Key Takeaways:
- U.S. fiscal policy may dominate economic activity and boost market uncertainty throughout the remainder of 2024 and beyond.
- A weakening dollar and better economic growth outside of the U.S. could support international assets such as emerging market (EM) debt.
- U.S. government spending could boost industrials, materials, semiconductors and equipment stocks.
- Investors can also consider high-yielding bank loans and collateralized loan obligations (CLOs), as well as private real estate.
U.S. fiscal policy's dominance on markets is growing. Markets have fluctuated in response to the U.S. Federal Reserve rate hikes that began in 2022 and may become more sensitive to fiscal policy through the remainder of 2024 and beyond. The increasing influence of U.S. government spending, deficits and debt over economic activity and a new presidential administration are top of mind for investors who observe how policies may affect the economy.
Investors should consider that government spending and debt can lead to higher inflation, and that tariffs in response to trade tensions can fuel price increases. Amid ongoing uncertainty over inflation, fiscal policy that increases national debt may lead to higher risk premiums and headwinds for asset prices.
Fortunately, the drawbacks of higher risk premiums may not be evenly distributed across asset prices, which means there can be winners and losers among sectors depending on the degree of fiscal policy influence. Investors aiming to structure portfolios that can benefit from these challenges may consider opportunities in emerging markets (EM) debt, U.S. equities, loans and private real estate.
A Weakening Dollar May Boost International Assets Like EM Debt
The value of the U.S. dollar is influenced by relative interest rates and growth differentials between the U.S. and the rest of the world. On both counts, trends that have strengthened the greenback may have run their course, making it a potentially opportune moment to explore non-U.S. currencies and international assets, like equities and emerging market debt.
Economic activity is strengthening beyond the U.S., creating a less compelling case for U.S. economic growth to continue outperforming the rest of the world. As a result of dollar depreciation, EM debt offers the potential for increased income and portfolio diversification.1 Country picking matters more than other factors when it comes to investing in EMs, amid geopolitical concerns and elections around the world. EM debt is under-owned by investors and flows into dedicated EM debt funds may be shifting after several years of strong outflows.
Equities Outlook: Upward Earnings and Government Spending
The 2025 earnings forecast for the S&P 500 has been rising, and that suggests the index could be closer to 6,000 by the end of this year after climbing past 5,000 in February. In our view, economic activity is strengthening beyond the U.S., creating a less compelling case for U.S. economic growth to continue outperforming the rest of the world.
While fiscal spending may contribute to market uncertainties, it may also directly support certain sectors, such as industrials and materials as with the Infrastructure Act, and semiconductors and equipment as with the Chips Act. As a result, we are now focused on the areas where the U.S. government is spending the money.
Tailwinds for Bank Loans and CLOs
Credit markets may benefit from strong fundamentals and outsized starting yields. As a result, growth is easing but remains positive, inflation is falling, and peak interest rates appear to be in the past. In our view, near double-digit yields go a long way to buffer potential risks on the horizon.
Bank loans and CLOs, single securities backed by a pool of debt, are particularly attractive among fixed income options. They offer a senior/secured credit profile, high income with effectively zero rate duration, and they are trading cheaply compared to other assets. These factors can help bank loans and CLOs serve as effective hedges. The absolute yield in bank loans is one of the highest in fixed income, with levels comparable to long-run equity returns, and CLOs offer even higher yielding—and higher rated—opportunities. Loans and CLOs are two of the most attractive opportunities currently available to investors.
An Early Opportunity in Private Real Estate Investing
Private real estate values have fallen by approximately 20% from their peak in the second quarter of 2022, with transaction activity set to expand as existing financing matures and investors are required to recapitalize at higher costs.
While pockets of positive, but moderating, demand meeting elevated supply has put pressure on rents and vacancies, the long-term operating outlook for the asset class is strong. Real estate supply is set to diminish meaningfully by the end of 2024 and into 2025, and debt markets remain relatively healthy.
Bottom Line: As U.S. fiscal policy continues to impact markets, investors may consider opportunities based on what assets and sectors fiscal policy influences most. Current conditions are bolstering potential in international assets such as EM debt, industrials, materials, semiconductors and equipment stocks, and high-yielding bank loans and collateralized loan obligations, as well as private real estate.
1 Diversification does not eliminate the risk of loss.
