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Ripped from the Headlines

Key Investment Storylines for 2024

12 December 2023

4 min read

Scott DiMaggio, CFA| Head—Fixed Income

Gershon M. Distenfeld, CFA | Director—Income Strategies

Chris Hogbin| Global Head—Investments

Nelson Yu| Head—Equities

Matthew D. Bass| Head—Private Alternatives

Investors are entering the new year with many concerns about macroeconomic conditions and market volatility. The heads of our fixed-income, equities and alternatives businesses lay out some of the key investment storylines to watch in 2024.

Fixed Income: Time to Prepare for Falling Yields

Key central bank rates and bond yields remain high globally and are likely to stay elevated well into 2024 before retreating. Further, the chance of higher policy rates from here is slim. The potential for rates to decline is much higher.

In the euro area, for example, after years of negative yields, the highest-rated euro government bonds currently yield nearly 3%. Meanwhile, inflation in the region is heading back toward target. Given weak expected growth, the European Central Bank may need to ease midyear.

In the US, where inflation—while declining—is still well above the Federal Reserve’s target, we expect rates to remain elevated into the second of half of 2024. Given current trends in economic data, we think the Fed has completed its rate-hiking cycle and will remain on pause until inflation is closer to 2%, when it can begin to ease in the face of cooling US growth. While the US Treasury market has experienced a bit of a relief rally in recent weeks, yields remain very compelling overall, in our view.

For bond investors, these conditions are nearly ideal. After all, most of a bond’s return over time comes from its yield. And falling yields—which we expect in the latter half of 2024—boost bond prices. Investors should consider extending duration in this environment to gain exposure to rates.

Both Government Bonds and Credit Have a Role to Play

Of course, developed-market government bonds represent just one part of the global bond market. Yields across credit-sensitive assets such as corporate bonds and securitized debt are also higher than they’ve been in years, giving income-oriented investors a long-awaited opportunity to fill their tanks. In fact, we believe that both government bonds and credit sectors have a role to play in portfolios today.

It’s true that sustained higher rates are likely to lead, eventually, to a turn in the credit cycle. Rate hikes are already weighing on activity in many sectors. Corporations have continued to beat earnings expectations, but not as impressively as earlier in the year. Some companies have noted that consumers are spending less. Indeed, households have nearly depleted savings accumulated during the pandemic. Leverage is creeping higher, and interest coverage—the ratio of a company’s EBITDA to its total interest payments—has begun to decline.

But because corporate fundamentals started from a position of historic strength (Display), we’re not expecting a tsunami of corporate defaults and downgrades. That said, investors should be selective and pay attention to liquidity. CCC-rated corporates and lower-rated securitized debt are most vulnerable in an economic downturn. Long-maturity investment-grade corporates can also be volatile and are currently overpriced, in our view. Conversely, short-duration high-yield debt offers higher yields and lower default risk than longer debt, thanks to an inverted yield curve.

High Interest Coverage May Help Cushion the Impact of Higher Rates

Bloomberg US Corporate High-Yield Index: Interest Coverage (EBITDA/Interest) (×)

Line chart shows the interest coverage level of the Bloomberg US Corporate High-Yield Index, a key measure of corporate fundamentals.

Historical and current analyses do not guarantee future results.
EBITDA: earnings before interest, taxes, depreciation and amortization
*Reprice 27% of all existing debt to current market rates (8.5%); 27% represents the percentage of the US high-yield market maturing over the next three years. Historical data provided as weighted average from 1Q:08 to 1Q:23.
As of June 30, 2023
Source: Bloomberg, J.P. Morgan and AllianceBernstein (AB)

Equities: Positioning Allocations for a Range of Outcomes

Even in a world of higher bond yields, equities still have an important role to play in allocations. Higher bond yields have led to a decline in the equity risk premium (ERP), the excess return that investors expect to earn over a risk-free rate. However, between 1983 and 2008, when the ERP was at a similar level to today’s, the S&P 500 Index delivered solid annualized returns of 10.2%.

