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Episode 20 - Outlook 2024: Long-term perspective on markets and economies – Part 1
Mario Gonzalez Perez
Managing Director Financial Intermediaries Iberia
Robert Lind
Economist
Flavio Carpenzano
Investment Director
Katharine Dryer
Head of Equity Business Development

Heading into 2024, it is difficult to remember another time when the outlook was so uncertain. Recession or expansion? Inflation or deflation? Higher interest rates for longer or central banks preparing to pivot? The first of a two-part series features Mario Gonzalez Perez in conversation with Capital Group economist Robert Lind, fixed income investment director Flavio Carpenzano, and head of equity multi-asset and solutions business development, Katharine Dryer. Together, they outline their long-term perspective on markets and economies.



Mario González-Pérez is head of the Iberia and U.S. Offshore Client Group at Capital Group, and is co-responsible for leading the company’s Spanish branch. He has 20 years of investment industry experience and has been with Capital Group for 19 years. Prior to joining Capital, he worked at Banco Santander in Madrid. He holds an executive MBA with distinction from London Metropolitan University and a bachelor’s degree in computer science engineering from Universidad de Valladolid, Spain. Mario is based in Madrid.

Robert Lind is an economist at Capital Group. He has 35 years of industry experience and has been with Capital Group for six years. Prior to joining Capital, Robert worked as group chief economist at Anglo American. Before that, he was head of macro research at ABN AMRO. He holds a bachelor's degree in philosophy, politics and economics from Oxford University. Robert is based in London.

Flavio Carpenzano is an investment director at Capital Group. He has 18 years of industry experience and has been with Capital Group for two years. He holds a master's degree in finance and economics from Università Bocconi. Flavio is based in London.

Katharine Dryer is Head of Equity Business Development for the Europe and Asia Client Group. She has 25 years of investment industry experience and has been with Capital Group for 1 year. Prior to joining Capital, she has worked at Jupiter Asset Management as deputy chief investment officer, and at BlackRock as a Client Strategist. She holds a master’s degree in modern and medieval languages from the University of Oxford, and an MBA from Cass Business School. Katharine is based in London.


Catherine Craig: This week on Capital ideas we're bringing you this two-part podcast on our most popular event of the year, the 2024 Outlook.

In this replay, head of the Iberia and US offshore client group, Mario Gonzalez Perez is in conversation with our economist Robert Lind, our investment director Flavio Carpenzano, and our head of equity multi-asset and solutions business development, Katharine Dryer. Together, they outline their long-term perspective on markets and economies. I'm your host, Catherine Craig. Let's get into it.

Mario Gonzalez Perez: My name is Mario Gonzalez, I’m a sales director for Capital Group in Europe and your host today. We were chatting before we started today about how difficult it is for all of us to think about any other time, you know, with such a high level of uncertainty in the market. Is it going to be a recession or is it going to be an expansion. Is it going to be high rates or is it going to be lower rates. Is it going to be inflation or is going to be deflation. So, there are so many questions, very important questions that all investors have currently. And we'll be touching on those as part of the conversation today. For these I have the pleasure today to have three very senior and very qualified members of our investment group. So, these are Robert Lind, Katharine Dryer, Flavio Carpenzano. Rob is with 35 years of experience in the market, is our chief economist in Europe. And with his help, we are going to be drawing that macro picture for 2024 and beyond. Then, based on that macro panorama and with help of Katharine and Flavio, we are going to be sharing with you our views on both equity and the fixed income markets. And most importantly, we are going to be also identifying where we see value in those asset classes. Katharine with over 26 years of experience in the industry, is our equity and multi-asset asset class lead in Europe and Asia. And Flavio Carpenzano, with 18 years of experience in the markets, he's one of our senior fixed income investment directors based in London. So, three key areas to touch on today, macro, fixed income and equities.

So, Rob, with no further delay, let's start drawing that macro picture. I guess we're going to start with the US, the largest economy in the world, back in 2021, December 2021. If I remember correctly, you already warned us in this same setting about inflation that could be perhaps more persistent than what the market was anticipating at the time. I think since then the reality is that inflation is going the right direction. We have seen a couple of very positive prints in the US and in Europe. So, I guess the first question is on the direction of inflation and rates in the US. So, what our views both for inflation and rates in the US economy.

