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Summer 2024 Investment Outlook – July 23 Replay

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At a glance

The year’s second half brings significant events alongside the usual capital market cacophony: The U.S. campaign season alongside elections in several key countries, NATO and G20 summits, the Olympics and other major developments set to unfold. The Federal Reserve (Fed) and other central banks remain in focus as investors anticipate a transition from officials raising interest rates to cutting rates. Businesses and consumers continue to show strength, with some divergence under the surface at the country, sector and income distribution levels, requiring investors to anticipate marginal change. While the global economy is expected to slow, the growth impulse remains positive and corporate earnings continue to deliver despite high expectations.

Asset classes had mixed performance to start 2024, with global equities providing positive total returns led by the United States and followed by emerging markets and developed international. Bonds remain more sluggish due to sticky inflation pressures impacting prices, which has helped commodities thus far in 2024. Real Estate stocks have been underwhelming to kick off the year, with income offset by weaker prices as investors weigh how much further repricing may exist across office, multifamily and other property market subsectors.

We continue to hold a positive forward outlook for diversified portfolios. Our bias has been to favor equities and real assets over fixed income; we remain optimistic on consumer and business spending with companies continuing to prioritize shareholders through stock buybacks and dividends. Inflation will likely gradually recede but remain pesky, and investors could seek inflation protection in portfolios through commodities. We do see several opportunities for bond investors across both taxable and tax-exempt fixed income, but we emphasize diversified yield sources.

While we maintain a constructive forward view, we are mindful of election risks, commercial real estate woes, ongoing geopolitical tensions, potential consumer and business deceleration that exceeds expectations, and other variables that could drive adverse capital market activity. Our process remains team oriented, global in scope and data driven. We appreciate the opportunity to share views across the capital market landscape through our team-based approach.

― Eric Freedman, Chief Investment Officer, U.S. Bank

Global economy

Quick take: The U.S. economy remained solid in 2024’s first half with strong growth, moderating inflation and a tight labor market. Developed market economies are delivering a modest recovery as global central banks begin to trim interest rates. Emerging market economic growth is diverse; China is struggling to reignite activity, India remains resilient and regional Asian economies are benefiting from technology infrastructure spending.

  • Continued spending by U.S. consumers remains a key factor to support economic growth into year-end as they adjust to higher borrowing costs and higher prices. Low unemployment, solid wage gains and ample job openings support consumers and their adaptability to higher interest rates. Government spending into the election could lift economic growth. Inflation continues to ease since peaking at 9.1% in 2022, though it remains elevated relative to the 2.2% average for the prior two decades. Slowing shelter cost increases should ease price pressures, but inflation is unlikely to reach the Fed’s 2% target this year amid a tight labor market. This summer, investor attention turns to the platforms of presumptive candidates President Joe Biden and former President Donald Trump. While market returns historically depend more upon the path of the economy than election outcomes, specific sectors and industries are often influenced by candidate and party policy agendas.
  • Europe and the United Kingdom are seeing a modest recovery from recessions as their central banks start lowering interest rates, and Japan continues to benefit from rising wages. Growth levels are likely to remain modest but positive as inflation slows and consumers and businesses across Europe, Japan and the United Kingdom adjust to the highest interest rates in a decade. The recent recovery remains shaky and dependent upon the pace and path of global central bank interest rate policies, the potential recovery of global trade and the impact of regional conflicts in Gaza and between Russia and Ukraine on raw materials costs.
  • The Chinese economy continues to struggle through weak consumer sentiment amid challenges in the housing market. Growth is unlikely to accelerate into year-end without stronger stimulus measures to revive consumer sentiment. Economic growth in Taiwan and South Korea is supported by strong global technology spending on artificial intelligence (AI) infrastructure. India has seen remarkable economic growth for the past two years and post-election policies may sustain the economic momentum, though the recent election led to a more divided government than forecasters expected. Moderating oil prices likely mean slowing growth in Brazil and Mexico.