Softening inflation data and still-healthy US employment figures have supported a recent recovery in equity markets. Still, market conditions are murky. Slower progress toward the Fed’s inflation target or a faster acceleration of unemployment—or both—could determine whether the global economy has a soft landing, hard landing or no landing at all.

As sentiment has shifted between these outcomes over the past year, so has equity market performance. After peaking in early August, the MSCI World Index declined through October before recovering in November, showing a lack of conviction in any one outcome.

Different equity strategies are sensitive to the potential outcomes in different ways. Our research of US equity factor returns in varying economic scenarios from 1991 to 2023 is instructive (Display). In scenarios with stronger economic growth and falling inflation, cyclical value stocks have generally performed well, while growth stocks lagged. When economic growth was weaker and inflation was rising, growth factors performed well. But in a hard landing—i.e., recession—past performance suggests that strategies featuring strong profitability or higher levels of dividend yield provide the best cushion.

Quality factors performed well in all three environments. In a world of higher inflation and interest rates, we believe stocks with quality features will continue to deliver by virtue of their focus on balance sheet strength and profitability, which underpin financial resilience.

How Do Different Equity Factors Perform in Different Economic Scenarios?

US Equity Factor Return Trends (1991–2023)

Schematic graphic depicts the performance of five different US equity factors in a soft landing, hard landing and no landing scenario.

For illustrative purposes only.
This graphic is not a simulation of an investment strategy given the small sample sizes.
Directional arrows are determined by the T-Stat of the factor return, or a measure of significance of the factor returns experienced in each environment. A T-Stat > +1 suggests some directional support for the factor, < -1 suggest some directional challenges to the factor, and in between a neutral environment. A T-Stat of +/-1 suggests that the returns experienced are moderately different from 0.
Methodology: At the beginning of each month, we defined each environment by looking at the level and change of the Institute for Supply Management (ISM) purchasing managers’ index (PMI) and the prior month’s change in US 10-Year Treasury yield relative to the average of the prior three months. In stronger economic growth conditions, the PMI was flat or rising below 55. In weaker economic growth conditions, the PMI was between 50 and 55, and falling. In recessions, the PMI was below 50 and falling.
From January 1, 1991 to September 30, 2023
Source: Bloomberg, Center for Research in Security Prices, ISM, S&P Compustat, Thomson Reuters I/B/E/S and AB

Are Conditions Improving for Active Equities?

But what about actively managed equity portfolios, which haven’t performed well this year? Growth managers have had a particularly tough year. The extreme market concentration seen in 2023, with the “Magnificent Seven” dominating market gains, has made it hard for active managers to outperform without positioning heavily in the entire group of mega-caps.

We believe conditions are improving for active managers. Our research shows that performance of the S&P 500 and MSCI World Equal Weighted indices trailed their corresponding cap-weighted benchmarks by 14.9% and 8.9% in 2023 through November 24. History suggests that after extremely narrow returns, a broadening of the market can persist for several years.

Meanwhile, our research shows that the dispersion of stock returns has increased in the US and global markets to levels that are typical of market stress, which we’ve seen during the US taper tantrum and Brexit and after the tariffs introduced by former President Donald Trump. After similar episodes, active managers have performed well. Today, the dispersion of returns has been particularly high outside the Magnificent Seven. That means that individual names are trading more independently, creating fertile ground for active managers to outperform, in our view.

To identify stocks that can outperform, portfolio managers should look for quality businesses and rigorously assess how individual company earnings could be affected by a range of macroeconomic outcomes.

Investors, too, should revisit their allocations. Those who have been underweight value stocks may want to consider adding exposure, as value may do well in a softer landing. Growth and quality-focused strategies should help if the economy muddles through. And we think lower-volatility equity strategies provide much-needed defenses if a deeper downturn develops. While the right mix will differ based on individual investor goals, striking a thoughtful balance between different active equity portfolios is the best way to position for a market that could veer in many directions during 2024.

