Capital IdeasTM

Investment insights from Capital Group

Markets & Economy
Episode 27 – Can the U.S. economy survive higher interest rates?
Will Robbins
Equity Portfolio Manager
John R. Queen
Fixed Income Portfolio Manager
Michelle Black
Solutions Portfolio Manager

In this episode, we’re talking about the near and long-term outlook for stocks and bonds. How are the markets coping with U.S. interest rates at a 23-year high? And what does it mean for your asset allocation approach? Helping us answer these questions are equity portfolio manager Will Robins, fixed income portfolio manager John Queen, and solutions portfolio manager Michelle Black, each of whom has over 20 years of experience as a professional investor at Capital Group.

William L. Robbins is an equity portfolio manager at Capital Group. He has 32 years of investment industry experience and has been with Capital Group for 29 years. Earlier in his career, as an equity investment analyst at Capital, Will covered small-capitalization companies, REITs and U.S. banks. Prior to joining Capital, he was a part of the investment team at Tiger Management Corp. in New York and a financial analyst with Morgan Stanley. Will holds an MBA from Harvard Business School and a bachelor’s degree from Harvard College, graduating magna cum laude. Will is based in San Francisco.

John Queen is a fixed income portfolio manager at Capital Group. He also serves on the Portfolio Solutions Committee. He has 34 years of investment industry experience and has been with Capital Group for 22 years. Earlier in his career at Capital, John was a trader and dealer service representative. Previously in his career, he was chief operating officer and chief compliance officer, as well as managing director overseeing bond portfolios at Roxbury Capital Management, an affiliate of Wilmington Trust. Before that, he was managing director at Hotchkis and Wiley. John holds a bachelor's degree in industrial management from Purdue University and attended the U.S. Military Academy at West Point, where he majored in mechanical engineering. He also holds the Chartered Financial Analyst® designation. John is based in Los Angeles.

Michelle Black is a solutions portfolio manager at Capital Group. Her focus is on fund-of-funds and multi-asset solutions. She is the principal investment officer of the American Funds Target Date Retirement Series®, the chair of the Target Date Solutions Committee and also serves on the Portfolio Solutions Committee and the Custom Solutions Committee. She has 29 years of investment industry experience and has been with Capital Group for 22 years. During her tenure at Capital, Michelle led the development of asset allocation design for private high-net-worth clients. She has been deeply involved in glide path development for our target date series, and also worked as an asset allocation investment specialist out of our London office, where she helped construct multi-asset solutions for global institutions. Prior to joining Capital, Michelle was manager of the Los Angeles office and an investment planning analyst at Sanford C. Bernstein & Co. She holds a bachelor’s degree in business administration from the University of Southern California. She also holds the Certified Investment Management Analyst® and Certified Private Wealth Advisor® designations, is a member of the Investments & Wealth Institute and serves on the CIMA commission. Michelle is based in Los Angeles.

Will McKenna: This week on Capital Ideas, we’re talking about the near- and long-term outlook for stocks and bonds. How are the markets coping with U.S. interest rates at a 23-year high? And what does it mean for your asset allocation approach?

Helping me answer those questions are equity portfolio manager Will Robins, fixed income portfolio manager John Queen, and solutions portfolio manager Michelle Black, each of whom has over 20 years of experience as a professional investor at Capital Group.

This episode features highlights from our recent webinar, “Asset allocation for 2024.”

I’m your host, Will McKenna. Let’s get into it.

Will McKenna: Will, I thought we'd start with you. We've mentioned your time covering banks in the great financial crisis. This time last year, we had you on one of these panels, uh, talking about that because we were in the middle of a Silicon Valley Bank turmoil. You know, so fast-forward to today, uh, what's your perspective on the investment environment these days? Where do you see us heading from here?

Will Robbins: Well, I might just give a few words of closure on that bank experience because what a difference a year makes. At the time we talked about the need for a firewall and the waves of expectations of how to respond to the crisis in that moment. We called it the three Rs, the rate which we'd experienced at fast uptick in rates, the regulatory response and recession. And we've gotten two of those three. Um, so I think we can sort of put aside now the fact that we largely are at the end, we think of the rate cycle, the rising rate cycle, and especially those dramatic rate increases that had such a negative impact on the banks. And we've seen regulation that's really helped draw that line in the sand and prevented the contagion from being experienced.

