen and what could potentially mess things up? So, I thought what we would do is start off with an outlook of the macro impact of things. And when you think of macro, you think of growth and you think of inflation. And the U.S. has certainly displayed some persistent growth. It has also displayed some persistent inflation. Where do you think things are headed and how is the U.S. positioned with the rest of the world? Bryant, do you want to start?

Bryant: Yeah, I’ll start on the growth side. I have some comments on inflation, as well, but growth is a key part of that. And the last bastion of support for the U.S. economy, in my view, has been the U.S. consumer. They’ve been far more resilient than I anticipated and I think a lot of the market anticipated, but we're starting to see cracks in that. We're starting to see the low end, in particular, having a hard time dealing with the inflation in their basket of goods. You're seeing spending patterns changing and as a result, I'm getting more and more concerned that that last leg of growth will begin to fade. On the commercial side or on the corporate side of spending, CapEx (capital expenditures) is also beginning to slow. Companies are getting a little bit more hesitant on that next dollar of spending, I think largely because they're uncertain about regulatory policies. The election’s coming up, so you're starting to see new orders begin to fade a little bit. The only thing that’s now holding it up is the AI spend. So, when I look at the overall growth profile for the U.S., I'm getting a little bit more concerned about corporates’ desire to spend and consumers' ability to spend, which could put some pressure on growth, which may help inflation in a minute. But we'll come back to that.

Noah: And I would add to that and I think it's consistent, what we saw in 2023 and even in the first part of 2024 is a growth cycle that was really driven by the U.S. There have been challenges around the rest of the world. Europe is notoriously quite slow. Revisions outside of the U.S. in the developed world have been coming down, even though U.S. revisions have been moving up. But we all know that this is one global economy. All the different countries are still tethered to each other and that is true for the U.S., as well. So, the way that we're looking at things is, yes, the U.S. did bolster global growth with some of the stronger consumer demand that we saw over the last couple of years. What that has done is that's buoyed some of the places that were more challenged that may have otherwise been in a recession. Really supported Europe, for example. Not strong growth, but slightly positive. Now, what we're starting to see is a little bit of compression. So, maybe that's putting a lid on U.S. growth. Maybe the best on the U.S. growth side is behind us. We don't expect re-acceleration outside of the U.S., but we do think that there is compression and it's probably the two meeting somewhere in the middle.

Travis: So, then with respect to inflation, again, it's been persistent in the U.S. We're probably higher than a number of other places in the world. It's been driven by strong labor markets and also the fiscal stimulus that's been going on. Where do you see things headed?

Bryant: I mean, it's hard to be surprised that we have inflation being sticky, right? The fiscal spending is still working its way through. All of those bills were passed now years ago, but the money is just being spent right now. And so, that's going to continue to put pressure on inflation. I think some of the policies also, the way we've changed how we repay student loans as an example, is highly inflationary and just beginning. The way we think about how higher interest rates on our savings accounts are also potentially inflationary. And so, I'm not surprised that inflation has been a little sticky. But ultimately, a lot of what we talk about is fighting the symptom of inflation. The disease the Fed (Federal Reserve) has to figure out is the labor market. How do you balance supply and demand of labor so that the perception of future inflation starts to come down below their 2% target? And right now, the Fed's very own consumer survey suggests that people expect inflation to be pushing 3% or higher one year and three years forward. Until that comes down, people will continue to demand higher wages because of their fear of higher inflation. And so, ultimately, the issue here is that the Fed has to get the first part of the conversation figured out, which is reducing growth rates so that the labor situation can resolve itself from a supply and demand imbalance situation. So, I think inflation remains sticky. I think the Fed's in a bit of a box right now. And importantly, everyone's going to continue to believe, I think, that inflation is a challenge for their spending power.

Travis: Growth and inflation, we kind of hit upon it already. The Fed is in a little bit of a pickle. Other central banks around the world maybe are a little bit further along than where we are in the States. But with respect to the Fed, Noah, how many cuts this year, if any? And what do you see?

Noah: We think the Fed likely cuts once in 2024. The timing of that cut, I don't think it actually matters that much. Is it before the election? Is it after the election? We think it's more likely that it ends up being after the election, but I don't think that's going to alter the trajectory of inflation or growth for the U.S. But we're in the camp that the Fed ends up cutting once this year. They're not going to be the first central bank to cut, but they also probably won't be the last. I think it'll be a gradual normalization of rates on the front end of the curve.

