By Erik Sherman

Financial and economic prognostication has become a little more careful. Especially after the positive takes at the end of 2022 that eventually had to contend with ongoing higher interest rates, impacts on banks, and yields on the U.S. 10-year Treasury that would eventually approach 5% and challenge alternative investments to offer enough return to investors.

But at we count down the final days of 2023, it’s time to update a look ahead, which will be a complicated process for alternative investments. Depending on the form of asset, implications and actions might vary significantly, depending on regional economies and dynamics.

“Economically speaking, everyone is kind of gearing up for this slowdown which is very clearly underway in Canada,” says James Orlando, director of economics at TD Economics. “If you look at GDP growth trends, consumer trends, it has a weakness that makes people nervous. We do have the economy having a trough in the first half of 2024.” And then a rebound because eventually the economy slows and “you no longer need 5% interest rates.”

Canada’s Office of the Parliamentary Budget Officer agreed in its October 2023 economic and fiscal outlook, which expected the Bank of Canada to maintain a 5% interest rate through the first quarter of 2024, weak consumer spending through the first half of 2024. The PBO also expects the unemployment rate to rise to 6% in the middle of next year and then to remain elevated through the first half of 2025.

A Global Perspective

For international trends, the Federal Reserve in the U.S. in its September Summary of Economic Projections looked for an overall change in real GDP to be 2.1% in 2023 and 1.5% in 2024 for a significant slowdown in growth and an unemployment rate to rise from 3.8% to 4.1% through next year and core inflation dropping to 2.6%. They do expect a fall in the benchmark federal funds rate from 5.6% at the end of 2023 to 5.1% eventually in 2024.

Oxford Economics looked at different regions of the world, like Latin America. “Most countries in the region have recently approved budgets that contemplate either softer consolidation efforts, like in Chile, or increased spending, like in Mexico,” they wrote in early December. “However, Argentina’s budget is still up in the air as Milei’s radical plans to slash government expenditure could face political resistance.”

“Preliminary figures showed eurozone headline inflation fell 0.5 ppts in November to 2.4%, with core inflation posting a slightly larger drop to 3.6%,” Oxford also wrote. “Prominent ECB members have recently voiced worries about the ‘last mile’ of disinflation, but a further sharp drop in market interest rate expectations suggests that markets are increasingly convinced that the ECB’s outlook for inflation is well wide of the mark.”

And for emerging markets, Oxford wrote, “Emerging market economic growth exceeded our expectations this year, but the cross-country pattern of GDP upside surprises appears uncorrelated with the historic sensitivity to the U.S. economic cycle. EM growth will slow in 2024 as the global backdrop worsens. We forecast EMs ex-China GDP growth at 2.8%, 0.3 ppts below this year and the five-year pre-Covid average.”

Rate Drop on the Horizon?

One useful strategy may be to look for 2024 profits from bonds purchased when yields were high and prices low. “If our view is true, the Bank of Canada will cut in 2024,” Orlando says. “That’s good news for bond-holders right now.” As interest rates and yields drop, prices will rise. “If yields stay at this level or go down, that’s good news.” It will be the opposite of what happened to some U.S. banks that were heavily invested in government and mortgage bonds at low yields when interest rates jumped.

Commercial real estate is tricky with different areas of uncertainty depending on geographic area and type, like residential versus office. “Both sides look terrible now,” says Phillip Colmar, managing partner and global strategist at MRB Partners. “Unfortunately, the pensions went into that and real estate’s in trouble.”

But that depends on where a pension looks and what it bought.

“We have chronic undersupply of homes in Canada,” Orlando adds. “We’re still going to have an undersupply of homes. That’s a long term positive [for investors]. That puts a floor under prices.”

The same can’t be said right now for office properties. But then, as Colmar notes, there is also a difference from the U.S. in available financing. “In Canada, you can’t lock to that 30-year mortgages,” because often a 5-year debt that needs payoff or refinancing is all that’s available. “We had 40% of the mortgage market reset. The negative amortization that just can’t pay the interest has just gone vertical. It’s a crisis brewing.” Unless interest rates fall.

In the U.S., volumes of new multifamily construction are resulting in falling values, rising vacancy rates, and downward pressure on rents. Conditions can differ in other regions where pensions also have investments. To understand the implications in 2024, it’s necessary to break down holdings by area and take a portfolio view of valuations and ongoing net operating incomes.

Across private market investment, “there’s been a slowdown in activity in this year,” says Clay Khan, head of Canadian business at Neuberger Berman. Macroeconomic conditions have been a challenge. “Pensions have essentially been limited in their activity because allocation issues. Over time I think what you’ll see is less emphasis domestically and more on global assets.”

Infrastructure investment is still popular in many parts of the world. But while there’s interest “to hold ESG with a great marketing buzz about it,” says Colmar, corporate clients are finding a lot of confusion about what it ultimately means, especially as companies increasingly use the term for marketing purposes.

So, 2024 will be a time for reconsideration and reevaluation for pension funds, especially as they watch what regional economies and central banks’ interest rates decision in the new year.