January 2024 insight: Valuations temper outlook

Alastair George believes that 2024 follows Q423’s extraordinary rally in global government bonds. Combined with a dovish pivot in US interest rate policy in December, financial conditions have eased considerably in a matter of weeks. Provided inflation continues to fall towards central bank targets, this represents a constructive foundation for equity markets in 2024. Nevertheless, bullish views also need to account for over-extended US equity valuations, in our view. The ‘easy money’ has been made in government bonds as yields are now much closer to those likely to prevail over the medium term. We viewed long-term yields close to 5% as unsustainable – but equally a second period of ultra-low interest rates this decade is unlikely, in our view. US government bonds now appear within sight of levels consistent with inflation targets and long-term GDP growth. Geopolitical risks are not diminishing. The market reaction to events in Gaza has been modest to date and the war in Ukraine is for now perceived by markets as a static regional conflict. Success in diversifying energy supplies in Europe means stable energy markets and investors have become insensitive to the risks. Nevertheless, escalation in either Ukraine or the Middle East could disrupt energy markets and supply chains, potentially rekindling inflation. Even as the initial ESG investment craze has diminished in recent years, the actual economic disruption caused by climate change is increasingly evident with 2023 the hottest year on record and even institutional investors who do not have a specific ESG mandate have a duty to assess future policy and economic disruption risks within portfolios. Investors start 2024 with a solid foundation in terms of the outlook for US interest rates and long-term government bonds. We maintain a neutral outlook on global equity markets following the rally of Q423 as equity valuations have risen in tandem with declining bond yields, tempering the bullish case for global equities. US equity markets appear to be fully priced at present and upward revisions to earnings estimates may be required to sustain the current market momentum. 

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