Slow then grow

After the up-and-down volatility of the pandemic and its aftermath, we see 2024 as an important transition year that sets the stage for more sustainable rates of growth and market returns ahead.

Key takeaways

Growth is likely to slow in early 2024, but we see no synchronized collapse across the global economy, as many fear. 


The latter half of 2024 should show a return to sustainable economic momentum as well as an improvement in corporate earnings.


We expect global economic growth to strengthen in 2025. This should become apparent to investors as earnings estimates for 2025 rise. We expect a 12% increase in earnings per share (EPS) over the next two years. 


The two pillars of investment returns – income and growth – have been reinvigorated. Therefore, this a very good time to build new balanced portfolios or to add to existing ones.


Valuations for key elements of core portfolios are more attractive today. Our 10-year strategic return estimates1 for the constituents of global portfolios have doubled from two years ago.


Yields in the US have risen toward two-decade highs. We think investors should take advantage of them now. Inflation-adjusted “real” Treasury yields of 2.5% are higher than in 80% of all periods over the past 25 years. Broader US fixed income yields are 4% above expected inflation.


Equity valuations are more attractive now. Except for large cap technology, many sectors trade at moderate valuations. Accordingly, we have already increased our exposure to small- and mid-sized growth equities and are likely to add more equity exposure over the year to come. 


While supply shocks are a possibility, we expect the upcoming period of slower growth to take pressure off labor markets. We expect these trends to alter the course for monetary policy. That said, we do not expect the US Federal Reserve (Fed) to push policy rates back toward zero or resume Quantitative Easing.

Entering the third phase: bull/bear/bull

The massive swings in global output and inflation driven by COVID in the early 2020s are fading into the history books. The immediate world growth outlook is modest, far from “roaring” like the “Twenties” of a century ago. However, prospects for a sustained expansion after a near-term period of slower growth are solid. We expect global growth to strengthen in 2025 after another year of convalescence in 2024 (Figure 1).  

Investors should recognize this “Slow then grow” pattern. It’s a transition that is unfolding in three distinct phases:

  1. Massive fiscal and monetary stimulus by policymakers around the world drives equity and bond markets to unusually strong returns in 2020-2021, despite the pandemic shock.

  2. Global markets then suffer a payback in 2022-2023. This period was one of just three years in the last century during which combined bond and stock returns were negative together.

  3. After a “valuation reset” for both stocks and bonds, we see a period of lower inflation, slower growth and higher earnings ahead. 2024 should start slower and see the economy accelerate as the year progresses. These "third-phase" conditions could offer stronger return opportunities in 2024 and 2025. 

Aftershocks diminishing

We expect an acceleration in the rate of economic growth in the latter part of 2024 and a stronger 2025 (Figure 2). Markets lead the economy and will begin to react to prospects for 2025 in 2024. This may allow US equities to reach new highs once the calendar flips over again. Though politics will be grabbing the headlines and creating anxiety for investors at year end, we think a brightening economy and markets will be evident at election time.

Figure 1: Citi Global Wealth (CGW) Real Gross Domestic Product (GDP) Forecasts
CGW Real GDP Forecasts (%) 

 

2020

2021

2022

2023E

2024E

2025E

US

-2.8

5.8

1.9

2.4

1.6

2.6

China 

2.2

8.5

3.0

5.5 

4.0

4.0

EU 

-6.3

5.6 

3.4

0.5

0.4

1.3 

UK 

-11.0

7.6

4.3

0.6 

0.6

1.5

Global 

-3.3

5.9 

3.3

2.6

2.2

2.8 

CGW EPS Forecasts (%) 

 

2020

2021

2022

2023E

2024E

2025E

S&P 500

-13.5

46.9

6.0

0.9

5.1

6.8

Source: Citi Global Wealth Investments and Bloomberg as of November 12, 2023. All forecasts are expressions of opinion and are subject to change without notice and are not intended to be a guarantee of future events. Indices are unmanaged. An investor cannot invest directly in an index. They are shown for illustrative purposes only and do not represent the performance of any specific investment. Index returns do not include any expenses, fees or sales charges, which would lower performance. Past performance is no guarantee of future results. Real results may vary. 

Figure 2: Developed market equities year-over-year (YoY) change in share price versus next-six-months projected earnings per share (EPS) 

Source: Bloomberg through October 31, 2023. Indices are unmanaged. An investor cannot invest directly in an index. They are shown for illustrative purposes only and do not represent the performance of any specific investment. Index returns do not include any expenses, fees or sales charges, which would lower performance. Past performance is no guarantee of future results. Real results may vary.

In recent years, we’ve likened the record economic swings of 2020-2021 and the inflation that followed as an “earthquake” and “aftershocks.” The amplitude of aftershocks tends to decrease over time. Massive swings in demand from services to goods and back was a recipe for inflation, but those swings are abating (Figure 3). 

For forecasters it has been difficult to determine how much of the pandemic period’s strange features will become structural issues for the economy. The evidence suggests that most pandemic impacts are transitory. Supply chains have normalized. Tradeable goods prices have stabilized, and macro stimulus has largely, if not completely, been unwound (Figures 4-5).  

