Buy quality

We expect a moderate rally in global equity indexes in 2024 as earnings grow and as interest rates and bond yields fall. In our base case, we see the S&P 500 rising to 5,000 by December.

Our base case is for a 9% rise in earnings per share for S&P 500 companies this year, after a flat outcome in 2023. We think leaner inventories, one-off base effects in healthcare, and earnings contributions from the technology sector and other quality companies should offset cyclical headwinds from slower US economic growth. We expect 3% growth for European companies and 16% from emerging markets.

We also believe that lower interest rates and bond yields should provide a tailwind for stocks, provided we avoid a meaningful contraction in economic growth. In 2023, the equity risk premium deteriorated as bond yields rose, making equities progressively less appealing relative to bonds. We expect that trend to reverse in 2024.

Of course, uncertainty around the broader macroeconomic and geopolitical outlook creates uncertainty around our earnings estimates. The MSCI All Country World Index is trading at 16.7 times 12-month forward price-to-earnings (P/E), 13% above its 15-year average, as of 4 January. Hence, we maintain a neutral stance on equities. 

Regionally, we like emerging market equities and rate UK equities as least preferred.

Quality stocks. We believe that companies with strong returns on invested capital, resilient operating margins, and relatively low debt on their balance sheets will be best positioned to continue to generate profits in an environment of weaker growth.

A proxy for these stocks, the MSCI ACWI Quality Index, has historically outperformed the MSCI ACWI by 1 percentage point over six-month periods in which growth slows but stays positive (as measured by the Atlanta Fed GDPNow survey)—the environment we expect in 2024.

Also, quality stocks have historically outperformed in the late stages of the business cycle, including in periods of economic contraction, which should offer portfolio protection if the economy slows more than we expect. The quality tilt also aligns with our preference for US technology companies, which should be among the key beneficiaries of AI-related demand for both hardware and software. Investors can also find quality stocks within stable quality-income and high-quality cyclical stocks in Europe, and in select names in Asia.

US small-cap stocks. We believe that investors can consider complementing core holdings in quality stocks with tactical exposure to US small caps. US small caps’ relative valuations are trading 10–15% lower than they were prior to the regional banking crisis in March, with the segment suffering from fears that the Fed could hold rates at elevated levels for a prolonged period to bring inflation lower. With around 50% of small-cap debt subject to floating rates (versus 10% for large caps), the segment is highly sensitive to interest rates, and so should be a particular beneficiary of a more favorable “Goldilocks” scenario. 

Investors can invest in fixed income and equities while aligning with sustainability objectives.

Multilateral development bank (MDB) bonds, which channel capital into development projects with environmental and social goals, are rated AAA and offer slightly higher yields than benchmark government bonds.

Sustainable bonds—comprising green, social, sustainability, and sustainability-linked bonds—offer comparable yields to otherwise identical traditional bonds while delivering transparency on the projects financed from their proceeds.

“ESG leaders” strategies within equities and bonds focus on companies with top metrics across environmental, social, and governance criteria. Some empirical research supports a link between companies with better sustainability management and financial performance, and ESG leaders’ portfolios correlate strongly with “quality” factors, and typically enjoy valuation premiums across both equities and bonds.