End-of-Year Encore: Macro Economy: The 2024 Outlook

Original Release on November 13th, 2023: As global growth takes a hit and inflation begins to cool, how does the road ahead look for central banks and investors? Chief Fixed Income Strategist Vishy Tirupattur hosts a roundtable with Chief Economist Seth Carpenter and Chief U.S. Equity Strategist Mike Wilson to discuss.

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Vishy Tirupattur: Welcome to Thoughts on the Market. I am Vishy Tirupattur, Morgan Stanley's Chief Fixed Income Strategist. Today on the podcast we'll be hosting a very special roundtable discussion on what is ahead for the global economy and markets by 2024. I am joined by my colleagues, Seth Carpenter, Global Chief Economist and Mike Wilson, Chief Investment Officer and Chief U.S. Equity Strategist. It's Monday, November 13th at 9 a.m. in New York.

Vishy Tirupattur: Thanks to both of you for taking the time to talk. We have a lot to cover, so I am going to go right into it. Seth, I want to start with the global economy. As you look ahead to 2024, how do you see the global economy evolving in terms of growth, inflation and monetary policy?

Seth Carpenter: Thanks, Vishy. As we look forward over the next couple of years, there are a few key themes that we're seeing in terms of growth, inflation and monetary policy. First, looks like global growth has stepped down this year relative to last year and we're expecting another modest step down in the global economy for 2024 and into 2025. Overall, what we're seeing in the developed market economies is restrictive monetary policy in general restraining growth, whereas we have much more mixed results in the emerging market world.

Inflation, though, is a clear theme around the world. Overall, we see the surge in inflation. That has been a theme in global markets for the past couple of years as having peaked and starting to come down. It's coming down primarily through consumer goods, but we do see that trend continuing over the next several years.

That backdrop of inflation having peaked and coming down along with weaker growth means that we're setting ourselves up for overall a bit of an easing cycle for monetary policy. We are looking for the Fed and the ECB each to start an easing cycle in June of this year. For the Fed, it's because we see growth slowing down and inflation continuing to track down along the path that we see and that the Fed will come around to seeing.

I would say the stark exception to this among developed market economies is the Bank of Japan. We have seen them already get to the de facto end of yield curve control. We think by the time we get to the January policy meeting, they will completely eliminate yield curve control formally and go from negative interest rate policy to zero interest rate policy. And then over the course of the next year or so, we think we're going to see very gradual, very tentative increases in the policy rate for Japan. So for every story, there's a little bit of a cross current going on.

Vishy Tirupattur: Can you talk about some of the vulnerabilities for the global economy? What worries you most about your central case, about the global economy?

Seth Carpenter: We put into the outlook a downside scenario where the current challenges in China, the risks, as we've said, of a debt deflation cycle, they really take over. What this would mean is that the policy response in beijing is insufficient to overcome the underlying dynamics there as debt is coming down, as inflation is weak and those things build on themselves. Kind of a smaller version of the lost decade of Japan. We think from there we could see some of that weakness just exported around the globe. And for us, that's one of the key downside risks to the global economy.

I'd say in the opposite direction, the upside risk is maybe some of the strength that we see in the United States is just more persistent than we realize. Maybe it's the case that monetary policy really hasn't done enough. And we just heard Chair Powell talk about the possibility that if inflation doesn't come down or the economy doesn't slow enough, they could do more. And so we built in an alternate scenario to the upside where the US economy is just fundamentally stronger. Let me pass it back to you Vishy.

Vishy Tirupattur: Thank you Seth. Mike, next I'd like to go to you. 2023 was a challenging year for earnings growth, but we saw significant multiple expansion. How do you expect 2024 to turn out for the global equity markets? What are the key challenges and opportunities you see for equity markets in 2024?

Mike Wilson: 2023 was obviously, you know, kind of a challenging year, I think, for a lot of equity managers because of this incredible dispersion that we saw between, kind of, how economies performed around the world and how that bled into company performance. And it was very different region by region. So, you know, first off, I would say US growth, the economic level was better than expected, better than the consensus expected for sure, and even better than our economists view, which was for a soft landing. China was, on the other hand, much worse than expected. The reopening really never materialized in any meaningful way, and that bled into both EM and European growth.

I would say India and Japan surprised in the upside from a growth standpoint, and Japan was by far the star market this year. The index was up a lot, but also the average stock performed extremely well, which is very different than the US. India also had pretty good performance equity wise, but in the US we had this incredible divergence between the average stock and the S&P 500 benchmark index, with the average stock underperforming by as much as 12 or 1300 basis points. That's pretty unusual. So how do we explain that and what does that mean for next year? Well, look, we think that the fiscal support is starting to fade. It's in our forecast now. In other words, economic growth is likely to soften up, not a recession yet for 2024, but growth will be deteriorating. And we think that will bleed into further earnings deterioration.

So for 2024, we continue to favor Japan, where the earnings of breadth has been the best looks to us, and that's in a new secular bull market. In the US, it's really a tale of two worlds. It's companies that have cost leadership or operational efficiency, a thing we've been espousing for the last two years. Those types of companies should continue to outperform into the first half of next year. And then eventually we suspect, will be flipping pretty aggressively to companies that have poor operational efficiency because we're going to want to catch the upside leverage as the economy kind of accelerates again in the back half of 2024 or maybe into 2025. But it's too early for that in our view.

Vishy Tirupattur: How do you expect the market breadth to evolve over 2024? Can you elaborate on your vision for market correction first and then recovery in the later part of 2024?

Mike Wilson: Yes. In terms of the market breadth, we do ultimately think market breadth will bottom and start to turn up. But, you know, we have to resolve, kind of, the index price first. And this is why we've continued to maintain our $3900 price target for the S&P 500 for, you know, roughly year end of this year. That, of course, would argue you're not going to get a big rally in the year-end. And the reason we feel that way, it's an important observation, is that market breadth has deteriorated again very significantly over the last three months. And breadth typically leads the overall index. So until breadth bottoms out, it's very difficult for us to get bullish at the index level as well. So the way we see it playing out is over the next 3 to 6 months, we think the overall index will catch down to what the market breadth has been telling us and should lead us out of what has been, I think a pretty, you know, persistent bear market for the last two years, particularly for the average stock.

And so we suspect we're going to be making some significant changes in both our sector recommendations. New themes will emerge. Some of that will be around existing themes. Perhaps AI will start to actually have a meaningful impact on overall productivity, something we see really evolving in 2025, more than 2024. But the market will start to get ahead of that. And so I think it's going to be another year to be very flexible. I'd say the best news is that although 2023 has been somewhat challenging for the average stock, it's been a great year for dispersion, meaning stock picking. And we think that's really the key theme going into 2024, stick with that high dispersion and stock picking mentality. And then, of course, there'll be an opportunity to kind of flip the factors and kind of what's working into the second half of next year.

Vishy Tirupattur: Thanks, Mike. We are going to take a pause here and we'll be back tomorrow with our special year ahead roundtable, where we'll share our forecasts for government bonds, corporate credit, currencies and housing. As a reminder, if you enjoy the show, please leave us a review on Apple Podcasts and share Thoughts on the Market with a friend or colleague today.