In the second half of 2024 and beyond, investors should closely monitor the growing impact of U.S. fiscal policy on the markets and consider the opportunities it presents across various asset classes, such as emerging market debt, U.S. equities, loans, and real estate.
Key Takeaways:
- U.S. fiscal policy could dominate economic activity and contribute to market uncertainty in the latter part of this year.
- Investors should evaluate which assets and sectors are most influenced by fiscal policies.
- A weakening U.S. dollar and stronger growth abroad could support international assets like emerging market debt.
- U.S. government spending may benefit sectors like industrials, materials, semiconductors, and equipment stocks.
- Opportunities also exist in high-yielding bank loans, collateralized loan obligations, and private real estate.
In recent years, monetary policy has commanded investor attention, particularly in response to Federal Reserve rate hikes starting in 2022. However, fiscal policy is likely to take center stage for the remainder of 2024 and beyond due to increased government spending, deficits, and the looming U.S. election. Investors will be keenly watching how different candidates’ policies might impact the economy, according to Morgan Stanley
Investment Management’s Portfolio Solutions Group.
Fiscal Policy and Inflation Concerns
Regardless of who wins the upcoming U.S. presidential election, investors need to consider how government spending and rising debt levels could drive inflation and increase price pressures due to trade tariffs, says Jim Caron, Chief Investment Officer of the Portfolio Solutions Group. The next six to 18 months may be crucial in shaping the future of inflation, and swelling national debt could lead to higher risk premiums and potential headwinds for asset prices.
While the risks of higher premiums might not affect all asset prices equally, Caron notes that certain sectors could still benefit from fiscal policy changes. Investors can look at opportunities in emerging market debt, U.S. equities, loans, and private real estate to position themselves for potential gains.
A Weaker Dollar and Emerging Market Debt
The strength of the U.S. dollar is largely driven by relative interest rates and growth differentials between the U.S. and other global markets. However, these factors may be reaching their limits, offering a strategic moment to explore international assets such as emerging market debt and international equities.
“Economic activity is strengthening outside the U.S., making the case for continued U.S. economic outperformance less compelling,” says Jitania Kandhari, Deputy Chief Investment Officer of the Solutions and Multi-Asset Group. Brad Godfrey, Co-Head of Emerging Markets at Morgan Stanley, adds that emerging market debt, while not dependent on a weaker dollar to perform well, benefits when the dollar’s strength is no longer a headwind. With global elections and geopolitical factors in play, country-specific investments in emerging markets are more critical than ever.
### U.S. Equities and Government Spending
The earnings outlook for U.S. equities remains promising, with the S&P 500 projected to rise further by the end of the year, according to Andrew Slimmon, Head of Applied Equity Advisors at Morgan Stanley. Though U.S. stocks typically experience a correction of around 10% annually, the last such correction was in late 2023, suggesting that another pullback may be on the horizon.
Still, fiscal spending could provide support to specific sectors. Government initiatives such as the Infrastructure Act and the Chips Act are expected to benefit industrials, materials, semiconductors, and equipment sectors. “Our focus is on where the U.S. government is directing its spending,” says Slimmon.
As fiscal policy grows more prominent, investors can position themselves to take advantage of shifts in the market by focusing on sectors and asset classes most likely to benefit from government spending and policy decisions.
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