U.S. equity market

Quick take: AI enthusiasm continues to push broad U.S. equity indices higher in 2024. Decelerating inflation, moderating interest rates and stable earnings growth are directionally consistent with higher equity prices.

  • U.S. equities begin the third quarter on the heels of strong year-to-date performance led by large technology companies. The 20 largest S&P 500 companies are outpacing the index by more than a two-to-one margin so far this year, led by AI bellwether NVIDIA, which advanced 149%.
  • Waning inflation, moderating interest rates and stable earnings projections support higher-trending U.S. equity prices in the second half. At current price levels, the S&P 500 trades at 22.4 times the consensus 2024 earnings estimate of $244 per share, according to Bloomberg, FactSet and S&P Cap IQ, at the high side of its 25-year historical average, yet short of extremes.
  • Consumer spending appears to be broadening out while business spending remains robust. We are seeing early spending indications on durable goods and apparel, positive catalysts for Consumer Discretionary companies in the coming quarters. At the same time, surging demand for accelerated computing and generative AI continues across nations, industries and companies. Companies and countries are looking to employ AI capabilities to improve and modernize their workflow, reach production faster and improve accuracy and efficiency.
  • We favor balanced exposure to both technology-oriented growth sectors and defensive, income-oriented sectors. We see compelling investment opportunities over both the short- and long-term in areas such as data capture, storage, processing, software and analytics, security, distribution and power generation. At the same time, defensive/income-oriented sectors such as Real Estate, Consumer Staples, Industrials and select Healthcare companies should respond favorably to an eventual less-restrictive Fed policy stance. A balanced approach combining growth-oriented technology and defensive sectors provides exposure to evolving technologies while capitalizing on favorable risk profiles of sectors and companies that have lagged during the rising interest rate environment.
Chart shows the 20 largest companies in the S&P 500 and their year-to-date return through June 14.
Source: FactSet, June 14, 2024. Top 20 company weighted average (uses current weight).

International equity markets

Quick take: Policy support remains a key variable driving foreign developed equity returns, while broadening sector and constituent company participation highlight positive market momentum heading into 2024’s second half. Idiosyncratic return drivers lead to a mixed outlook across emerging market equities.

  • Foreign developed equities remain highly sensitive to interest rates and credit conditions. Cyclical sectors, representing 50% of total foreign developed equity exposure, assumed leadership from secular growth sectors in the second quarter. The European Central Bank (ECB) reduced its policy rate on June 6 for the first time in eight years, while the Bank of Japan (BoJ) ended its negative interest policy in March. Easing ECB monetary policy supports improved European credit demand and economic activity while positive BoJ interest rates bolster Japan’s Financial sector profitability outlook.
  • Broadening market participation supports our overall glass half-full outlook. In March markets witnessed a watershed moment, with Japan’s domestic equity market eclipsing its previous all-time high set 35 years ago. Major European markets also broke out to new highs in the second quarter, with positive year-to-date returns evidenced across 10 of the largest 11 country allocations as of June 30. Despite modest declines in June, more than 50% of foreign developed constituent companies across most individual countries continue to trade above their respective 100- and 250-day average closing prices, highlighting broad foreign developed market participation and technical strength heading into 2024’s second half.
  • Emerging market equities delivered mixed second quarter performance while the forward outlook varies across individual countries. South Korea and Taiwan appear particularly well positioned to benefit from continued AI spending, with semiconductors representing one-third of both countries’ respective domestic equity market capitalization. Indian equities rallied to a new all-time high after national elections resulted in Prime Minister Modi’s governing party continuity, with strong economic growth projections supporting the country’s robust profit outlook. Meanwhile, domestic internet and retail companies dominate China’s stock market, representing more than 40% of total market capitalization. Low consumer confidence and weak spending contributed to three consecutive annual declines in China’s stock market from 2021 to 2023, and policymakers’ success in stimulating consumer demand remains a critical driver for China’s second half outlook.
Chart shows select developed markets and the percentage of country index constituent prices above their average closing price over trailing time periods.
A positive trend indicates that the 15-day average country equity market index price is higher than its respective 50-day or 200-day average price. Sources: Bloomberg, U.S. Bank Asset Management Group, June 17, 2024.

