Sailing into calmer seas, but navigate with caution

To the surprise of many experts on Wall Street, markets have shown resilience and, with the help of the “Magnificent Seven” stocks, closed out 2023 strongly despite numerous uncertainties and global turmoil. Will growth stocks, including technology names, steal the show once again this year or have valuations run off too far? This will be the hot question in investors’ minds. High quality bonds will once again be thrust into the limelight as interest rates begin to fall. Prospects for the Malaysian economy and market are also looking brighter for the year ahead.

Barring all that, investors should brace themselves for another year fraught with uncertainties. Major events include a potential recession in the US, escalation of the Middle East war and a busy year ahead in terms of global political elections.

UOB Group executive director and head of wealth management advisory and strategy Abel Lim says that the expectation of rate cuts by the US Federal Reserve is a key event that will define 2024.

“In the December FOMC (Federal Open Market Committee) meeting, the Fed gave a clear signal that the rate hike cycle is over, with the latest Fed’s dot plot indicating three rate cuts in 2024. All of this suggests that interest rates have peaked, which is no doubt a positive to markets,” he says.

Sailing into calmer seas, but navigate with caution

More importantly, high quality dividend stocks have historically done better than other asset classes like bonds and commodities during periods when inflation declines from a peak and tend to have lower volatility than the broader market, which becomes more relevant in a slowing economy.” — Lim, UOB

As bond prices rise when interest rates and yields fall, bonds are one of Lim’s favourite asset classes in 2024. Many existing and newly issued bonds are also offering attractive yields as the US interest rates remain above 5% at the time of writing.

However, investors are advised to look into high quality, investment-grade bonds and bond funds as opposed to high-yield corporate bonds that come with higher risk of default. After all, the US’ and global economic growth are still expected to slow, which means companies with weaker balance sheets will find it harder to survive.

The market also seems to be too optimistic on the Fed’s rate cut, says Lim.

“They are expecting nearly six rate cuts this year, which seems to appear overly optimistic. The divergence between the Fed and the market’s expectations could lead to market volatility in the near term.

“Meanwhile, it is important to note that we are still in the slowdown phase of the economic cycle, and the delayed impact of interest rate hikes might further slow economic growth. In such an environment, it is crucial to stay diversified to ride through potential volatility,” he adds.

Lim says high quality bonds and bond funds can act as a portfolio stabiliser and hedge against an economic slowdown.

What about equity?

Lim says the group maintains a neutral stance on equities. Investors have to be more tactful and selective, partly by having a stronger focus on quality dividend stocks which can generate attractive income when cash and bond yields fall.

“For quality dividend stocks, investors should focus on Asia ex-Japan. Those who seek to enhance yield can think of this as another tactical investment strategy, given the attractive valuations and high dividend yields in the region.

“More importantly, high quality dividend stocks have historically done better than other asset classes like bonds and commodities during periods when inflation declines from a peak and tend to have lower volatility than the broader market, which becomes more relevant in a slowing economy.”

Sector-wise, global healthcare is one of Lim’s top picks as it fetches both defensive and growth characteristics. “The stable demand for healthcare products and services throughout economic cycles enable it to perform well in a weak economic growth environment, while the rising use of technology and artificial intelligence (AI) in medical treatment could boost the industry’s long-term growth. Moreover, a positive earnings growth outlook in 2024 can be a catalyst for the sector.”

Malaysia’s GDP expected to grow 4.6% in 2024

In 2024, things are also looking brighter on the local front, says Julia Goh, senior economist with the global economics and market research team at UOB Malaysia.

For one, Malaysia’s annual growth is expected to improve further to 4.6% in 2024 from an estimated 4% last year, backed by a base case scenario of a soft landing of the global economy.

“The domestic growth drivers include an expansionary Budget 2024 and initiatives outlined under the national blueprints. The favourable labour market conditions, pickup in tourism activity, recovery from technology cycle downturn, continuation of existing investments and realisation of investments approved would further support domestic demand,” Goh says.

Currently, the ringgit has a higher correlation to the CNY than other regional peers. Malaysia is also encountering a relatively bigger negative interest rate differential with the US rate than most countries.” — Goh, UOB Malaysia

She says the key takeaways for Budget 2024 include a sizeable development expenditure outlay of RM90 billion (equivalent to 4.6% of the country’s gross domestic product [GDP]) to support development and construction activity for transport, education, healthcare and flood mitigation programmes.

Other significant measures are on subsidies and taxation, which reflect the government’s commitment to strengthening the country’s fiscal position. It aims to reach a fiscal deficit of 3.5% of GDP by 2025 and 3% in the medium term.

“There were also several measures in the budget that reflect Malaysia’s ambitions to accelerate the energy transition journey. They include the promotion of renewable energy generation capacity, installation of solar panels, promotion of new green growth areas such as electric vehicles (EVs), hydrogen, CCUS (carbon capture, utilisation and storage) and sustainable financing,” says Goh.

