Russell Investments warns of long-term risks of soft-landing optimism

Investors feeling optimistic about the predicted soft landing in 2024 could still feel the sting of rate rises, according to Russell Investments’ strategists.

A soft landing refers to the process of a central bank raising interest rates just enough to stop an economy from experiencing high inflation without entering a recession.

Investors who were fearful of a recession in 2023 are being attracted back into the market amid increased economic growth, falling inflation and corporate profits holding up, which has the potential to push major market indices to record highs, strategists said.

However, they said the risks of economic growth eventually disappointing markets are underappreciated. The US labor market is cooling, with job openings down about 25% compared to their peak in 2022 alongside signs that lower-income households are coming under stress.

Russell Investment strategists also found default rates on credit cards and auto loans are above pre-pandemic levels and high-yield default rates in the corporate sector are picking up and commercial real estate delinquencies have continued to rise.

Andrew Pease, chief investment strategist at Russell Investments, said: “Although declining inflation means central banks can start easing in the second half of the year, the lagged impact of previous rate rises is yet to be fully felt.

“Just as last year’s investor pessimism was overdone, we worry this year’s optimism could eventually prove to be excessive.”

He added that, while the firm predicts it is “more likely than not” that the US will avoid a recession in 2024, uncertainty remains elevated. He said: “Markets have priced in all, if not more than all, the positive news in recent months.”

Key asset class views

Equities

Russel Investments’ strategists said their equity market outlook is constrained by expensive valuation multiples, optimistic industry consensus earnings growth expectations and overbought sentiment.

In February 2023, the team noted the previous overweight in Quality equities — profitable companies with strong balance sheets — had neutralized, leaving equities with limited upside.

Similarly, non-US developed equities still trade at a steep discount to US equities, but these markets’ abilities to deliver differentiated earnings remain uncertain.

Fixed income

The firm’s strategists identified government bonds as an opportunity for attractive returns as yields still trade will in excess of expected inflation. They said US Treasuries are a preferred overweight exposure, where the firm’s fixed income strategy team sees particularly good value in the five-year point of the yield curve.

They also said the team’s favorable outlook for government bonds continues to extend across most major developed sovereign markets, including Canada, Germany, Australia and the UK, with Japan being the only notable outlier.

In terms of US high yield and US investment grade, the strategists said spreads are very tight against a backdrop of elevated economic uncertainty, leading the team to dampen its normal strategic overweight to corporate credit.

Currencies

Russell Investments has a neutral stance on the US dollar. It said it is expensive, which suggests potential for the greenback to decline over the medium-term.

However, the potential for a global recession in 2024 could result in further upside for the dollar in the short term as investors flock to the relative safety of US assets.

Pease said: “On balance, our investment decision-making process leans slightly cautious, but it does not show markets at an extreme that would incline us to position portfolios markedly risk-on or risk-off. Instead, most of our portfolio strategies at the beginning of the second quarter are emphasizing security selection and diversification to protect client outcomes across a wide range of potential scenarios in the year ahead.”