Robert Lind: Well, thanks Mario, for starting with an easy question. I think it's fair to say that there's a lot of debate within our team about what happens to inflation and interest rates in the U.S. I think there's a very strong divide between those people who think that we've now seen the worst of the inflation numbers want a smooth glide path to target. And those people who think it's going to be more problematic, I side with those who think we are seeing more of a problem as far as US inflation is concerned, yes, we've seen this reduction in headline inflation. Core inflation has started to moderate. But I do think that over the course of the next year, it's going to be more difficult to ensure that inflation continues to fall back towards the Fed's target. And I think that's part of the reason why I'm a little bit more sceptical than the markets are at the moment about how far the Fed we will be able to cut interest rates in 2024. I think the Fed is likely to want to see confirmation that inflation is moving back towards target before it sanctions those rate cuts and I think that could well take most of 2024 before we get to that confirmation.

Mario Gonzalez Perez: Excellent. So, yes, and making notes as you speak. So, you think that that last mile of inflation, perhaps, you know, it is proven to be tougher than anticipated? The markets are already discounting some interest rate cuts in the US., so, first part of next year. But you feel that might not happen. What about in Europe? I think the market is also discounting perhaps rate cuts in Europe ahead of the US. What are your views of both on inflation but also on interest rates from the central bank in Europe?

Robert Lind: In Europe, the inflation story was predominantly about energy. That's what drove the pickup in headline inflation last year. Increasingly over the course of the last six months, we started to see that story change. It's become less about energy, and it's become more about wage growth. And I think here in Europe there is probably more concern even than in the US about that wage growth and its likely impact on inflation in 2024. For instance, we can see in Germany, we can see in the UK very deliberate attempts by workers to recoup some of those lost real income gains that were the effect of higher energy prices. I think that's feeding through into higher wage growth. That wage growth is going to be with us for much of 2024, even if it doesn't accelerate further from here. I think the extent to which wage growth will fall back is likely to be fairly limited given that labour markets are still pretty tight. And so, I think that is likely to lead to much greater inflation persistence. So actually, I'm perhaps more concerned about inflation underlying inflation in Europe even than in the US.

Mario Gonzalez Perez: Excellent. So, that inflation in Europe is transitioning from being an energy inflation to more on wage growth. So, we feel it might be more structural views on the US dollar. So, we have seen the dollar very, very strong for a number of years. Do you feel that in the short term that's going to continue? What about if we look at the mid and long-term prospects of the dollar? Do we think that the dollar is starting to go into a multi-decade sort of declining cycle or what our views are on the dollar?

Robert Lind: I think in a sense, the way to think about the dollar is to regard it a bit like a growth stock in the equity market. What I mean by that is that the US dollar from a valuation perspective, looks as if it's overvalued now. Lots of indicators, whether you look at purchasing power parity or more sophisticated measures of overvaluation, would suggest that the dollar is significantly overvalued against almost all other major currencies. But I think the problem with those overvaluation metrics is that they don't really give us a catalyst for it changing. And as we know, exchange rates can overshoot for quite a long time, several years in many instances, particularly the dollar, the dollar has had these very pronounced up cycles periodically over the course of the last 30 or 40 years. So, I think we need to be very clear that even though there is a strong valuation argument against the dollar, it's highly likely that better US growth prospects will continue to suck capital into the US and continue to drive the dollar up. And that's certainly the view of our strategist. I think we are likely to see, at least in the early part of 2024, further dollar strength. And I think it's perhaps only once we get towards the turning point in the Fed's interest rate cycle, once we get that confirmation that the Fed is going to start cutting interest rates, I think that would be the catalyst for the dollar to weaken. But I really don't see that happening until well into 2024.

Mario Gonzalez Perez: Excellent. So, I really like the analogy of the dollar. And you know, the growth is so big and so clearly the turning point is going to be when the Fed starts cutting rates. Until then, we feel that the dollar is going to remain strong. You mentioned about growth in the US economy in this time last year we were anticipating some sort of recession in the US. Reality is that, you know, that has materialised. So why has been the case? Do we still feel there's going to be recession in the US? Has the US gone through some sort of like recession across different sectors? And what are your views on the growth for the US economy for next year?