The country’s transition into a greener economy presents not only opportunities but risks as well. Investors will be keeping an eye on how companies and businesses adapt to such changes.

“Climate-related risks and opportunities are likely to be important considerations for businesses as energy transition policies gain momentum. Businesses may face continued challenges from elevated costs and slower demand as potential domestic policy changes could weigh on growth and inflation this year,” adds Goh.

Bumpy path of recovery for ringgit in 2024

Emerging market currencies, including the ringgit, are expected to strengthen against the US dollar as the Fed is expected to cut interest rates, which is good news for countries like Malaysia. Goh shares this view, highlighting that a narrowing interest rate differential lays the path of recovery for Asia’s currencies, including the ringgit.

“The dovish signals from the Fed in December 2023 reaffirm our view that US interest rates have peaked, which also suggests that the ringgit has bottomed [out] and should recover in 2024.”

Will Bank Negara Malaysia follow in the Fed’s footsteps to cut rates in 2024?

“We expect stable interest rates to remain supportive of the economy and for Bank Negara to stay the course in keeping the overnight policy rate (OPR) unchanged at 3% through the year,” says Goh.

However, she adds that there are still several headwinds, including geopolitical and macro risks, that could derail the ringgit’s recovery. The Chinese economic growth, partly reflected through the strength of the yuan (CNY), is also a key determinant of the ringgit’s recovery.

“Currently, the ringgit has a higher correlation to the CNY than other regional peers. Malaysia is also encountering a relatively bigger negative interest rate differential with the US rate than most countries.

“Hence, Malaysia’s stable and positive macroeconomic fundamentals, alongside a subsequent recovery in the CNY, and a peak in the US Fed rate followed by expected rate cuts, would be key determinants to the ringgit’s performance in 2024,” says Goh.

UOB senior foreign exchange strategist, senior vice-president of global economics and markets research Peter Chia expects the Fed to cut rates by 75 basis points (bps) in 2024. He expects the Fed to cut rates by 25bps, each in June, the third and the fourth quarters this year.

With a soft landing remaining our central scenario, we do not expect the Fed to cut rates aggressively.” — Chia, UOB

“We expect the US growth slowdown to be more apparent in the first half of the year with a technical recession on the cards but for a soft landing as our base case. Hence, we do not expect the Fed to cut rates aggressively,” he says.

Growth stocks, including tech names, back to centre stage

Franklin Equity Group (Franklin Templeton) executive vice-president and chief investment officer Jonathan Curtis says 2024 may present an inflection point for many companies, especially those in the technology sector. He believes several factors may drive returns for the technology sector, including a reacceleration in revenue and earnings, resilient secular demand for digital transformation, and a transition into the “application” phase of generative AI.

Further tailwinds include a more stable inflation and interest rate environment and reasonable valuations for tech companies relative to their potential future growth.

“We believe the technology sector is well positioned for a period of more stable rates as investors return to more enterprise-centric technology names,” Curtis says.

While Curtis believes the “Magnificent Seven” could continue to benefit from high research and development (R&D) expenditure and strong demand for generative AI, he also sees attractive opportunities in smaller capitalisation (cap) companies.

We believe the technology sector is well positioned for a period of more stable rates as investors return to more enterprise-centric technology names.” — Curtis, Franklin Equity Group (Franklin Templeton)

“The 2023 environment of high R&D and capital expenditure has been beneficial for several of the ‘Magnificent Seven’. We anticipate continued growth for these names as the demand for generative AI continues to strengthen and each firm leans into its specific strengths.

“However, firms have begun to shift investments from R&D to applying AI developments and infrastructure to support new use cases. More technology companies could begin deploying generative AI to increase the value of their products and services.

“As a result, we expect to see more beneficiaries further down the market capitalisation spectrum, particularly in industries like software and internet services. We also believe valuations for smaller companies remain attractive and serve as good entry points for investors, as compared to the valuation expansion seen for large-cap names through 2023. Hence, the firm’s technology strategy is overweight, relative to its benchmark, in mid- and small-cap names.”

The technology sector may serve as a complement to an investor’s core portfolio, as it is a rapidly growing sector comprising nearly a quarter of the MSCI World Index as of Dec 31 last year.

The MSCI World Information Technology Index has also posted strong long-term performance with an 18.2% annualised return in the last decade, compared with the MSCI World Index return of 8.6% during the same period.

“In our view, the sector offers both strong fundamentals and growth opportunities with a reasonable level of volatility, which suits medium- to long-term investors,” says Curtis.

US small- and mid-cap equities over EU and China?

Voya Investment Management managing director, senior portfolio manager and analyst Stephen Jue favours US equities over Europe and China. He is also less bullish on emerging markets.

“We continue to prefer US equities over Europe and China. We remain underweight Europe because of slowing macroeconomic momentum while China continues to disappoint.