Bond markets

Quick take: High-quality bonds offer compelling yields, but inflation remains a lingering risk for bond prices. Supplementing high-quality bond allocations with riskier high yield bonds and unique fixed income exposures like non-agency mortgages and insurance-linked securities (reinsurance) can boost and diversify portfolio income.

  • Bond market yields imply a gradual interest rate cutting cycle starting later in 2024 that aligns with the Fed’s patient approach. Inflation remains higher than policymaker expectations. In response, Fed officials have expressed little urgency in cutting rates. Today’s relatively high Treasury yields should adequately compensate investors for the uncertainty of Fed policy changes.
  • Stable U.S. Treasury sales and tapering Fed balance sheet maturities relieved investor fears of rising Treasury supply. The Treasury expects to keep sales of long-term bonds stable for the rest of this year relative to the past two quarters by issuing more short-term Treasury bills, despite longer-term imbalances and high deficit spending. In June, the Fed slowed the pace at which it is shrinking its balance sheet to allow $25 billion in Treasury bonds to mature each month without reinvestment, a drop from the prior pace of $60 billion per month.
  • Corporate bonds can provide meaningful income returns despite their somewhat rich valuations. Nominal corporate bond yields remain elevated, near their highest level since 2009, due to high U.S. Treasury yields. However, the extra yield on corporate bonds over Treasuries held at relatively low levels in the second quarter, limiting the degree of potential for bond price gains beyond Treasuries. Municipal bond valuations are closer to historic norms, creating attractive income opportunities. The potential for issuance headwinds to fade in the typically quieter summer months sets up favorable return opportunities in municipal bonds.
  • Mortgage bonds not backed by the government and reinsurance offer compelling income with unique return characteristics. Mortgage bond fundamentals remain solid. Home price gains in recent years create strong collateral support, and mortgage delinquencies remain low. Slow housing market activity also continues to constrain new mortgage bond supply, providing a favorable technical tailwind. For qualifying investors, reinsurance (insurance-linked securities) offers above-average yields, currently exceeding 10%. This income compensates for insurance payout risks stemming from global catastrophes such as hurricanes. These events can be sporadic, and reinsurance can provide a meaningful and differentiated source of return that is uncorrelated with the normal business cycle.
Chart show Treasury net bond issuance less Fed purchases as a percent of GDP.
Source: U.S. Bank Asset Management Group Research, Bloomberg, U.S. Treasury; Data period: December 31, 2002-March 31, 2024. Forecast assumes net Treasury issuance according to the Treasury’s Sources and Uses Table with ongoing $60 billion in Fed Treasury runoff per month.

Real assets

Quick take: Publicly traded real estate investment trusts (REITs) are poised to generate solid returns should interest rates fall. Additionally, increased capital expenditures to power AI and “green” energy should benefit infrastructure companies and commodities.

  • Public REITs trade at discounts to the value of the properties within the portfolios, providing a cushion to prices if fundamentals deteriorate more than expected. Aside from property types with idiosyncratic risk factors, like office and retail, which are adjusting to how people work and shop, most property types are performing well fundamentally, with vacancies and earnings growth at long-term averages, though income growth is slowing. Fundamentals for the industrial, residential, cellular tower and data center real estate sectors appear to be stable.
  • Utilities and midstream energy companies should continue to generate above-average income growth, with increasing demands for electricity from data centers benefiting both. These sectors also continue to produce strong and stable dividends for income-oriented investors.
  • The energy needs to power AI and the green technologies will require a material increase in demand for fossil fuels and various metals for an extended period. The supply side of the commodity market faces challenges due to lack of investment in productive capacity, which has lengthened timelines to create new supply. Additionally, global conflict has the potential to reduce supply and lengthen delivery times leading to supply shocks. This favors investments in commodities and the companies that extract, transport and process them.