Figure 3: YoY change in inflation-adjusted US consumer goods and services spending  

Source: Haver Analytics as of October 24, 2023.  

Figure 4: YoY change in the Global Supply Chain Pressure Index versus the US Consumer Price Index (CPI) for goods (as opposed to services)  

Source: Haver Analytics through October 31, 2023. Indices are unmanaged. An investor cannot invest directly in an index. They are shown for illustrative purposes only and do not represent the performance of any specific investment. Index returns do not include any expenses, fees or sales charges, which would lower performance. Past performance is no guarantee of future results. Real results may vary.

Figure 5: Change in the US money supply (“M2”) versus the change in federal deficit as a percentage of GDP 

Source: Haver Analytics through October 31, 2023

Rolling sector recessions are ending

Various developed and emerging market economies are currently suffering from drags on economic growth that likely won’t be repeated in 2024 and beyond. Export volumes of goods across the world are falling. Manufacturing activity has contracted, along with the faster-adjusting segments of housing markets (Figure 6). This is beginning to clear the overhang of high inventories that has been the source of significant recession risk (Figure 7). 

Those who fear a full-blown recession are overlooking that there are sector recessions running through various industries now, impacting the economies most exposed to them. In the US, for example, there is a clear recession in real estate and certain manufacturing sectors, but there is no broad-based collapse. Globally, services industries that endured a depression in 2020 have grown disproportionately and are unlikely to either contract or boom in 2024. This composition of growth benefits the services-heavy US economy for now. But over the coming two years, as the global manufacturing contraction ends, a broader worldwide economic expansion should begin to kick into gear.  

Figure 6: YoY change in imports and real estate investment  

Source: Haver Analytics through September 30, 2023.

Figure 7: YoY change in US inflation-adjusted business inventories  

Source: Haver Analytics through September 30, 2023. 

China’s slide

Relative to the US, an opposite dynamic is unfolding in China currently. Property and trade sectors are much larger shares of China’s economic activity, and the larger structural changes needed to clear major imbalances have not been sufficiently implemented. In the near term, these headwinds pose a great challenge for China’s policymakers.  

The impact of China’s challenges has not been all bad for the global economy. China’s struggles are lowering the cost of goods worldwide at a time when inflation concerns remain high.

The immediate stimulus measures undertaken by the Chinese government in recent months have been significant, probably enough to engender a cyclical recovery in 2024 and into 2025. Indeed, the latest data suggest it has already started. That said, an ongoing, deep slowdown in China is perhaps the biggest risk to worsening the “slow” and delaying the “grow” in our accelerating global growth pattern. 

Labor markets are poised to slow, stemming US rate pressures

A center point of our Wealth Outlook is a sharper slowing in US employment in 2024 than many expect. Job gains in 2022-2023 exceeded GDP gains by the most since 1974. However, we believe this period of falling productivity – another anomaly from the pandemic era’s strange swings in demand and labor composition – is likely coming to an end. As Figure 8 shows, labor input is already slowing while productivity growth is rebounding. 

The US labor market is far more cyclical than most developed market economies, with relatively low barriers to hiring and firing. Consequently, US monetary policy is also much more variable, constantly reacting to the state of employment (Figure 9). As a contrast, consider that Japan has not changed its short-term policy rate significantly since 2008 (though that could be about to change – see our discussion of the prospect of yen strengthening in No. 8 of “Our top 10 high-conviction potential opportunities”).  

In 2023 to date, US employment gains have averaged 239,000 per month. While strong, this run rate is half the average of the same period in 2022. In October, those gains slowed to 150,000. We expect them to slow further in 2024. 

An economic collapse is not a prerequisite for Fed easing. As employment growth slows, the Fed will become increasingly concerned about the interaction of its self-described restrictive monetary policy and the labor market. It is notable that since 1980 (when the Fed started taking more responsibility for controlling inflation), the Fed has begun cutting rates with US employment averaging gains of 146,000 per month for the half-year before. 

This is one of the reasons the Federal Open Market Committee (FOMC) participants forecast two rate cuts as a median estimate in 2024. While we don’t project anything close to a return to zero interest rate policy, we will note that easing cycles tend to be more pronounced than the Fed’s projections made a year or more in advance. 

Employment Growth Down, Output Up

As labor markets cool off, we think corporate profits will heat up. Many cyclical industries contracted output in 2023 even while hiring across the economy rose. As consumer spending slows in 2024, that will leave firms in a position to boost production. After all, large declines in global trade anticipated a consumer demand collapse that never occurred and left inventories contracting. Corporate profits have already risen for the past two quarters, and we see S&P 500 EPS over the next two years rising 12%. 

Shifts in the composition of industry demand and output play a larger role in the short-term than enduring technological innovation, but greater benefits could soon be realized on the latter front as well (see our article about the Unstoppable Trend of digitization and how to invest in it).