We continue to prefer US equities over Europe and China. We remain underweight Europe because of slowing macroeconomic momentum while China continues to disappoint. Although other emerging market countries have better near-term prospects, it’s difficult to be bullish on EM (emerging market) equities overall when China is dragging.” — Jue, Voya Investment Management

“Although other emerging market countries have better near-term prospects, it’s difficult to be bullish on EM (emerging market) equities overall when China is dragging,” he says.

On the other hand, the US equity market is showing encouraging signs, broadening beyond the “Magnificent Seven” (Microsoft, Amazon, Meta, Apple, Alphabet, Nvidia and Tesla) that fuelled much of the rise in the US equity market this year.

“As interest rates appear to be on a lower path with an economic soft landing more likely, we see opportunities to invest for a growth reacceleration across sectors and industry groups. This, while maintaining an emphasis on innovation and quality for our thematic equity funds,” he says.

Jue adds that small- and mid-cap stocks have the potential to outperform large caps this year, given historical performances during a recovery phase and that returns have been relatively muted over the past few years.

“The relative outperformance of large-cap growth stocks was pronounced last year, while the small- and mid-cap index valuations are closer to their pre-Covid-19 levels. Even if there’s more market volatility ahead, smaller stocks might be further along the route to recovery. We think estimates by investors have discounted more of the uncertainties ahead, perhaps more so than for large caps.

“However, if the Fed can get rates down to about 3.5%, you might be able to get a little bit of multiple expansion [in the small- and mid-cap space]. And that, combined with a reacceleration in earnings growth, could offer some attractive opportunities in 2024.

“There will be bumps along the way, but there are reasons to be optimistic,” says Jue.

JP Morgan Asset Management head of Southeast Asia Funds Supreet Bhan is also anticipating the Fed to cut rates in mid- to late-2024. Valuation rerating could take place against such a backdrop, especially for growth stocks, including technology counters.

“The prospects of a soft landing could also allow investors to broaden their US equity allocation across sectors,” adds Supreet.

The prospects of a soft landing could also allow investors to broaden their US equity allocation across sectors.” — Supreet, JP Morgan Asset Management

Overall, he expects both bonds and equities to perform in the first half of 2024, but cautions investors that the market could be getting ahead of itself by pricing in aggressive rate cuts in 2024.

“Inflation is not truly defeated and therefore it is too early to discuss rate cuts. That being said, falling bond yields, a lower US dollar and positive performance since mid-October last year are largely in line with what we expect following the end of the hiking cycle. We believe this could be the overall market direction in 1H2024.”

On the fixed income front, Supreet favours longer duration government bonds and investment-grade corporate bonds as current yields are still attractive, and that bond prices could rise as yields fall. These high quality bonds can help investors lock in incomes while limiting their downside.

“Beyond this, investors may also choose to broaden their fixed income allocation to include US high-yield corporate debt. Despite the tight credit spreads, the high level of yields to maturity provides income opportunities,” he says.

Turning his sights to China, Supreet says its economy is facing challenges due to lower confidence among consumers and businesses. Monetary easing by the central bank alone may not be effective in boosting aggregate market demand. Fiscal stimulus will play a key role in jump-starting the Chinese economy.

The Chinese property sector is another sector that requires further support through fiscal and monetary stimulus policies.

“Despite lingering uncertainties, we continue to see opportunities in the Chinese equity market. In our view, there are sectors with good earnings outlook and reasonable valuations, such as communication services and consumer discretionary.

“Moreover, emerging sectors, such as renewable energy, EVs and advanced manufacturing continue to benefit from substantial policy support. They have the potential to be a new export engine for China,” he says.

Privilege Conversations: UOB – THE EDGE WEALTH FORUM 2024

The forum will be held on three dates in January. As this is a closed event, UOB clients interested in attending to learn more about market views from local and foreign investment experts should speak to their client advisor or relationship manager. Business journalist and presenter Freda Liu will serve as master of ceremonies for all three events while Datuk Ho Kay Tat, publisher and group CEO of The Edge Media Group, will be the moderator for the third event held in KL.

Jan 13 (9.30am) ➤ George Town, Penang

The first of three planned events will be held at the JEN Hotel by Shangri-La. The speakers comprise Julia Goh, UOB Malaysia senior economist of global economics and market research; Supreet Bhan, JP Morgan Asset Management head of Southeast Asia Funds; and Abel Lim, UOB executive director and head of wealth management advisory and strategy.

Jan 20 ➤ Johor Bahru, Johor

The second event will take place at DoubleTree by Hilton Hotel. The speakers consist of Peter Chia, UOB senior foreign exchange strategist, senior vice-president of global economics and markets research; Jonathan Curtis, Franklin Equity Group executive vice-president and chief investment officer; and Abel Lim.

Jan 27 ➤ Kuala Lumpur

The third event will be held at Shangri-La Hotel. The speakers are Julia Goh, Supreet Bhan and Stephen Jue, Voya Investment Management managing director, senior portfolio manager and analyst.