Bryant: I think the data would support the Fed cutting zero times this year. And I think the hard part is if they do cut when they're supposed to, which means they're cutting because inflation has moved lower and global growth or U.S. growth has slowed, it'll be viewed negatively at first. Right now, everyone's kind of waiting and anticipating this cut that's all of a sudden going to catalyze equity markets, especially to higher highs. And I think it's probably wrong. If the Fed is put into a spot where they're supposed to cut, it‘s because bad things are happening and it's going to keep happening for a while. You don't just cut today and all of a sudden change the path of the economy. And so, I think the conditions in which we would get that cut could be negative. So, I'm going to call for zero cuts this year with one exception. I think in the case of a Trump victory in the U.S. elections, I would not be shocked if the Fed were to move their meeting in November to after the elections and immediately cut to curry favor with our new president, which would be the wrong thing to do, but I think it's possible, just given human nature and the nature of how the Federal Reserve operates. And so, that, to me, would be the only condition in which a positive cut would happen. Because at that point, we probably don't see the growth slowing enough. We don't see inflation dropping enough, but they would be doing it for political reasons as opposed to monetary and economic reasons, which would be a bad thing overall, but probably good for the equity markets in the short run.

Noah: That would be incredibly shocking. And it would be very damaging to the Fed's credibility. If they were to do that, that would be something that we haven't seen in our lifetimes.

Bryant: It's a low probability risk, but it's out there and one that you have to be thinking about.

Travis: We will talk in November and see what ends up happening. So, given everything we've talked about with this macro kind of a background, what types of investments should do well in this environment? So, Noah, you're facing an inverted yield curve. You're facing tight spreads. You're facing a Treasury that is issuing more bonds than people ever thought were possible. Before I came here, I saw a commercial on TV and it's the parody about “What's in your wallet?” So, I'd love to know what's in your portfolio, as a rip-off of that commercial?

Noah: Yes. So, we have concerns. One of the biggest concerns that we have is valuations, right? And in any investment decision, it is not only the risks that are out there, which are critically important, but it is also what is the compensation for the risks that you're bearing. And unfortunately, the compensation for bearing risks in fixed income more broadly are not really attractive when you look at the incremental yield income that you can get for taking on default risk, right? Or just general recessionary types of conditions. Therefore, what are we looking for? We don't drive the value in the market. We respond to it. And what we're seeing right now and where we're seeing opportunities is high-quality carry.

Travis: Bryant, you are facing your own set of challenges. You've got an equity market near record highs, you have stretched valuations by some people's accounting, and you have the market being led higher by a small number of stocks. What is in your portfolio?

Bryant: Yeah. You're right. We have a lot of things to think about, a lot of things to worry about. So, in this situation, given valuation risk, geopolitical risk, concentration risk, we want to first start bottom up actually. And so, across all of our portfolios, both in the U.S. and globally, we're focused on how do companies drive their own destiny? What allows them to navigate all the uncertainties that are out there? And it always comes back to a company's balance sheet because the unique part of a balance sheet is that it provides the support. It is the last line of defense for every company, for every individual, frankly, right? And so, we want to own businesses that have balance sheets that are suboptimal, meaning they’re below their maximum optimization, so they have room to invest no matter what's happening around them. And that balance sheet can be used to support their business and support their equity prices in times of distress. And so, all of our companies today have this fortress-like balance sheet that provides financial freedom. They'll protect their capital if bad things do happen, but allow companies to navigate individually and control their own destiny through acquisitions, investments, buying back stock, dividend policy, etc. That is the most important element across every name, across every one of our portfolios.

Travis: I also want to turn a little bit of time to talk about the geopolitical situation in the world. We have an election in the States in the fall and the mudslinging has already started. There are elections in Europe. There's an election in the U.K. There's South Africa. Mexico just had their presidential election. All kinds of things going on. We have Israel at war. We have Russia at war. And we are a moment's notice or a mistake away from any kind of a conflict in Korea, Taiwan, or Iran. What keeps you up at night?

Noah: It's a lot to keep any investor up at night. The list of reasons for insomnia. But I will say there is, I think, a common thread here. I would bucket a lot of those into two camps. One is your black swan, tail event types of situations that are highly destructive, negative growth impact, kind of recessionary. Those things are always and ever omnipresent. And there's nothing anybody can do about those. That's always a possibility, but fortunately tends to be a very small likelihood type of scenario. On the other hand, you have a broad array of incredibly high likelihood scenarios that have some similar dynamics. And this is true in the U.S. elections. I think it is true with what we saw in Mexico. This is true with a lot of the elections around the world in 2024. And that is movement towards protectionism, right? There are populist elements in a lot of places, particularly in the developed world and most of the roads point towards policies that are inflationary. On the one hand, you can say this group wants more spending and this group wants less taxes. You can quibble about, specifically, different policy differences, but one thing that seems to be a common thread is both are inflationary and that's true on the trade side. That's true on the fiscal side. And that is a concern as a fixed income investor and what that means for inflation dynamics. So, that's something that we're very, very focused on. We think that there are very legitimate risks, both in the U.S. and abroad, associated with those political situations.

Travis: Yeah. Bryant?