Private Credit: Banks in Retreat

In a little more than a decade, private credit has gone from a niche strategy to a key component of a diversified investment portfolio. We expect that evolution to move forward in 2024 as stricter capital requirements force banks to continue their retreat from many types of lending, widening the opportunity set for non-bank lenders. At the same time, a potential turn in the credit cycle may increase borrower stress, making managers’ ability to underwrite credit risk more important than ever.

Rising interest rates have sparked deposit flight from banks in the US and Europe this year and forced many to take mark-to-market losses on assets and securities. Banks are also on the clock for complying with updated global Basel III regulations, which come into effect in 2025 and will include a rewrite of the risk-weighted asset framework. This is likely to prompt many to further reduce certain types of long-term lending and to shed some of the loans—residential, commercial, corporate, consumer—already on their balance sheets (Display).

Banks in Defensive Mode After the Deposit Outflows

Left chart shows declining growth rate of securities at US banks. Right chart shows declining growth rates of different types of loans at US banks.

Past performance does not guarantee future results.
As of June 30, 2023
Source: US Federal Reserve Board

Filling the Credit Vacuum

For alternative lenders, this represents an attractive opportunity to generate income by filling that credit vacuum. It may involve purchasing seasoned loans from banks or entering into forward flow agreements agreements to acquire new ones at high interest rates upon origination. Banks, meanwhile, benefit by maintaining customer relationships and generating fees without incurring the high regulatory capital charges that would come with keeping these loans on their books. We expect to see more partnerships between banks and asset managers in which the latter can provide a more diversified source of funding than deposits.

We also see a growing opportunity in specialty finance, a $4 trillion global market to which investors are largely underallocated. Specialty finance refers to directly originated, privately negotiated loans secured by specific cash-flowing assets or receivables. It spans loan portfolios and lender finance and ranges from underlying assets such as automobile and equipment leases to more esoteric assets, such as the revenue streams generated by royalty payments. These asset classes have the potential to generate attractive returns and also provide diversification to a broader private credit portfolio.

Overall, we expect a promising investment environment to persist into 2024. Yields may decline somewhat but are likely to remain well above their pandemic-era lows. Deal terms should remain favorable, with low loan-to-value ratios and asset values that reset as rates rise. At the same time, limited partners may face challenges, should persistently high rates increase borrower stress. This will underscore the importance of diversification and having a deep investment team with a track record of lending throughout the economic cycle.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. Views are subject to revision over time.

About the Authors

Scott DiMaggio, CFA

Scott DiMaggio is a Senior Vice President, Head of Fixed Income and a member of the Operating Committee. As Head of Fixed Income, he is responsible for the management and strategic growth of AB’s fixed-income business and investment decisions across the department. DiMaggio has previously served as director of Global Fixed Income and continues to be a portfolio manager across numerous multi-sector and multi-currency strategies. Prior to joining AB’s Fixed Income portfolio-management team, he performed quantitative investment analysis, including asset-liability, asset-allocation, return attribution and risk analysis for the firm. Before joining the firm in 1999, DiMaggio was a risk management market analyst at Santander Investment Securities. He also held positions as a senior consultant at Ernst & Young and Andersen Consulting. DiMaggio holds a BS in business administration from the State University of New York, Albany, and an MS in finance from Baruch College. He is a member of the Global Association of Risk Professionals and a CFA charterholder. Location: New York