Robert Lind: Well, this is a very big debate, is probably even more of a debate in our team than the inflation debate. And I think it largely rests on the view that a recession is almost inevitable after you've had such strong growth. The question, I think, is rather what kind of recession are we likely to see? Because I think there is a sense that almost a kind of moral argument that after such a period of strong growth, we need to see quite a significant recession to take out some of the excesses? I think we are worried that that is still a potential risk, but our most likely outcome now is that we actually see a soft landing. And what we mean by that is that, yes, the US economy can't continue to grow at the kinds of rates that we've seen over the last few quarters. 5% annualised GDP growth is not sustainable in the US. A more sustainable rate would be around maybe one and a half to 2%, and that's the rate that we expect to see through most of 2024, perhaps with 1 or 2 quarters below that. But certainly, that would represent to us a soft landing rather than anything more serious, a recession that would entail fairly significant contractions in GDP, fairly significant rises among employment, as I say, is a risk scenario, but it's not our most likely scenario as things stand today.

Mario Gonzalez Perez: So, it's more of a deacceleration of growth in the US rather than a recession, not traditional recession as we as we know it. What about in Europe? I mean, we saw Germany, the engine of growth in Europe being technical recession. You know, we have seen some southern European economies are slowing down in the last quarters. What are your views in terms of growth of the European economy for 2024?

Robert Lind: It's very easy to be very pessimistic about Europe, and many people are. I've been fairly cautious about growth through the second half of this year because I think there are problems, particularly in the industrial sector and we know the reasons for that. It's about Germany in particular, and it's partly the overhang of the post-pandemic boom, but it's also the weakness of growth in China and other major industrial countries. So that is a problem. I think there are some signs that that problem is now starting to abate. We're starting to see signs that the inventory levels, which got to very high levels, are starting to come down. And I think that does mean that early in 2024, I'd expect to see a rebound in the industrial sector. I think the other thing that's important from a European perspective is that consumers haven't really gone on the kind of spending splurge that we've seen in the US. Yes, we saw some rebound in consumption, particularly in tourism, after the reopening from the pandemic, but we haven't seen the kind of debt fuelled splurge that would typically lead to a significant fall in consumption. And if anything, over the course of the next 12 to 18 months, I think we're going to see some positive factors still work through, most notably those lower energy prices and lower headline inflation rates should give a boost to real incomes. So, I think European consumers could actually be surprisingly robust over the course of the next year or two. So, for those two reasons, I think the European growth pessimism that we currently see is exaggerated. I'm not about to suggest that Europe is going to enjoy the kinds of growth rates we've seen in the US. But I do think that over the course of the next year we should start to see a strengthening in economic activity that should continue into 2025.

Mario Gonzalez Perez: Excellent, and we will talk later on with Katharine and with Flavio about opportunities in the European space, both in fixed income and in equities. A soft landing in the US with the acceleration of growth and a quite constructive on Europe thinking that there's going to be a rebound on the industrial sector and a room for growth. From a consumption point of view for the European economy. This time last year as well, you were quiet, I guess, against the consensus of the market on China. You know, the third largest engine of growth for the global economy. At the time, the markets were very excited about the reopening of the economy after a very tough period of zero COVID policies. At the time, you already were warning us that that that growth of the Chinese economy was going to be more in the 3-3.5% range rather than the 5% that the market anticipated. I think time proves you right. What are your views? Our views on China for 2024 and beyond.

Robert Lind: I have to give credit to my colleague Stephen Green, who called the Chinese slowdown a few years ago and has been still very cautious about China's growth rate. He argues that for both economic reasons and political economy reasons, what's happening in the political system in China at the moment? He would argue that China is slowing to an underlying growth rate, as you say, which is closer to 3% than the 6% that we got used to a few years back. So that's the sort of structural story. I think the question where there is a lot more uncertainty is what is likely to be the policy response from Beijing to the cyclical pressures which are building? Because I think we are seeing evidence that there is overcapacity in some parts of the Chinese economy that's creating some disinflation or deflation in certain industries. And I think the government is very aware of the dangers of that, not least because it's looked at the example of Japan, for instance, and seeing the problems that entrenched deflation can cause. So, I think there is a lot more speculation now about the government doing something in terms of fiscal expansion to try and mitigate some of those growth risks. But I think the way to think about that is not that China wants to get growth back up strongly, but rather it just wants to put a floor under the economy and prevent it from getting worse. And I think that is certainly a view that is consistent with what we will see in Europe, this kind of mild recovery underpinned by stronger demand from China. But it won't be the kind of strong surging growth that we saw when China lasted major stimulus programs following the global financial crisis in 2009, 2010, and then again in 2015, 2016. The stimulus is much smaller. This time it's more about managing the downside rather than trying to create lots of upside.

