CONTRIBUTORS
Stephen Dover, CFA
Chief Investment Strategist
Head of Franklin Templeton Institute
Tony Davidow, CIMA®
Senior Alternatives Investment Strategist
Franklin Templeton Institute
Preview
Many of the same issues that impact traditional investments also impact alternative investments. Some of the issues provide headwinds, while others provide tailwinds. Rising interest rates can favor private credit because of the floating-rate nature of most of their debt, can hurt commercial real estate as credit conditions tighten, and also negatively impact private equity because of the rising cost of capital to finance transactions.
The US stock market has soared throughout much of 2023, with the S&P Index 500 up 20%1 despite some challenging headwinds. The fixed income markets also started to anticipate the end of the US Federal Reserve’s (Fed) tightening cycle, with 10-year Treasury yields falling from a peak of over 5% in October to below 4%.2 The US and world economies have remained resilient despite monetary policy tightening and have continued to grow at a greater-than anticipated rate.
Geopolitical risks and tensions remain elevated with the ongoing wars in Ukraine and Gaza, and 40 national elections slated to occur in 2024. The United States has its own set of political challenges, with presidential and congressional elections in 2024, and ongoing threats of a government shutdown, political gridlock, a growing debt load and growing social unrest.
2024 economic outlook
We expect the economy will slow in 2024 but avoid a hard landing recession, and inflation will moderate but not reach the 2% Fed target. This will likely prompt the Fed (and other central banks) to cut interest rates over the next year.
US and global economic resilience to higher interest rates has occurred because so many had financed at the lower, prevailing interest rates and did not need to refinance as rates rose. At some point, higher borrowing costs, compounded by tighter lending, will lead to softening demand. A risk is that the Fed may be slow to recognize this and respond too late, leading to a harder landing than the markets are anticipating.
We are moving from an economic environment with rising inflation to one with weakening economic growth and falling inflation. As the chart above indicates, historically, this has been positive for value stocks, private equity, infrastructure and relative value investments. US monetary policy and credit conditions have become more restrictive during 2023 as interest rates have risen, with the implication that economy will weaken, unemployment will rise, and a growing number of households and businesses will experience credit duress in 2024.
Read the full paper to learn more. Topics covered include:
- Private credit: Disruptions create opportunities
- Private equity: Secondaries anyone?
- Commercial real estate: Diversification matters
- Hedge funds: Not all strategies are created equally
Endnotes
- Source: Krauskopf, Lewis. “Resurgent S&P 500 crests new 2023 closing high after roller-coaster year.” Reuters. December 3, 2023.
- Source: Kiderlin, Sophie. “10-year Treasury yield drops below 4% after Fed signals rate cuts are ahead.” MSN. December 2023.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal.
To the extent the fund invests in alternative strategies, it may be exposed to potentially significant fluctuations in value.
Investments in many alternative investment strategies are complex and speculative, entail significant risk and should not be considered a complete investment program. Depending on the product invested in, an investment in alternative strategies may provide for only limited liquidity and is suitable only for persons who can afford to lose the entire amount of their investment. An investment strategy focused primarily on privately held companies presents certain challenges and involves incremental risks as opposed to investments in public companies, such as dealing with the lack of available information about these companies as well as their general lack of liquidity. Diversification does not guarantee a profit or protect against a loss.
Risks of investing in real estate investments include but are not limited to fluctuations in lease occupancy rates and operating expenses, variations in rental schedules, which in turn may be adversely affected by local, state, national or international economic conditions. Such conditions may be impacted by the supply and demand for real estate properties, zoning laws, rent control laws, real property taxes, the availability and costs of financing, and environmental laws. Furthermore, investments in real estate are also impacted by market disruptions caused by regional concerns, political upheaval, sovereign debt crises, and uninsured losses (generally from catastrophic events such as earthquakes, floods and wars). Investments in real estate related securities, such as asset-backed or mortgage-backed securities are subject to prepayment and extension risks.
An investment in private securities (such as private equity or private credit) or vehicles which invest in them, should be viewed as illiquid and may require a long-term commitment with no certainty of return. The value of and return on such investments will vary due to, among other things, changes in market rates of interest, general economic conditions, economic conditions in particular industries, the condition of financial markets and the financial condition of the issuers of the investments. There also can be no assurance that companies will list their securities on a securities exchange, as such, the lack of an established, liquid secondary market for some investments may have an adverse effect on the market value of those investments and on an investor’s ability to dispose of them at a favorable time or price.