Alternative investments

Quick take: Hedge fund managers are positioning for opportunities amid geopolitical and macroeconomic volatility, with this year’s historic national elections covering half of the world’s population creating additional uncertainty. Tactically oriented managers who stay nimble and can trade quickly appear well suited for this environment.

  • Hedge funds generated modestly positive first half returns, and the market backdrop remains constructive for many strategies. Managers navigated bounces in technology stocks, interest rates and commodities, moving from a risk-on (more aggressive) sentiment in the first quarter to more defensive positioning in the second quarter over inflation and economic growth concerns. Equity market neutral, a strategy buying long select securities while selling others short, is one of the best-performing strategies this year, while positive commodity price momentum benefited trend-following strategies.
  • Managers investing in distressed debt and corporate restructurings generated higher returns this year compared to many other hedge fund strategies. An extended period of high financing costs continues to challenge highly leveraged companies, and the current credit cycle is unusual, with a higher default rate for loans issued by leveraged companies than similar credit quality corporate bonds. We continue to see attractive opportunities for relative value hedge fund managers who can position their long and short portfolios accordingly.
  • We anticipate more defensive positioning and oscillating risk appetites across most hedge fund strategies leading up to the U.S. elections on November 5. Additional market pullbacks may also encourage some managers to position portfolios for upside volatility. Hedge funds are eager to show their ability to generate returns through both risk-on, risk-off and volatile transitions between these two paradigms. Managers who stay agile and appropriately size the risks in their portfolios for conditions that may quickly change appear well-positioned in this environment.

Private markets

Quick take: Private equity investment managers continue to drive value by acquiring smaller businesses to build up their existing portfolio companies in fragmented industries. Investment managers are also actively acquiring corporate carveouts, identifying opportunities to implement value creation strategies on these often-undermanaged subsidiaries of larger companies.

  • Despite a slow start to the year, indications point to a pickup in deal activity in 2024’s second half. The primary factors supporting our view include a large amount of capital raised by private market investment managers that has yet to be deployed, aging funds that are approaching end of the term and a supportive economic backdrop. A sharp slowdown in economic activity, stubborn inflation that does not trend down to the Fed’s 2% target and persistently higher interest rates would present challenges to our positive thesis.
  • An outright sale or company listing on a public exchange remain the most natural paths to driving liquidity back to investors. In lieu of traditional exit paths, investment managers have been creative in delivering cash back to investors through dividend recapitalizations and through the sale of companies to a continuation vehicle. A continuation vehicle is a new fund the investment manager sets up to attract new investors. The original fund sells the company or a portfolio of companies to the new continuation vehicle and provides the original fund investors an option to receive cash or roll their portion of the equity ownership into the new entity.
  • Middle market and early growth stage companies provide opportunities. Within private equity buyout, we are partnering with smaller and more nimble investment managers focused on the lower end of the middle market with ample opportunities to professionalize business operations, upgrade sales organizations and consolidate fragmented industries. We remain cautious about investing in mature software companies given increasing competition from AI investments for tighter corporate budgets, preferring investments in early growth stage of a software company solving critical business problems. We remain cautious regarding commercial real estate but find digital infrastructure, last-mile industrial and self-storage sub-sectors attractive.
Chart shows the number of private equity companies sold by setting up a continuation fund between 2017 and March 31, 2024.
Sources: U.S. Bank Asset Management Group; Pitchbook, March 31, 2024.
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This commentary was prepared June 2024 and represents the opinion of U.S. Bank. The views are subject to change at any time based on market or other conditions and are not intended to be a forecast of future events or guarantee of future results and are not intended to provide specific advice or to be construed as an offering of securities or recommendation to invest. Not for use as a primary basis of investment decisions. Not to be construed to meet the needs of any particular investor. Not a representation or solicitation or an offer to sell/buy any security. Investors should consult with their investment professional for advice concerning their particular situation. The factual information provided has been obtained from sources believed to be reliable but is not guaranteed as to accuracy or completeness. Any organizations mentioned in this commentary are not affiliated or associated with U.S. Bank in any way.