Bryant: I completely agree actually. I think that people worry about is China going to invade Taiwan and how do I invest around that? Or what's happening with Russia and Ukraine? How will that end? And we think about these in big picture elements, but what really matters is what Noah just said. Everything I see looks inflationary. I think the number is like half of the voting world has a major election this year. That's a significant percentage of potential change. But almost in every situation, the underlying element is inflationary. And so, I don't worry about all the possible things that could happen because oftentimes, as investors, you end up being way too early on predicting it or you assume some black swan event and it doesn't happen and you lose a lot of capital and a lot of time, frankly, trying to figure that out. What I want to do is make sure that I own a basket of companies that's going to allow me to navigate through that volatility. And then, I know what I’m going do under various scenarios when it does happen. Because opportunities come and go very quickly, you need to be ready to react and act as it happens in real time. And so, what we should be doing now is thinking about which companies we own that can navigate these various risks. Make sure you don't get overexposed to any one region, right? Be careful about your overall exposure from a country standpoint, from a currency standpoint, and, ultimately, be ready to act depending on what happens. For example, a U.S. investor has to know their Biden playbook and their Trump playbook right now. You just have to know that. As an EM (emerging markets) investor, you need to know what's going to happen if China invades Taiwan. How much exposure do I have there? What’s my benchmark look like? What's going to happen with sanctions, if it happens? And so, just being prepared for those, I think, is far more important than actually trying to invest behind the particular timing of any one outcome.

Travis: Sounds like good advice. So, with all that on the table, we come to the last section of the podcast here and it's the prediction section. So, we've been asked to continue the tradition of the SpringTalk prediction here and talk about, by the end of the year, what's going to be the best performing asset class. Is it going to be, from a broad base point of view, is it going to be the 10-year? Is it the S&P 500? Is it commodities? Is it something else? Any thoughts?

Noah: I can start. I'll maybe start with a compliment to the equity world and then, I'll take a shot at it. And then, you can have a rebuttal. So, I'll give you a chance to respond. But what's the highest returning asset class? Fixed income, commodities, or equities? It's likely equities. The modal outcome is equities. It should be. And if you look historically, equities tend to outperform in the long run. And they have the highest hit rate of outperforming. They should. I don't think there's anything different today that would make you think otherwise. What is different, and this is where I think investors need to understand, it really follows from Bryant's conversation before, right? You have to be prepared ahead of time for the “what if you don't get what is expected?”, right? You have to have that playbook ahead of time. And the issue right now with equities, I think, comes back to valuations, the concentration of valuations within those largest companies that are driving indices today. And there's a lot of potential downside risk. So, investors need to really be able to grapple with and be prepared for not what is the most likely outcome. Most likely, stocks probably outperform. They're probably your best asset class for the rest of the year, but they really need to focus on what happens if that isn't the case. And fixed income today has a better answer to that question than it has had in decades. Rates in the U.S. and globally were incredibly low. Made it very, very difficult for them to be able to do one of the major things that fixed income is supposed to do, which is to be able to provide ballast during times of uncertainty, when something happens that is unexpected. That's different today. Today, fixed income can provide that. And so, it really provides investors with some of that insurance, some of that downside protection in the event that we don't get what everybody is expecting for the back half of this year.

Bryant: I agree, equities. I think equities beat the 10-year. I think commodities are a very nice hedge for some of those other events that could happen. And so, some commodity exposure makes a lot of sense. But I think it's more nuanced than that. Let's just go around the world. EM is cheap. It's very cheap right now. If you look at it at the historical discount of EM versus developed markets, it’s at a two standard deviations discount now. This is a good time. If you ever wanted to buy EM, now it seems like a good time. Just be aware of your exposure to key regions and work with your manager to figure out how to navigate that. If I'm going to go developed market ex-U.S., small caps look attractive to me relative to large caps. Why? Well, one, valuation discounts, just like EM versus developed markets, developed market small caps versus developed market large caps are very cheap today. But also, as those monetary policies begin to evolve and we start seeing rates cutting, you should see the market shift back down cap. So, I like small cap equities versus large cap equities in developed market ex-U.S. Now, in the U.S., a lot of investors just look at the S&P 500 as their target. That, to me, scares me today. The valuation risk, the concentration risk really bothers me. I don't think you're paid to own those equities unless you have a very fearful view of what's happening in the U.S. economy. If you're fearful but want to have U.S. equities, then go ahead and buy S&P 500 today. That's fine. But over the next 12 months, I think you're being paid to begin to methodically move out of that large cap growth S&P 500 category and start to move into the value side of every market cap and move down cap.

Travis: I totally appreciate your comments about broadening things out and it was great to have this conversation about these topics. So, with that being said, Bryant, Noah, thank you very much for joining us today.

Bryant: It was a lot of fun.

Noah: Thanks for having us.

Travis: And for our audience, thank you for joining us today on SpringTalk.

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