Gershon M. Distenfeld, CFA

Gershon Distenfeld is a Senior Vice President, Director of Income Strategies and a member of the firm’s Operating Committee. He is responsible for the portfolio management and strategic growth of AB’s income platform with almost $60B in assets under management. This includes the multiple-award-winning Global High Yield and American Income portfolios, flagship fixed-income funds on the firm’s Luxembourg-domiciled fund platform for non-US investors. Distenfeld also oversees AB’s public leveraged finance business. He joined AB in 1998 as a fixed-income business analyst and served in the following roles: high-yield trader (1999–2002), high-yield portfolio manager (2002–2006), director of High Yield (2006–2015), director of Credit (2015–2018) and co-head of Fixed Income (2018–2023). Distenfeld began his career as an operations analyst supporting Emerging Markets Debt at Lehman Brothers. He holds a BS in finance from the Sy Syms School of Business at Yeshiva University and is a CFA charterholder. Location: Nashville

Chris Hogbin

Chris Hogbin is the Global Head of Investments for AB. In this broad leadership role, he oversees all the firm’s investment activities. Hogbin is responsible for driving investment success across asset classes, fostering collaboration and sharing best practices across investment teams, as well as leveraging a common infrastructure and evaluating opportunities to invest in capabilities that deliver better outcomes for clients. He is also a member of the firm’s Leadership team and Operating Committee. Hogbin joined AB’s institutional research business in 2005 as a senior analyst covering the European food retail sector. In 2010, he was named to Institutional Investor’s All-Europe Research Team and was ranked as the #1 analyst in his sector in both 2011 and 2012. Hogbin became European director of research for the Sell Side in 2012 and was given additional responsibility for Asian research in 2016. In 2018, he was appointed COO of Equities for AB. In 2019 Hogbin was promoted to co-head of Equities, becoming head of Equities in 2020. Prior to joining the firm, he worked as a strategy consultant for the Boston Consulting Group in London, San Francisco and Shanghai, where he was responsible for the execution of critical business-improvement initiatives for clients in the financial-services and consumer sectors. He holds an MA in economics from the University of Cambridge and an MBA with distinction from Harvard Business School. He is a trustee of the Public Theater in New York.

Nelson Yu

Nelson Yu is a Senior Vice President, Head of Equities and a member of the firm’s Operating Committee. As Head of Equities, he is responsible for the management and strategic growth of AB’s equities business and investment decisions across the department. Since 1993, Yu has experience generating investment success in global equity markets by joining fundamental research with rigorous quantitative methods. He joined AB in 1997 as a programmer and analyst, and served as head of Quantitative Equity Research from 2014–2021. Since 2017, Yu also served as head of Multi-Style Core Equity strategies, with over $10 billion in assets. Most recently, he was CIO of Equities Investment Sciences and Insights, which brings together resources across Data Science, Quantitative Research, Advisory Services, Risk and Global Execution to deliver differentiated capabilities and insights to AB’s equities investment platform. Prior to joining AB, Yu was a supervising consultant at Grant Thornton. He holds a BSE in systems engineering from the University of Pennsylvania and a BS in Economics from the Wharton School at the University of Pennsylvania. Yu is a CFA charterholder. Location: New York

Matthew D. Bass

Matthew Bass is Head of Private Alternatives and a member of the Operating Committee. As head of AB’s Private Alternatives SBU, he is responsible for the leadership and strategic growth of the business, which includes all of AB’s private market investment strategies. Previously, Bass held various roles in the firm’s Alternatives business (including as head of Alternatives and Multi-Asset Business Development, and COO), where he was responsible for business strategy, sourcing of new investment teams, product development and capital raising. Prior to joining the firm in 2010, Bass was a program director at the US Department of the Treasury, responsible for the design and implementation of various real estate and real estate capital-markets programs pursuant to the Troubled Asset Relief Program. Before that, he was a vice president at The Blackstone Group’s GSO Capital Partners unit, where he was involved in analyzing, evaluating and executing private debt and equity investments. Bass began his career in the Financial Institutions Investment Banking Group at UBS, where he was responsible for executing M&A and capital-raising transactions for banks, asset managers and specialty finance companies. He holds a BS in finance from Lehigh University. Location: New York