U.S. Bank and its representatives do not provide tax or legal advice. Your tax and financial situation is unique. You should consult your tax and/or legal advisor for advice and information concerning your particular situation.

Diversification and asset allocation do not guarantee returns or protect against losses. Based on our strategic approach to creating diversified portfolios, guidelines are in place concerning the construction of portfolios and how investments should be allocated to specific asset classes based on client goals, objectives and tolerance for risk. Not all recommended asset classes will be suitable for every portfolio.

Past performance is no guarantee of future results. All performance data, while deemed obtained from reliable sources, are not guaranteed for accuracy. Indexes shown are unmanaged and are not available for investment. The S&P 500 Index is an unmanaged, capitalization-weighted index of 500 widely traded stocks that are considered to represent the performance of the stock market in general. The Consumer Price Index is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food and medical care. It is one of the most frequently used statistics for identifying periods of inflation or deflation.

Equity securities are subject to stock market fluctuations that occur in response to economic and business developments. International investing involves special risks, including foreign taxation, currency risks, risks associated with possible difference in financial standards and other risks associated with future political and economic developments. Investing in emerging markets may involve greater risks than investing in more developed countries. In addition, concentration of investments in a single region may result in greater volatility. Investing in fixed income securities is subject to various risks, including changes in interest rates, credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications, and other factors. Investments in debt securities typically decrease in value when interest rates rise. The risk is usually greater for longer-term debt securities. Investments in lower-rated and non-rated securities present a greater risk of loss to principal and interest than higher-rated securities. Investments in high yield bonds offer the potential for high current income and attractive total return but involve certain risks. Changes in economic conditions or other circumstances may adversely affect a bond issuer’s ability to make principal and interest payments. The municipal bond market is volatile and can be significantly affected by adverse tax, legislative or political changes and the financial condition of the issuers of municipal securities. Interest rate increases can cause the price of a bond to decrease. Income on municipal bonds is free from federal taxes but may be subject to the federal alternative minimum tax (AMT), state and local taxes. There are special risks associated with investments in real assets such as commodities and real estate securities. For commodities, risks may include market price fluctuations, regulatory changes, interest rate changes, credit risk, economic changes and the impact of adverse political or financial factors. Investments in real estate securities can be subject to fluctuations in the value of the underlying properties, the effect of economic conditions on real estate values, changes in interest rates and risks related to renting properties (such as rental defaults). Hedge funds are speculative and involve a high degree of risk. An investment in a hedge fund involves a substantially more complicated set of risk factors than traditional investments in stocks or bonds, including the risks of using derivatives, leverage and short sales, which can magnify potential losses or gains. Restrictions exist on the ability to redeem or transfer interests in a fund. Private capital investment funds are speculative and involve a higher degree of risk. These investments usually involve a substantially more complicated set of investment strategies than traditional investments in stocks or bonds, including the risks of using derivatives, leverage, and short sales, which can magnify potential losses or gains. Always refer to a Fund’s most current offering documents for a more thorough discussion of risks and other specific characteristics associated with investing in private capital and impact investment funds. Reinsurance allocations made to insurance-linked securities (ILS) are financial instruments whose performance is determined by insurance loss events primarily driven by weather-related and other natural catastrophes (such as hurricanes and earthquakes). These events are typically low-frequency but high-severity occurrences. Private equity investments provide investors and funds the potential to invest directly into private companies or participate in buyouts of public companies that result in a delisting of the public equity. Investors considering an investment in private equity must be fully aware that these investments are illiquid by nature, typically represent a long-term binding commitment and are not readily marketable. The valuation procedures for these holdings are often subjective in nature. Private debt investments may be either direct or indirect and are subject to significant risks, including the possibility of default, limited liquidity and the infrequent availability of independent credit ratings for private companies.