Mario Gonzalez Perez: So, China will definitely have a different role than the one that it had after the global financial crisis four years ago. So, Kathy, let me bring you into the conversation at this stage. I mean, earnings growth, consensus from analysts are very, very strong, both in developed markets and emerging markets. What are our views on these that we feel that this could be a supporting factor for equity markets next year.

Katharine Dryer: I think we have to acknowledge that we're coming off a very challenging 2023. So, as we as we look forward and consensus estimates, as you say, are very optimistic. If we look at where the pickups are coming, it's coming from I.T., health care materials. So quite broad in terms of that expectation of recovery and earnings growth. We are at the beginning of the year, so we should expect some revisions as we go through the year. And I think we just need to be cognisant as well that these numbers are likely factoring in that sort of soft-landing scenario. So, there's more scope here, we think, for downside if that disappoints rather than upside, if it's if it's a better outcome for the overall economy.

Mario Gonzalez Perez: Perfect. So still constructive, but perhaps less optimistic than the market consensus. Rob, 2024 We are starting an election year for the US. We are a month away from the beginning of the primaries on the Republican Party in Iowa and New Hampshire. So, what are the key factors that you watch for, you know, ahead of a US election?

Robert Lind: Well, I think it's important to try and look beyond the personalities and think about what the likely consequences are going to be for economic policy. And I think there are a couple of areas where markets will want some guidance fairly quickly from both the White House and Congress. I think the first is in terms of the outlook for the budget deficit and fiscal policy. Over the course of the last year, we've seen a fairly significant expansion of the budget deficit in the US because of the Biden stimulus plans and the green transition. Increasingly over the course of the next few years, it looks as if on current forecasts, those deficits stay pretty high. So, a new president who comes in and maybe wants to turbocharge the economy again by cutting taxes or increasing subsidies might need to think about the longer-term consequences of that. And I think it's always possible that markets might start to fret about the sustainability of the US budget position. I think the second issue, particularly if we see a Republican president, is the potential for there to be some more trade tension with China. The tariffs that were introduced under the Trump administration in 2016, we can now see had a very negative impact on inflation that triggered the first rise in inflation. That started to cause some of the problems pre-pandemic that started to cause issues for the Fed. I think if we see much more aggressive trade measures and certainly that's the speculation and it's possible, we could see this as much from a Democrat president as a Republican. If we do start to see much more aggressive actions on the part of the US in terms of tariffs on Chinese imports, then I think that does raise significant questions for me about potential consequences for medium term inflation. So, I think those two things are going to be very, very important, not just for markets but increasingly for the Federal Reserve as well.

Mario Gonzalez Perez: Excellent, so budget deficit and how sustainable that is in the future. And then those trade tensions in China and the potential return of tariffs, especially if there is a Republican president. In every sort of electoral cycle as we get closer to November, Katharine, there is always those questions from clients about the real impact of having a Republican administration or a Democrat administration to the equity markets. Is there is a real impact really, especially when we think about in the mid-long term.

Katharine Dryer: I think we know to expect volatility. You know, markets will fret at certain points, but if we take history as our guide, actually if you look at past election years, the market hasn't been particularly impacted. It's still been possible to have good returns in election years and there's no clear market friendly winner, whether it's Democrats or Republicans, we don't see a big differential in historic returns. What we do see, if we look at history, is quite a lot of volatility coming into the primaries and then a potential for quite a strong bounce after that. And I think we're particularly waiting for who the Republican nominee is that that will create volatility here. I think we're braced as well for a bit of sector specific noise. Health care is the one that typically gets caught in the crosshairs. So that in a way, if you’re a long-term investor, can create some good entry points. And the one final thing that we do note in election years is that investors can be just that little bit more cautious and prone to stay in cash. But if you do look at the returns, you're actually not rewarded for doing that.