The recession is really where the jury's still out. Oh, I think we would consider even at this time last year that there's a big difference between rolling recessions, which would imply sort of a muddle through. And there's very much a view at that time, and in fact I would actually concur with that even now, a view that we will have pockets of weakness. The good example within that space is the commercial real estate. We're still seeing some aftereffects and we will for quite some time, but in turn, the broader economy still remains quite strong, uh, as evidenced by labour, uh, consumer spending, et cetera.

So, we still feel like there's a muddle through environment that gives us an opportunity to broaden out. Just thinking about what that implies perhaps for the rate complex as a starting point. And consistent with that view is a higher, for longer, maybe not higher from here, but just sustained consistently higher than what we've experienced over the past decade rate complex. Um, and that probably has implication or does have implications for the direction of the market. I think it, if you believe that you have to believe as well in a broadening of the strength in the equity markets beyond what we've seen as a very, very concentrated version over the last 12, 18 months.

Will McKenna: That's a great start. I'd love to just pick up on that because I'm sure our audience is thinking, "Boy, we've had the Magnificent 7 really driving markets here." Uh, say more about the markets broadening out. How do you see that playing out and where might some of those opportunities come from?

Will Robbins: Well, you can tell, I am in the broadening camp. There are probably two camps right now of equity investors, those that feel like we may be peaking and those that feel like we're broadening. I'm squarely in that broadening camp. It's driven by a number of different factors. On the bottom-up basis, we're in meetings with companies and talking with our analysts each and every day. And I, I'm actually stunned and surprised at just how many investment opportunities our analysts are identifying and are being emanated from research with 15% plus type return opportunities. So, it's a statement about what's out there that goes beyond that mega, mega cap tech space. From a top-down perspective, um, you know, we expect that there's going to be growth in almost every sector of the S&P 500 in terms of earnings for 2024. So, it gives sort of a, a good setup in general.

And in addition, you know, there's potentially some signs of concern around that very narrow momentum portion of the market, whether it be exhibited through higher volatility, uh, or through valuations. And then lastly, I kind of have a, a view that, um, we're in a buy the rumour or sell the news environment. We're probably past the buy the rumour and maybe closer to the sell the news. If you told me that we were in a higher for longer, uh, rate environment, which we believe we were, or I believe we were coming into 2023, I would say that's probably a setup for having, for seeing weakness in some of the long duration growth parts of the market.

In fact, we saw just the opposite based on idiosyncratic earnings surprises, co-driven by cost-cutting, AI growth opportunities, et cetera. Right? Um, from here it sort of feels like the earnings surprises to come from a much broader, deeper segment of the, the market and the valuations afforded those companies have not kept pace with what that sort of by the rumour segment of the market as we anticipated rate declines throughout 2023 enjoyed.

Will McKenna: That's great. So, you're in the broadening camp and you started to reference some elements of the Capital System, the deep research and what you're seeing around opportunities and, and earnings coming through. John, let me bring you into this and maybe, uh, touch on another element of the Capital System, which is the fact that our entire fixed income team and the economists get together twice a year to pull our best thinking and look ahead to develop an outlook for fixed income markets and things like the path of inflation and interest rates. You sit in the centre of that group, uh, would love to hear, you know, what is our view for how these things may play out? And of course, I'm sure everybody in our audience wants to know the exact date when the Fed is going to start cutting rates. So over to you.

John Queen: Well, I may not give you an exact date Will, but, uh, it was as always, a really a fantastic gathering. The, the depth of resources from across Capital Group, from around the world, come together to really work through, uh, what we're seeing in global markets, in the US, uh, economy and markets specifically, and then how that might play out in fixed income portfolios. And I think Capital Strategy Research, our economics group, really set the tone and because their report was called, uh, ‘Divergence and resilience’ and, and that's really what we looked at. So globally, there's a real divergence in the path of economic growth, uh, in a number of different countries. The US and a few others are squarely in the more resilient camp.

