With inflation seemingly in decline, it seems there is a new potential challenge to contend with. As prices dis-inflate, they could end up becoming a problem for profit growth.
Colin Dryburgh, Multi-Asset Investment Manager at Aegon Asset Management explains what this actually means in real terms.
He said: “Interest rates in most major economies are now at restrictive levels and inflation is declining. Recent data indicates that growth is slowing. Risks are skewed to the downside because the lagged impact of tighter monetary policy is yet to be fully felt, but the timing and extent of any recession remains unclear.
“The next move for interest rates is likely lower and this environment should be supportive for government bonds and corporate credit where current yields, at 15-year highs, are rightly attracting interest. Given the likely ongoing macro uncertainty, we are minded towards a bias for quality and, irrespective of credit rating, of being appropriately rewarded for the risk we take on. The significant repricing of interest rate risk means this is now a viable alternative on both an absolute and risk-adjusted returns basis in asset allocation decisions.
“In whichever market companies operate, the year ahead is likely to provide a different set of challenges than the recent past. Chief amongst these is managing dis-inflating, in some cases outright deflating, prices against a weaker demand backdrop. We expect profit growth will be hard to come by and is likely to disappoint current expectations. This suggests again a bias towards quality, a stock-picking focus on balance sheet strength and profitability.
“Geographically, the US economy remains relatively stronger, and its equity market leadership may broaden out; small and mid-cap equities have lagged and valuations are more attractive. Further afield, Japanese equities should continue to benefit from corporate restructuring, share buybacks and low domestic interest rates, whilst continental Europe looks likely to be hindered by its poor economic background. In the UK, many assets appear to remain un-loved and undervalued; whilst there are potential catalysts in the probability of rate cuts and a more business-friendly tone from both political parties, they are perhaps not a quick fix. Stock-pickers will find nuance and opportunity within that broad brush.
“Interest rate cuts will also help shape currency markets in 2024, the US dollar the principal beneficiary as other major central banks cut first. This will likely reinforce some of the preferences already noted in developed markets and militate against much renewed enthusiasm for emerging markets.
“Above all, the combination of an inflexion point in the rates market and ongoing macro uncertainty will present both challenges and opportunities for investors to navigate. Income will be an important component of total return. Flexible and nimble asset allocation will be the key.”
