As we enter 2024, there is no doubt that the soft-landing narrative has been on the ascendancy. Cooling – even if bumpy at times – inflation, a strong labour market and the Fed signalling rate cuts this year have all been strengthening the case for the elusive soft landing (Charts 1 & 2).
What is clear is that while the US economy is set to slow in 2024, at this juncture, the risk of recession seems to have fallen, reflecting the resilience of the US consumer combined with the robust fundamentals of the corporate sector (Chart 3).
Against this backdrop, much optimism can be found within financial markets today. With the recent surge in equities, many major stock markets have now broken through prior all-time highs.1 But one of the most important questions for investors is whether the tighter monetary conditions can indeed bring about a soft landing for the global economy.
Past experience suggests that this will be difficult; monetary tightening has almost always preceded downturns and soft-landing talk has often gathered pace prior to recessions (Charts 4 & 5).
Another important question for investors is that even if a recession is avoided, will the economy and profits meet current investor expectations or will asset prices need to correct? In fact, we see a number of risks in the equity market at present.
First, concentration in US equities continues to be a risk. The 2023 equity rally was unusually concentrated and a sign of investor fervour for stocks that could benefit from the growth of AI. The gap between the S&P 500 and the equal-weighted index was at its highest since 1998 during the dot com bubble (Chart 6).
Such disparities inevitably draw attention, particularly at a time when regulatory scrutiny has been increasing, evidenced, for example, by the looming implementation of the European Union’s Digital Markets Act or the European Commission’s antitrust case against Apple. Continued regulatory pressure has the potential to impact the profitability of the so-called Magnificent Seven reducing investor enthusiasm.2
Secondly, we are seeing a divergence between the logical link of index price performance and future earnings of the S&P 500 (Chart 7). Despite the softening earnings expectations, the market seems willing to pay up for lower expected earnings.
And while this break in relationship can last for a long time,3 it is nonetheless noteworthy and warrants caution, particularly as equity analyst expectations for 2024 imply that S&P 500 companies, in aggregate, will grow earnings by circa 10% – a lofty assumption in a year where below-trend economic growth is expected.
Lastly, uncertainty around the future Fed funds rate, due to an ambiguous inflation environment, makes the outlook harder to read. Analyst estimates of future S&P 500 equity earnings growth across sectors are more dispersed now than before the pandemic (Chart 8). This presents another reason for investors to be cautious, as asset prices become more volatile when investors are presented with new information that proves prior assumptions false.
As we move into a more challenging investment environment, one with the potential for greater geopolitical instability (Chart 9), we believe investors should consider ways to protect their portfolio.
Gold has a key role as a strategic long term investment and as a mainstay allocation in a well-diversified portfolio. Our analysis shows gold is a clear complement to equities and broad-based portfolios. Gold has historically provided returns, diversification and liquidity. These characteristics combined mean that gold can materially enhance a portfolio’s risk-adjusted returns.
Beyond gold’s strategic appeal and considering the potential challenges on the horizon, we believe that investors should look closely at the portfolio benefits gold can bring in 2024.
For many investors, high-quality government bonds, such as US treasuries, have long fulfilled the traditional role of a diversifier in investment portfolios, offering protection during periods when risk assets have come under pressure.
And while the return potential of US treasuries has improved recently, there are several advantages to diversifying the sources of safety in an investment portfolio beyond just high-quality government bonds. Gold can play a role alongside US treasuries. In fact, its negative correlation to equities and other risk assets increases as these assets sell off (Chart 10).
With few exceptions, gold has been particularly effective during periods of systemic risk, generating positive returns in 8 of the 10 worst quarters of performance for the MSCI USA index. Of the remaining two quarters, gold outperformed the MSCI USA index in both cases reducing overall portfolio losses (Chart 11).
Furthermore, the timing, magnitude and duration of any geopolitical crisis are always uncertain. They are hence virtually impossible to position for in advance. This will likely be exacerbated in a year with major elections taking place in the US and worldwide. For that reason, long-term strategic portfolio diversification is essential where gold can play a key role as a safe-haven asset (Chart 12).
Not only is gold a good strategic asset because it is beneficial during periods of uncertainty, it can also generate long-term positive returns in both good and bad economic times. In other words, gold can help reduce the worst outcomes without being overly detrimental to long-term portfolio growth (Chart 13).
A soft landing remains the most likely scenario but the likelihood of the Fed steering the US economy to a safe landing with interest rates above 5% is by no means certain. And taking into consideration the strong equity returns over the last year and the potential macroeconomic challenges further down the line, we believe investors should consider ways to protect their portfolio and narrow the range of potential outcomes.
As outlined, gold can help mitigate the key risks ahead by providing diversification that works, and enhancing risk-adjusted returns.
1The S&P500 surpassed 5000 for the first time in the history of the index in February 2024.
2The Magnificent Seven stocks are a group of high-performing and influential companies in the US stock market: Magnificent 7 Stocks: What You Need to Know (investopedia.com)
3Valuation ratios and the long-run stock market outlook: an update – Campbell and Shiller.
