Choose Optimism | The Connection

By Joe Zidle, Chief Investment Strategist, Private Wealth Solutions October 31, 2024

With 2024 in its final stanza, the world faces a trio of interconnected, generation-defining events, each with highly uncertain outcomes: an emotionally charged US presidential election, an escalating war in the Middle East, and the ongoing conflict in Ukraine. It’s easy to feel overwhelmed by the gravity of events like these. How we choose to view them depends very much on our own perspectives. I think of them as a dad, a veteran, and a voter. As an investor, I think it’s crucial to remain focused on the fundamentals, time and attitude included.

In the long run, it pays to be a market optimist*—literally. Private markets benefit the most due to their investment horizons. For example, private equity and private real estate have delivered impressive average annualized returns of 14% and 9%, respectively, throughout their histories.¹ Since its inception, private credit has also performed well, providing an annualized return of 10%.² On an annual basis, private equity has reported positive returns 88% of the time, while private real estate has achieved positive returns 89% of the time.³ Private credit stands out even more, with positive returns 96% of the time when measured annually.⁴ In comparison, public equities are more volatile but have still been positive 73% of the time annually.⁵ Statistically, the longer you hold your investments, the better your chances of success.

After being wrong about a recession in 2023, I decided to re-embrace optimism heading into 2024. Why? Because as my former partner, Byron Wien, was fond of saying, “[In markets] disasters have a way of not happening.” Also, the data from our portfolio companies supported that sentiment.⁶ Despite moderating revenue and profit growth, along with a reduced pace of hiring, their resilience pointed to a possible soft landing. Today, the data continues to support the argument for optimism. Corporate and household balance sheets remain healthy, real incomes are rising, central banks are loosening policy, and fiscal stimulus is flowing. These are not the conditions for a hard landing.

Defining the Landing

Broadly, four preconditions must be met before we can confidently declare any type of landing: (1) inflation close to target—otherwise, the central bank’s job isn’t done; (2) a series of rate cuts to take the pressure off the economy; (3) a positively sloping yield curve, because… well, it would be weird without one; and (4) a recovery in leading indicators. While all of these preconditions are in progress, the outcome isn’t binary. There are other possible scenarios besides a hard or soft landing, as we illustrate in the table below.

Figure 1: Types of Landings

Note: The above information is provided for illustrative purposes only and should not be considered research or investment advice. Represents Blackstone’s view of the current market environment as of the date appearing in this material only.

Soft Landing or Upside Potential?

Our base case is a soft landing, which we inch closer to every month that growth holds up, financial markets stay stable, and labor markets avoid significant deterioration. The labor market is softening by some metrics, but it’s still stable. Downward annual employment revisions and increased labor market slack from part-time employment and underemployment shows weaker labor demand. However, even as labor demand cools, output is expanding. Corporate profits are up 15% year-over-year (YoY), receiving upward revisions back to 2019 from the Bureau of Economic Analysis (BEA).⁷ Hours worked have declined to recessionary levels, but third quarter GDP grew at 2.8%.⁷

How do we square all this? Productivity growth, which we’ve written about in The Connection previously. The foundation for reinvigorated productivity was set in the late 2010s, when corporations began to invest in aging assets as labor churn settled and workers adapted to new jobs increasing their output per hour worked. The trend has continued post-pandemic, with productivity rising 2.7% over the past year, well above the 1.5% average from 2005–2019.⁸ We believe that this growth underpins the soft landing that’s materializing, and perhaps something even more positive. With better productivity, firms can increase output with fewer resources and avoid passing higher costs onto consumers, relieving pressure from inflation and labor markets.

In this environment, the Fed doesn’t need to be aggressive with the size and number of rate cuts. Rather, we expect a milder cutting cycle in which the Fed recalibrates the policy rate. At the same time, we’re in the early stages of a coordinated global interest rate-cutting cycle. With the amount of monetary and fiscal stimulus central banks are injecting into the global economy, we believe that there is considerable upside potential beyond a soft landing.

A Coordinated Global Rate-Cutting Cycle

Since Switzerland’s National Bank cut rates in March, 10 out of 11 G10 central banks have entered rate-cut cycles, resulting in a cumulative 425 basis point reduction, the most since 2009.⁹ Together, these central banks represent countries that account for about 43% of global GDP.¹⁰ Add China to the equation, and about 62% of global GDP is easing financial conditions.¹¹ This coordinated monetary stimulus provides the framework to stabilize or even accelerate global growth by lowering borrowing costs and encouraging investment and consumer spending across major economies. The Organization for Economic Co-operation and Development (OECD) has already revised up its estimates for global growth this year to 3.2% based on the combination of rising real incomes, increased central bank liquidity, and easing financial conditions.¹²

Figure 2: Number of Policy Rate Hikes and Cuts by G10 Central Banks

.