Um, I think last year we talked a lot about, despite Silicon Valley Bank and some of the other issues going on, that the US economy is dynamic and entrepreneurial, uh, and you, you rarely want to bet against it. And, and we've seen that. Um, on the other hand, there's some other economies that are struggling a little bit more with taming inflation, keeping growth high, the Eurozone, the UK, China for example. Um, so that divergence and resilience really set the tone. And then as we dug down in the US market, uh, you really looked at some of the things Will just talked about the fact that broadly our analysts are seeing fundamental strength in companies. While valuations on the credit side may not be super attractive, the companies themselves are doing quite well.

Um, we're hearing from the equity side, we're hearing it from our own credit analysts internally. We're hearing it from the economists looking from the top down. Uh, and so we continue to see a resilient, reasonably strong US economy despite much higher rates. One of the questions I've been asked several times over the past few years is, well, can the economy survive these high rates? And I think the answer so far has been yes, I think we think that is likely to be able to continue. Inflation is coming down a little more slowly than the Fed would like. Going back to again, what Will said about higher for longer, I think we're continuing to be in that mindset. So I don't know when the Fed will first cut, but I think it will be a little bit later and, and a little bit fewer cuts this year probably than the three to four that the market's currently pricing it up, uh, and getting closer to maybe year-end before it happens.

Will McKenna: Okay, great. Well, divergence and resilience, you heard it here first. Michelle, you know, you come at all this from an asset allocation lens. Let's get your outlook on, you know, what you're seeing in markets and economies and how that's informing your thinking about asset allocation.

Michelle Black: Yeah, absolutely. Uh, and I really think that, you know, both what, uh, John and Will have described is super helpful in informing how I think about the markets. And so, I think, you know, as an asset allocator, I'm really looking out over the next 10 to 20 years thinking about what the best strategic asset allocation is to help meet our investors' objectives given our starting point today. So, I think that's just important context to have as I go through my comments. But having said that, where are we today? Um, so we've heard a bit from John and Will in terms of fixed income and the equity markets.

When I look at this from an asset allocation perspective, and you look at equities, despite the strong gains we saw last year from a valuation perspective, when we look at fair value, cyclically adjusted P/Es, uh, which are based on estimates for macro factors such as real rates and growth, and we combine that with mean reversion, I'd say that they're not significantly overvalued. They aren't really stretched. And so, we're relatively constructive on equities. Having said that, given higher starting yields, fixed income also looks more attractive today than they did a year or two ago. So that equity risk premium has really compressed.

And I'd also say, you know, John mentioned inflation. Inflation has really come down much more quickly than markets were expecting even a year ago, even though it's not as quick or as fast as the Fed would like. And I think much of the inflation uncertainty, though not all, uh, much of it has dissipated. So, what that means is I think that we will continue to see negative correlations persist between Treasuries at least, and equities.

Will McKenna: Okay.

Michelle Black: And this is good for balanced investors. So, for investors who have been sitting on cash on the sidelines, I think that now it's a good time to start putting some of that cash to work to meet their long-term strategic allocations in order to meet their objectives. Uh, and you know, when I think about the markets and what looks interesting, I think I named three areas, well, uh, emerging markets equities. So, we talked about divergence. This is despite the slower growth that we've seen in China, and by the way, which we expect will continue going forward, our expectations are that we'll see slower growth there than market consensus. Uh, but that's okay. Um, these markets aren't monolithic. Um, and there are a number of interesting opportunities that are being presented by companies that are diversifying their supply chains, uh, like in Mexico or India or even Thailand. Uh, and these economies can also be helped by their own domestic demand. Um, but I do think that active management there is key in order to avoid the risks inherent in investing in those markets.

Uh, speaking of emerging markets, I'd say EM debt is also an interesting opportunity. Um, these are, uh, um, markets that have really evolved. They've broadened out over the past 10 to 20 years. They've matured and especially in local debt markets, um, many of them are investment grade. We have high starting yields. And you combine that with an expected tailwind coming from a weakening US dollar over the long run. This can be an attractive opportunity for certain investors, depending on what their objectives are. And then finally, the US markets. US equity and fixed income, uh, you know, Will touched on this, but, uh, productivity in the US has continued to be strong. We think it will continue to be higher in the future, um, offsetting lower labour force growth. Um, and we've continued to benefit from a lot of economic stimulus packages.

Will McKenna: Right.

Michelle Black: So taken together, um, I think that there are some really interesting opportunities from an asset allocation perspective.