This prospective improvement in corporate profits led us this past October to raise the equities allocation in our core portfolios to overweight from neutral for the first time since 2020. For now, the overweight is 2% and mostly centered on the US – but we suspect we’re being conservative. If the US dollar weakens along with falling interest rates, as we expect, and credit stays firm, equity returns could be significantly stronger and broader than we currently anticipate. This would suggest a higher global equity overweight if key conditions are met.

FIGURE 8: YoY change in US Non-Farm output per hour and hours worked

Source: Haver Analytics through September 30, 2023.

FIGURE 9: YoY change in Fed policy rate and growth of non-farm US employment  

Source: Haver Analytics through October 31, 2023. 

Resilience, with some risks 

The US and the world economy overall have endured the impact of higher rates and other macro policy tightening better than we and many others expected. Compared to our forecast a year ago, the US economy has seen a sharp upward revision for 2023 by a full 1½ percentage point in real GDP terms. The drop in US inflation from a peak of 9% has strongly helped US real incomes in the year past. By year-end 2024, we expect headline US CPI inflation to fall to 2.5%, from ~3.7% at year-end 2023. This slowing has boosted real incomes and sentiment at the same time savers have enjoyed a surge in real yields.

Many of the world’s economies are likely to experience the same deceleration in inflation given the normalization of supply chains and trade. This inflation drop can’t be counted on to boost economies quite as forcefully as in 2023, but other tailwinds may increase globally on a lag from the US as we move deeper into the year and then into 2025. 

The inversion of the US yield curve, even if less pronounced than before, remains an indicator of tight monetary policy. This can leave the economy more vulnerable to a shock, as was the case when the pandemic hit. Another supply shock that tips the economy into a broader recession can never be ruled out given geopolitical uncertainties. If a new, global shock were to materialize, monetary easing could be more profound than we expected, but it would be no immediate substitute for economic growth and profits. 

Assuming no imminent recession or major global supply shock, it seems likely that the Fed will ease monetary policy gradually in the coming few years. This should be consistent with 10-year US Treasury yields falling back somewhat, perhaps to 3.75% by year-end 2024. Investors should also understand that the long period of zero interest rates – and even negative yielding bonds – will go down in history as an outlier. We see this much like the mirror opposite period of “great monetary neglect,” which boosted inflation and yields throughout the 1970s. 

Investment Strategy: Both income and growth opportunities have been restored

The two pillars of investment returns – income and growth – have been reinvigorated. Yields in the US have risen toward two-decade highs (Figure 10). With investment grade US corporate bond yields averaging 6% and inflation decelerating, it is quite possible to earn real returns of 4% across a diversified range of fixed income.  

At the same time, tight monetary policy has driven both bond and equity investors to focus predominantly on the largest and safest perceived corporate balance sheets. This has left numerous growth opportunities behind. The seven largest US technology-related shares have driven most of the return in global equities in 2023. We believe this is unlikely to be the case in 2024 and 2025. 

Finding value in growth shares

Tight monetary policy could hasten the failure of chronically unprofitable firms, but the market appears to be looking for trouble well beyond the marginal businesses most likely to be at risk. As Figure 11 shows, the valuation of currently profitable and generally growing small- and mid-cap (SMID) US firms has dropped far below the valuation of large cap growers. In the past five years, the profitable SMID firms of the S&P 400 and 600 growth indices have averaged annual EPS growth of 11%. That’s even above the 9% pace of the large cap S&P 500 growth index. Yet, the SMID growth shares trade cheaper, for an unusually deep discount of 39% on current-year estimates compared to the valuation for the large cap segment. In fact, they trade 29% below their own 25-year history based on trailing price-to-earnings (P/E) ratio. 

We do not see this disconnect as a market dislocation similar in scope to early 2020. That period was followed by a 145% increase for the Russell 2000 index in the 19 months that followed. But surely, investment portfolios can’t ignore the value of growth while seeking income (Figure 12). This is true even when there is no “V” shaped recovery for the economy in sight.

Figure 10: US 5-year Treasury yield index

Source: Haver Analytics as of November 21, 2023. Indices are unmanaged. An investor cannot invest directly in an index. They are shown for illustrative purposes only and do not represent the performance of any specific investment. Index returns do not include any expenses, fees or sales charges, which would lower performance. Past performance is no guarantee of future results. Real results may vary.

Figure 11: US large-cap, mid-cap and small-cap growth forward P/E

Source: Bloomberg as of November 3, 2023. Small cap growth proxied using the S&P 600 Growth Index, mid cap growth proxied using the S&P 400 Growth Index, large cap growth proxied using the S&P 500 Growth Index.  Indices are unmanaged. An investor cannot invest directly in an index. They are shown for illustrative purposes only and do not represent the performance of any specific investment. Index returns do not include any expenses, fees or sales charges, which would lower performance. Past performance is no guarantee of future results. Real results may vary.

Figure 12: Inflation adjusted return indices for US stocks, bonds and cash

Source: Haver Analytics through October 31, 2023. Indices are unmanaged. An investor cannot invest directly in an index. They are shown for illustrative purposes only and do not represent the performance of any specific investment. Index returns do not include any expenses, fees or sales charges, which would lower performance. Past performance is no guarantee of future results. Real results may vary.

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