Mario Gonzalez Perez: And we'll come back to that point of having so much cash on the sidelines. So, Rob, I remember talking to you some time ago during the pandemic that about the role of governments globally. So, we saw that the pandemic was the fact to an inflection point about the role of governments within societies, you know, taking a much more paternalistic self-approach and increasing social budgets. So, I guess the question was now the pandemic is over? Do you feel that that's a temporary approach? Do you feel that actually governments are going to sustain, you know, that type of approach? And if so, what are the key impacts of that more of involve role of governments globally?

Robert Lind: I think history shows that we do see these big changes. It can take some time for those changes to become clear. But obviously, the last big policy change that we saw was in the late 1970s, early 1980s with the Thatcher Reagan liberalisation agenda, if you like, and much greater concern about inflation and containing budget deficits. What's interesting is that I think this combination of populism, the rising tide of populism in many countries, coupled with the impact of the pandemic and then more recently the war in Ukraine and even more recently than that, the war in Gaza has, I think, increased concerns that governments need to provide much more security for their populations. And populations themselves across the age range are actually demanding more security from governments. They want governments to intervene in economies because I think there is a growing sense that economies haven't worked for everybody. There hasn't been the kind of inclusive growth that I think we got used to in the 1950s and 1960s. And I'm not saying it's going to be easy to get back to that, but I do think there is an appetite among electorates and politicians to at least try and revisit some of that, and that does require greater government intervention. I think at the very least it means we're likely to see many governments running much larger budget deficits as they increase public spending on a wide range of areas health, education, transport, war, climate transition. Those kinds of issues, I think are going to require much greater fiscal spending. I think the other thing we should expect to see is that governments are going to intervene in economies, particularly as they promote industrial policies in their economies, to try and fend off the threat or the perceived threat from other countries. We're obviously seeing this in the US already with the perceived threat from China. I suspect we'll see similar kinds of things in many European economies. So, I do think that governments around the world are going to use much more activist industrial policy. So, this combination of looser fiscal policy and greater industrial activism does mean that we should get used to governments intervening across markets in a way that we've not seen for many years. And I think that is going to cause some issues in financial markets, not least because it could lead to higher and more volatile inflation and interest rates. So, I think that's an issue that we are going to have to think about in the medium to longer run.

Mario Gonzalez Perez: Excellent, thank you so much for that, Rob. So clearly you could be in the middle of a turning point, and we should be expecting larger deficits on, you know, governments across the world. And that will have an impact to more fiscal spending. And as you mentioned that potentially more intervention from a number of governments in their economies. You mentioned the conflict in Ukraine that we saw last year started. And, you know, that has continued over this year. We see also the starting of the conflict in Gaza after the terrorist attack on October the 7th. So, what are we expecting from those conflicts? And it is quite difficult to predict, but are we expecting those to potentially escalate? And do you feel that perhaps, you know, there's going to be a much more significant impact to the markets in the new year?

Robert Lind: Well, I think it's pretty clear that forecasting the course of a war is even more perilous than forecasting the course of an economy. I do think to your question that we should expect the Russia-Ukraine War to become effectively a continuation of what it is at the moment, which is almost a de facto standoff between Russia and Ukraine. I think that means that it could last for several years yet before we start to see any kind of resolution to that conflict. And I think in the Middle East, it's clear that given what we've seen in Gaza and in Israel over the course of the last few months, there is the potential for that to escalate further and spill over into the rest of the region. I have no idea whether that will happen, but that is a risk that I think many of my experts who work in political economy are sort of highlighting for 2024 and 2025. As an economist, I think the most important issue that we need to think about with both conflicts is the way in which this affects risk premiums in markets, but also the way in which they affect energy prices. Because we know from previous conflicts in both regions that energy prices can be quite significantly affected. And I would worry not just about oil, but about natural gas. And I think in those circumstances, we need to be aware that even though the current inflation numbers have improved quite significantly, it wouldn't take very much for those inflation numbers to start to go back up again if we did see spikes in energy prices and associated spikes in food prices and other commodities.

Mario Gonzalez Perez: Excellent, thank you for that, Rob. And of course, our thoughts and prayers are with the victims of those conflicts.

Closing disclosure

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

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