Will McKenna: Maybe you can give us the, the high-level overview of our 2024 assumptions and some of the changes relative to last year that we're seeing.

Michelle Black: Sure. Uh, so we have lowered our assumptions, uh, at the margin for equities. And Will, this isn't just because of, uh, higher starting valuations in the international non-US developed markets. We also expect a lower tailwind coming from a weakening US dollar because we saw some of that already last year. And in the emerging markets, I mentioned our, uh, lower growth assumptions for China earlier. We've lowered our nominal growth assumptions slightly. Um, but, uh, net, net, um, I think that, uh, emerging markets we're still expecting higher returns versus developed markets. And you contrast that with fixed income.

Um, so almost across the board, we're expecting, uh, higher returns for fixed income, given the higher starting yields, which are the largest driver of forward returns for investment grade fixed income. Um, the two exceptions to this would be US high yield and EM debt, which had very strong returns last year. So again, all of that being said, we're still constructive on equities globally. We think that fixed income can better play its role as an equity diversifier in case of concerns about slowing growth or an equity market downturn.

Will McKenna: That's great. Uh, and Will, maybe when you look at the equity, uh, slice of the pie or the equity assumptions, maybe give us some colour. I know you're mostly a US investor, but both on, on us, uh, markets as well as non-US and, and where you see maybe potential opportunities to do even better than what our estimates are.

Will Robbins: Yeah, I'll probably, I'll probably spend most of my time focusing on that last piece.

Will McKenna: Yeah.

Will Robbins: But I think it's important just to highlight some of the things that Michelle mentioned. We are very constructive over almost any time period. Certainly, the capital market assumptions are stretched out to a 20 plus year type time period, but, um, we're constructive on the US markets based on some of the, uh, resilience vitality that it has exhibited over long periods of time. We're also constructive on developed non-US. We've actually increased our growth rate for Europe recently based on, uh, some, uh, some economic inputs. And as we'd said, while the EM assumption capital markets assumptions have declined some to some extent over the past year as a result of China slowing, it's not a monolith. And that's going to be a theme that I'll talk about when I come to where I think we're finding opportunities, but EM is not a monolith.

Um, and, uh, and so we're seeing strength in Mexico, Taiwan, other places where to offset some of that weakness that we've seen in China. Um, to that end, and what again, where we try to, uh, where we spend a lot of our time, uh, each and every day is trying to do better than what we're we just described as these long-term, uh, capital markets assumptions. And within the equity markets, um, we know that there's been a concentration among this group of stocks we call the Magnificent Seven, but it too is not a monolith. And so, we do see opportunities within that group, without question. There are opportunities, uh, to invest in beneficiaries of AI, particularly those that have more discipline approach to cost structure.

And, uh, indeed now capital allocation. We see the institution of dividends among a number of those companies, some, uh, you know, quite recently. Um, also in the industrial space, you know, we talked earlier about the fact that we have analysts who are coming to our calls and to meetings describing investment opportunities that have very attractive rates of, uh, potential return. And I would say industrials tends to be one of those places where there are a plethora of ideas, uh, coming forward or potentially as a, or partly as a result of the resurgence of capital spending, uh, the reshoring and onshoring efforts that, um, that are happening in the US, some of the fiscal stimulus, uh, elements that, um, or inputs that, that Michelle alluded to. Um, even within the industrial space, we see particularly attractive opportunities in the commercial aerospace and leisure travel.

Will McKenna: Mm-hmm.

Will Robbins: Um, and so, those are good examples of where we feel like there's still a recovery that's, uh, potentially can be enjoyed as a result of, uh, kind of coming off of this COVID hangover, if you will. The last piece I'll just highlight, it hasn't been a great sector over the recent past to be invested in, but the healthcare space arguably is one of the biggest beneficiaries of AI.

Will McKenna: There's so much innovation, right, going on.

Will Robbins: There's a ton of innovation in that space. Um, the companies clearly had some disappointments, either through pipeline developments, um, or just the fact that they simply weren't showing near term growth because of longer term pipeline, um, expiry or near-term expiry, longer term, uh, pipeline opportunities. We do think that those pipeline discoveries will accelerate as a result of the application of AI. The valuations on this companies are quite attractive. It's an area that we're spending a lot of time on and feel like is a very attractive, um, area to shop in.

