Quick Thoughts: Checking the CIO pulse

Year-to-date, the equity market has continued to advance, expectations for up to six Federal Reserve (Fed) interest-rate cuts in 2024 have dwindled to less than two, global bond yields have risen, credit spreads have tightened, oil prices have surged, and the US dollar has defied consensus expectations by strengthening even further.

Considering these developments, we decided to use a recent gathering of 20 of our chief investment officers (CIOs) responsible for overseeing the firm’s spectrum of investment strategies—including equity, fixed income and alternative strategies—as an opportunity to check their collective investment pulse. In what follows, we summarize our survey of their perspectives on the global economy, monetary policy, corporate profits and market outcomes, highlighting how our most experienced risk-takers now view the 2024 investment landscape. We conclude with observations about where we at the Institute see investment opportunities and risk.

What will the Fed do?

We begin with Fed policy, arguably one of the most significant factors driving global bond markets and, by extension, of great importance for the performance of global equities.

Reflecting the market’s shift toward later and smaller rate cuts this year, our CIOs also now believe that the Fed will only ease modestly in 2024. Most respondents (53% of 16 individuals queried) foresee the fed funds rate between 4.50%–5% at the end of this year, consistent with two, perhaps at most three, quarter-point reductions. That is a sharp decline from market consensus expectations of roughly 150 basis points (bps) of Fed easing expected at the beginning of the year. The CIOs’ more cautious views on Fed easing reflect both better-than-expected US growth and stickier-than-expected US inflation as reported in the first quarter of 2024.

Notably, 88% of our leading investment professionals expect some Fed easing this year and none of them believes the Fed will smash consensus expectations with a hike. Therein lies, however, a potential risk for markets this year should US growth and inflation data continue to surprise to the upside.

Are inflation risks rising?

Given their views on the Fed, it is perhaps unsurprising that an overwhelming majority of respondents don’t expect the Fed’s preferred measure of inflation, the core Personal Consumption Expenditures price index, to fall back to its 2% target by year-end. Rather, three quarters of our CIOs believe US inflation will remain stuck in a higher range of 2.50%–3% over the final nine months of this year.

Watch your duration

Given expectations for modest Fed rate cuts amid sticky US inflation, it is hardly surprising that our CIOs also think that US 10-year Treasury yields will remain range-bound over the remainder of 2024, with most respondents seeing yields oscillate between 4%–4.50%.

Nearly 90% of those surveyed expect the 10-year yield to remain below 4.50%. That’s of interest, insofar as the year-end yield implied by the shape of the curve is 4.40%¹ (as of April 8, 2024). This suggests that a majority of our investment teams hold a moderately bullish view on duration fixed income returns compared to the (implied) consensus of investors. Accordingly, they do recommend moving out of cash and into shorter-duration fixed income.

What are the risks?

We also asked our CIOs to choose their biggest concern from the following list: US recession, corporate earnings disappointments, US elections, geopolitics, Fed policy, fiscal policy and “other.”

While no single category garnered more than 50% of responses, the top-three worries were (in order): earnings disappointments, geopolitics and Fed policy. Given the Russia-Ukraine war, conflict in the Middle East and recurring tensions between China and the United States, concerns about geopolitics are understandable. Geopolitical worries are also partly responsible for spiking oil prices this year, which could feed through into inflation outcomes and monetary policy responses.

What is perhaps more surprising is the shared concern about corporate profits. Consensus sell-side earnings expectations are typically overly optimistic, but in both the fourth-quarter 2023 earnings season and in the pre-announcement period ahead of the first-quarter 2024 reporting period, earnings have not proven to be a major disappointment.

What is also notable is that despite a soaring US fiscal deficit (6.3% of gross domestic product in 2023²) and sharp increase in US federal government indebtedness over the past 15 years, our CIOs apparently do not rank debt issuance or the lifting of the debt ceiling as particularly problematic for the economy or markets this year.

US equities remain resilient

Given only modest expectations for Fed rate cuts and concerns about earnings disappointments, it is perhaps surprising that our CIOs expect the S&P 500 Index to remain broadly stable this year. Of course, a year-end forecast does not preclude intermittent volatility.

A plurality of respondents (41%) expects the S&P 500 to finish the year in a range between 5200–5400, relative to a prevailing level at the time of the survey of 5200. Despite those tepid expected returns, 71% of those surveyed indicated that the US equity market would deliver the best returns by asset class during the remainder of 2024. That top ranking is also consistent, however, with CIO expectations for tepid returns in fixed income.

The same outcome was captured in a question about the best- and worst-performing asset classes for 2024, with equities taking the top spot and bitcoin pulling up the rear. The latter is, perhaps, surprising because bitcoin has advanced 56% year-to-date,³ easily besting all other major asset classes.

Earnings expectations are too high

As noted, our respondents have concerns about 2024 earnings disappointments. Relative to the consensus (as reported by FactSet) for 10.4% US corporate earnings growth this year, a plurality (41%) of our CIOs believes earnings will be in a range of 0%–5%. Three-quarters of respondents believe earnings will be below the sell-side consensus.

What we think

We conclude with a few observations on what we, at the Franklin Templeton Institute, think about the outlook for fundamentals, asset markets and investment opportunities.

Regarding the broad macroeconomic contours and policy implications, we share the view that the US economy will remain resilient and avoid recession this year, that US inflation will only slowly grind lower, and that the Fed will be cautious about easing US monetary policy.

We also note that consensus earnings expectations are too high, in our view, but doubt that earnings growth will be negative this year, barring an unexpected economic recession. Indeed, in some sectors—including energy, financials (courtesy of higher lending rates), infrastructure and information technology—earnings could provide upside surprises.

We note, admittedly with some surprise, that global equity markets have absorbed the repricing of monetary easing this year with relative equanimity. That said, if inflation picks up in the face of sturdy US economic activity and a sub-4% US unemployment rate, equity and bond markets could be in for nasty surprises. Accordingly, despite the relaxed reception thus far this year to a Fed policy of “high for longer,” we have some concerns about investor complacency to monetary policy risk in 2024.

Still, many of our core investment themes for 2024 remain unchanged. In fixed income markets, we see this year’s backup in US Treasury yields as offering a potential opportunity to extend duration and, overall, we prefer duration to credit risk. Within equity markets, we believe opportunities reside outside the United States, above all in emerging markets and Japan (less so in Europe). We also see long-term thematic opportunities in energy and energy infrastructure (including as derivatives on the growing demand for electricity generation and transmission required to power innovations in artificial intelligence, alternative energy and electric vehicles).

Lastly, following exceptional global equity market performance from October 2023 through March 2024, we are not surprised to see the ongoing consolidation. While global equity valuations vary considerably by region and sector, the combination of elevated overall valuations in the United States (relative to long-run historical norms) and less support from falling interest rates suggests to us that returns over the next six to nine months will be more volatile than they have been since autumn 2023.

Accordingly, we continue to emphasize the desirability of active portfolio construction and rebalancing, augmenting equity holdings with duration fixed income, as well as select allocations in real estate and alternatives.