Source: Blackstone Investment Strategy Calculations, US Federal Reserve, European Central Bank, Bank of England, Bank of Japan, Bank of Canada, Sveriges Riksbank, Swiss National Bank, and Macrobond, as of 10/28/2024.

Stimulus in the US is more than just Fed cuts. The federal government has injected almost $7 trillion of fiscal stimulus into the US economy, and this year expenditures are up 10% YoY.¹³ Economic data continues to surprise to the upside, and the consumer is holding up well. Jobless claims remain low, as is the unemployment rate when looking back over history. Consumer spending along with business investment is supporting economic growth.¹⁴ Consumer spending accounts for roughly 70% of GDP growth, and higher-income households are responsible for 60% of all consumer spending.¹⁵ With record household net worth, this cohort’s spending is likely to continue. Financial conditions have eased, giving small businesses and lower-income consumers who are more reliant on short-term financing reprieve from higher rates.

China is making moves to jump-start its recovery. China has not recovered in the same way as the US following the pandemic, but its recent response to its sluggish economy is what we’re focused on. In September, China’s economic planning agency, the National Development and Reform Commission (NDRC), released its most comprehensive stimulus package since 2008, with total stimulus expected to reach more than 10% of GDP.¹⁶ Rarely have China and the US cut rates and pumped stimulus in their systems at the same time. The last time was 2008, but back then China was just a $4 trillion economy. Today, it’s almost five times larger.¹⁷

This first round of stimulus was a good start: lowering short-term interest rates and borrowing costs, providing loans to support the stock market, and reducing new and existing mortgage rates. In a positive sign, home sales increased over the Golden Day holiday week, notably in Beijing, where sales were up 81% YoY.¹⁸ While most of the stimulus announced thus far has been monetary, local governments still have 55% of their 35.5 trillion yuan in budget allocations left to spend on regaining consumer confidence.¹⁹ More specific fiscal plans should be released at the end of this year, with the NDRC already floating spending plans of around 300 billion yuan for 2025.²⁰  

Confidence is building in Europe. The European Central Bank (ECB) has reduced rates twice this year, while the Bank of England (BoE) has cut once. Data out of the UK is encouraging. Inflation has come down and allowed real wage growth to support consumption. As credit availability improves alongside consumer confidence, spending and consumption should increase. Steady momentum is expected in Euro area growth, as GDP is expected to climb from 0.8% in Q3 2024 to 1.3% in Q4 2025.²¹ With growth risks already deeply priced into markets, we believe that the UK and Euro area provide long-term opportunities for investment.

Japan is on the verge of a virtuous cycle. A generational shift is underway in Japan’s economy and financial markets. Following the Bank of Japan’s (BoJ) first rate hike in 17 years, the country is experiencing moderate inflation and the best period of nominal economic growth since the collapse of its asset bubble in the 1990s.²² The BoJ considers the current policy rate of 0.25% below neutral, and Governor Kazuo Ueda has signaled that they are waiting for the Fed to achieve a soft landing before raising rates again.

This environment should help capital investment over the next few years, the prospects of which are leading to higher GDP growth forecasts. Wage growth has reached a 30-year high, although household spending is soft with inflation at its highest level in decades.²³ New Prime Minister Shigeru Ishiba called for his cabinet to enact fiscal stimulus to offset the rising cost of living, which along with the pent-up savings, bodes well for consumer spending and economic activity. Policy measures to boost productivity and increase defense spending by 16% are also expected to pay dividends.²⁴

Figure 3: Central Bank Policy Rates

Source: Bloomberg, European Central Bank, Bank of England, People’s Bank of China, Bank of Japan and Federal Reserve, as of 10/21/2024. ECB rate represents deposit rate.

Investment Implications

We are optimistic that the Fed achieving a soft landing accompanied by a global easing cycle can support broadening global growth into 2025. But by steadying economic growth, global central banks may not be able to cut as much as markets have priced in. Global rates will decline, but we are not returning to the environment of the last cycle where rates reached a 5,000-year low. Volatility could rise, not fall, as markets react.