Will McKenna: Um, John, back to you. You know, as Michelle noted, our estimates for fixed income are moving higher, uh, higher starting yields, maybe the big driver there, but maybe give us, uh, your take on what we see there and where you see it going.

John Queen: Sure. Um, you know, as we look at, and Michelle described it very well, if you look out at expected returns in fixed income instruments, effectively, everything you get is the yield. So higher starting yields mean higher expected long-term returns. But, you know, when we're taking a 20- year outlook, you're not just looking at current yields because you have to make assumptions about what you think is going to happen in the economy in the longer run that affects terminal yields where we'll end up. One of the things that I think is often forgotten is that as a bond owner or a bond investor, um, the best outcome for you is actually for our rates to be as high as possible for as long as possible.

It's not what we kind of got used to with declining rates, capital appreciation, and then reinvesting at those very low rates for a long time. It's while we saw in 2020, the downside of rates rising, now we're seeing the benefit of the long-term compounding of higher yields.

Will McKenna: Mm-hmm.

John Queen: And that really goes across the fixed income markets. As we look out at the US economy, uh, productivity enhancements that are going on, we've seen significant business investment that tends to presage, um, productivity increases. There's also, uh, as has been talked about a few times, uh, GenAI that could well have some very positive productivity enhancements. In the long run, all of those things suggest we're in a more normal environment, uh, where fixed income can kind of play that income role again, that it hasn't for a while. Uh, and, you know, really benefit, uh, our shareholder portfolios across the various security types.

So, as I mentioned earlier, for example, credit doesn't look super attractive right now on a valuation basis, but it's not terrible. And the fundamentals behind those companies are quite good. And so, as we look across those portfolios, putting that puzzle together, um, there's a lot of good opportunities that we're seeing in various fixed income asset classes, both in the US and around the world.            

Will McKenna: Great stuff. Uh, John, you kind of talked about this earlier. Our group seems to think that rate cuts may come later or, or, and/or fewer, uh, but maybe Will, over to you on this. You know, how do you think equity markets might react to, to that, uh, if indeed rate cuts come later or-

Will Robbins: Come later. You know, I think, I think the equity markets would likely demonstrate stability, and as I said, I, I'm reasonably constructive on the US equity market under a stable rate environment. Um, if rates were to come down faster, it actually might imply more damage being done to the economy from what we've experienced previously, in terms of high-rate, you know, this high-rate complex, and so, um, it depends on the pacing, but a gradual decline or even stability, and I think we are... We're in a pretty good place for equity markets, again, given the growth expectations of earnings. If, if the higher for longer expectation actually translates into a five plus ten years, I think we, that starts to get into a doing damage to the economy place that I would be a little bit more concerned about. We're not there, but we're not that far away, and so we have to keep an eye on just how, how long the rate complex and especially the short end stays high, uh, for the purpose of ensuring that those, those earnings expectations can be met.

Will McKenna: Right.

Will Robbins: I fully expect, though, in the path that the con- market consensus is calling for, little faster rate cut, or even in John's path, which is a little slower, and, um, longer and slower to wait for those rate declines will actually have a very, uh, attractive setup for equities in the, in the earnings expectations that we seek to achieve.

Will McKenna: OK, there you have it. Special thanks to Michelle, Will and John for coming on the show. Capital Ideas is brought to you by Capital Group, one of the world’s largest and most experienced active investment managers.

We're always trying to get better, so if you have any feedback, including topics you'd like to see addressed in future episodes, send us an email at

For Capital Ideas, this is Matt Reynolds reminding you that the most valuable asset is a long-term perspective.

Closing disclosure

NOTE: The following disclosure contemplates NO product/strategy mentions other than in reference to a product/strategy covered by an investment professional, which does not constitute an offer or trigger the need for product/strategy-specific disclosures.

As discussed in this podcast, “rolling recession” refers to an economic downturn that hits different sectors of the economy at different times.

“The Magnificent 7” refers to a group of seven prominent U.S. stocks: Alphabet, Amazon, Apple, Meta, Microsoft, NVIDIA and Tesla.

“P/E” refers to price to earnings ratio, a common way of valuing a company by comparing its stock price to its earnings per share.

“EM debt” refers to bonds issued by developing countries.

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