Morgan Stanley IM: The BEAT – Our Seven Key Themes for 2024

1. Consensus Expectations
   Will the consensus get it right in 2024? This is a loaded question because many consensus forecasts that linked economic fundamentals with asset performance got it very wrong over the past two years. Things may be different in 2024, primarily because the initial conditions are not at all the same as in 2023, making it a bit easier for the consensus to in fact get it right. In summary, we suggest a modest neutral to overweight in equities and are closing our underweight in duration and becoming more neutral overall. We are funding these positions by reducing short-duration and cash holdings.
2. Stock-Bond Correlation
   The deeply negative correlation of stocks and bonds has been the linchpin to the attractive risk-return characteristics of balanced portfolios (60/40) since the GFC (Global Financial Crisis of 2008–2009). This was until the 2020 pandemic, resulting in a sharp rise in correlation that limited the diversification benefits of bonds, especially vexing when bonds and equities sold off together during 2022. Bonds have had another rough year in 2023, but as we look ahead to 2024, the starting valuations of global bonds are attractive to us. Crucially for balanced portfolios, we expect a lower correlation of stocks and bonds in the coming year.
3. Monetary Policy
   A key debate entering 2023 was whether monetary policy tightening would ultimately tip the economy into recession. It didn’t, but the dominant theme through most of 2023 was U.S. growth resilience and upside surprise. Even so, the risk debate entering 2024 still centers on the implications of monetary policy. We believe there are downside risks but think growth headwinds are fading and growth risks will diminish further should disinflation continue on its benign path.
4. Inflation
   U.S. inflation is likely to drop decisively over the next 12 months as transitory pandemic-related supply and demand shocks fade. In fact, all the key components of the Consumer Price Index (CPI) basket faced significant pandemic-related shocks. Today, those effects are rapidly reversing. We expect U.S. core PCE (Personal Consumption Expenditures) to fall from 3.5 % to below the consensus estimate of 2.6% by the end of 2024.
   
   We also expect rapid disinflation in the eurozone, but for different reasons. Compared to the U.S., we see less evidence of inflationary pressures in the region due to overheating economies. Instead, pressures on core inflation in the eurozone appear to be largely exogenous, with “imported” inflation being exacerbated by the energy shock of 2022. As these dynamics fade or reverse, we expect inflation to retreat to 2.0%.
5. Japanese Equities
   Japanese equities have regained meaningful investor interest in 2023. Looking ahead to 2024, the most important question is whether this recent outperformance is sustainable. The market currently is supportive of Japan’s rejuvenation, and we share that outlook in the medium-term, but recognize it might not be smooth sailing on a forward-looking basis. With valuations now in line with the long-term median, earnings growth will become the key driver for total return. Although we are constructive on Japanese equities in 2024, there are risks to watch for.
6. China
   A temporary rebound in Chinese equities is possible heading into2024, given near-term government support, inexpensive valuations and lightened positioning. However, investors are likely to look through any temporary respite, as structural issues remain entrenched. Property issues in China are likely to be a headwind for its economy in 2024 and beyond as roughly 70% of household wealth in China is tied to property value. Additionally, the political risk premium on China is likely too high for many.
7. Alternatives: Private Markets
   Private markets have experienced a series of disruptions in the last three years, culminating in asset prices beginning to adjust to a degree not seen since the GFC. As a result, many private markets participants have responded by slowing, and even pausing altogether, their private commitments (e.g., the amount of money an investor promises to a private fund). This sequence of events is causing the first industry-wide price correction in private markets since the GFC, and investors are attempting to identify the associated opportunities and risks.
   
   We evaluate opportunities in three distinct areas: markets that have already meaningfully repriced; markets that have experienced modest valuation changes, but at defendable levels; and markets where we expect continued valuation softening. In all markets we see opportunities ahead in 2024.

^{Risk Considerations}

^{There is no assurance that a portfolio will achieve its investment objective. Portfolios are subject to market risk, which is the possibility that the market values of securities owned by the portfolio will decline and that the value of portfolio shares may therefore be less than what you paid for them. Market values can change daily due to economic and other events (e.g. natural disasters, health crises, terrorism, conflicts and social unrest) that affect markets, countries, companies or governments. It is difficult to predict the timing, duration, and potential adverse effects (e.g. portfolio liquidity) of events. Accordingly, you can lose money investing in this portfolio. Please be aware that this portfolio may be subject to certain additional risks. Asset Allocation/Diversification does not protect you against a loss in a particular market; however it allows you to spread that risk across various asset classes In general, equity securities’ values fluctuate in response to activities specific to a company. Investments in foreign markets entail special risks such as currency, political, economic, and market risks. The risks of investing in emerging market countries are greater than risks associated with investments in foreign developed countries. Fixed-income securities are subject to the ability of an issuer to make timely principal and interest payments (credit risk), changes in interest rates (interest-rate risk), the creditworthiness of the issuer and general market liquidity (market risk). In a rising interest-rate environment, bond prices may fall and may result in periods of volatility and increased portfolio redemptions. In a declining interest-rate environment, the portfolio may generate less income. Longer-term securities may be more sensitive to interest rate changes. Mortgage- and asset-backed securities (MBS and ABS) are sensitive to early prepayment risk and a higher risk of default and may be hard to value and difficult to sell (liquidity risk). They are also subject to credit, market and interest rate risks. Certain U.S. government securities, such as those issued by Fannie Mae and Freddie Mac, are not backed by the full faith and credit of the United States. It is possible that these issuers will not have the funds to meet their payment obligations in the future. The issuer or governmental authority that controls the repayment of sovereign debt may not be willing or able to repay the principal and/or pay interest when due in accordance with the terms of such obligations. Investments in foreign markets entail special risks such as currency, political, economic, and market risks. The risks of investing in emerging market countries are greater than risks associated with investments in foreign developed countries. Real estate investment trusts are subject to risks similar to those associated with the direct ownership of real estate and they are sensitive to such factors as management skills and changes in tax laws. Restricted and illiquid securities may be more difficult to sell and value than publicly traded securities (liquidity risk). Derivative instruments can be illiquid, may disproportionately increase losses and may have a potentially large negative impact on performance. Trading in, and investment exposure to, the commodities markets may involve substantial risks and subject the Portfolio to greater volatility. Non-diversified portfolios often invest in a more limited number of issuers As such, changes in the financial condition or market value of a single issuer may cause greater volatility. By investing in investment company securities, the portfolio is subject to the underlying risks of that investment company’s portfolio securities. In addition to a Portfolio’s fees and expenses, a Portfolio generally would bear its share of the investment company’s fees and expenses. Alternative investments are intended for qualified investors only. Alternative investments, including hedge funds, provide limited liquidity and include, among other things, the risks inherent in investing in securities and derivatives, using leverage and engaging in short sales. An investment in an alternative investment fund can be speculative and should not constitute a complete investment program. This summary is for informational purposes only and does not constitute an offer to sell or a solicitation of an offer to buy interests in any fund.}