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Disclosures

Investment products and services are:
Not a deposit • Not FDIC insured • May lose value • Not bank guaranteed • Not insured by any federal government agency

U.S. Wealth Management – U.S. Bank is a marketing logo for U.S. Bank.

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The information provided represents the opinion of U.S. Bank and is not intended to be a forecast of future events or guarantee of future results. It is not intended to provide specific investment advice and should not be construed as an offering of securities or recommendation to invest. Not for use as a primary basis of investment decisions. Not to be construed to meet the needs of any particular investor. Not a representation or solicitation or an offer to sell/buy any security. Investors should consult with their investment professional for advice concerning their particular situation.

U.S. Bank and its representatives do not provide tax or legal advice. Your tax and financial situation is unique. You should consult your tax and/or legal advisor for advice and information concerning your particular situation.

Diversification and asset allocation do not guarantee returns or protect against losses.

Based on our strategic approach to creating diversified portfolios, guidelines are in place concerning the construction of portfolios and how investments should be allocated to specific asset classes based on client goals, objectives and tolerance for risk. Not all recommended asset classes will be suitable for every portfolio.

Past performance is no guarantee of future results. All performance data, while obtained from sources deemed to be reliable, are not guaranteed for accuracy.

Equity securities are subject to stock market fluctuations that occur in response to economic and business developments.

International investing involves special risks, including foreign taxation, currency risks, risks associated with possible differences in financial standards and other risks associated with future political and economic developments. 

Investing in emerging markets may involve greater risks than investing in more developed countries. In addition, concentration of investments in a single region may result in greater volatility.

Investments in fixed income securities are subject to various risks, including changes in interest rates, credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors. Investment in fixed income securities typically decrease in value when interest rates rise. This risk is usually greater for longer-term securities. Investments in lower-rated and non-rated securities present a greater risk of loss to principal and interest than higher-rated securities.

Investments in high yield bonds offer the potential for high current income and attractive total return, but involve certain risks. Changes in economic conditions or other circumstances may adversely affect a bond issuer’s ability to make principal and interest payments.

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The municipal bond market is volatile and can be significantly affected by adverse tax, legislative or political changes and the financial condition of the issues of municipal securities. Interest rate increases can cause the price of a bond to decrease. Income on municipal bonds is free from federal taxes, but may be subject to the federal alternative minimum tax (AMT), state and local taxes.

There are special risks associated with investments in real assets such as commodities and real estate securities. For commodities, risks may include market price fluctuations, regulatory changes, interest rate changes, credit risk, economic changes and the impact of adverse political or financial factors. Investments in real estate securities can be subject to fluctuations in the value of the underlying properties, the effect of economic conditions on real estate values, changes in interest rates and risks related to renting properties (such as rental defaults).

Hedge funds are speculative and involve a high degree of risk. An investment in a hedge fund involves a substantially more complicated set of risk factors than traditional investments in stocks or bonds, including the risks of using derivatives, leverage and short sales, which can magnify potential losses or gains. Restrictions exist on the ability to redeem or transfer interests in a fund.  A hedge fund’s offering memorandum and related materials contain important information about investing in the fund, including the investment strategies, fees, expenses, and levels of risk involved in the fund’s investment strategies.  Potential investors are encouraged to review a fund’s offering memorandum and related materials with tax and legal advisors before investing in a hedge fund.

Private equity investments provide investors and funds the potential to invest directly into private companies or participate in buyouts of public companies that result in a delisting of the public equity. Investors considering an investment in private equity must be fully aware that these investments are illiquid by nature, typically represent a long-term binding commitment and are not readily marketable. The valuation procedures for these holdings are often subjective in nature.

Private debt investments may be either direct or indirect and are subject to significant risks, including the possibility of default, limited liquidity, and the infrequent availability of independent credit ratings for private companies.