This new investment landscape underscores the need for proper diversification. The positive year-to-date performances of equity and bond markets may make it tempting to overlook their positive correlation. However, the fact that the two moved in tandem in 2022 with positive correlation, but suffered negative annual returns, is proof that the traditional 60/40 portfolio is unreliable.²⁵ We’ve exited the secular bond yield decline that began in the 1980s, and bonds no longer offer the downside protection that they have in the past. Allocators are investing in a different rate environment and must look past traditional assets to increase risk-adjusted returns.

Figure 4: Stock-Bond Correlation

Source: Bloomberg, as of 9/30/2024. Based on the combination of a five-year rolling correlation of one-month changes in the S&P 500 and the Bloomberg US Government Bond Index from February 1973 to September 2024.

As interest rates normalize, income will again become a focus for investors. Over the past three years, the easy pickings of 5%+ in money markets and other “near cash” investments attracted record amounts of inflows and interest income boomed. A record $6.5 trillion currently sits in money market funds. Private credit offers an alternative with its attractive yield and secular tailwinds. The asset class is well positioned to benefit from increased merger and acquisition activity as banks continue to step back from corporate lending. High-quality investments are still key and investors need to focus on earnings growth, and profits over multiple expansion moving into the next cycle.  

Figure 5: Money Market Funds Outstanding Balance
(Trillions of US dollars)

Source: Investment Company Institute and Macrobond, as of 10/21/2024. Total weekly money market fund assets.

For steady and diversified cash flows in addition to capital appreciation of the underlying assets, we highlight long-term contracts within the infrastructure space. Infrastructure funds have proven their value in portfolios, as they’ve provided uncorrelated returns in the low-rate environment of the last cycle and during the higher inflation environment following the pandemic. There is global demand for this asset class, with large amounts of investment needed to upgrade aging infrastructure as well as to support the next generation of digital infrastructure and the commodities that will power the energy transition.

In our Guest Column, Sean Klimczak, Global Head of Blackstone Infrastructure, explores the critical role of infrastructure in the global economy, and he highlights how Blackstone is positioned to address the growing investment demands of this essential asset class.

*Despite all the uncertainty, optimists tend to live better lives, live longer, and—let’s face it—are probably more fun to be around. But optimism isn’t just good for your life; it’s good for your portfolio, too.

1. Cambridge Associates, NCREIF and Bloomberg, as of June 30, 2024. Represents Cambridge Associates Private Equity Index and NCREIF All Property Index.
2. Cliffwater, as of June 30, 2024. Represents Cliffwater Direct Lending Index.
3. Cambridge Associates, NCREIF and Bloomberg, as of December 31, 2024. Represents Cambridge Associates Private Equity Index and NCREIF All Property Index.
4. Cliffwater, as of December 31, 2024. Represents Cliffwater Direct Lending Index.
5. Standard & Poor’s, Bloomberg as of December 31, 2024. Represents S&P 500 Index total returns.
6. Blackstone corporate private equity portfolio companies as of September 30, 2024.
7. US Bureau of Economic Analysis, as of October 30, 2024. Year-over-year seasonally adjusted annual rate as of third quarter 2024.
8. US Bureau of Economic Analysis, as of September 26, 2024.
9. US Bureau of Labor Statistics, as of September 5, 2024.
10. Source: Blackstone Investment Strategy Calculations, US Federal Reserve, European Central Bank, Bank of England, Bank of Japan, Bank of Canada, Sveriges Riksbank, Swiss National Bank, and Macrobond, as of September 30, 2024.
11. Blackstone Investment Strategy calculations, government sources, World Bank and Macrobond, as of September 30, 2024. 
12. OECD, as of September 25, 2024.
13. Congressional Budget Office as of June 30, 2024 and White House as of March 31, 2024.
14. Federal Reserve Bank of Atlanta, as of October 7, 2024.
15. US Bureau of Economic Analysis, as of June 30, 2024 and US Census Bureau as of September 25, 2024.
16. Bloomberg, MNI as of October 28, 2024.
17. World Bank, as of December 31, 2023.
18. China Index Academy, CNBC as of October 9, 2024.
19. Bloomberg, as of September 27, 2024.
20. Reuters, as of July 25, 2024.
21. Bloomberg, as of October 28, 2024.
22. Morgan Stanley, as of June 25, 2024.
23. The Japan Times, as of September 5, 2024.
24. AP News, as of December 22, 2023.
25. Bloomberg, Standard & Poor’s, as of December 31, 2023. Based on portfolio of 60% S&P 500 and 40% Bloomberg US Aggregate Bond Index.