Commentary: 3 questions investors should consider in 2024 — Lazard's Evan Russo

While market trends take time to fully develop, they also need a place to start and often only gain momentum years after they first take root. This could be said for a number of trends that I believe are set to make their mark across global economies in the coming years and may not be getting enough attention from investors and markets alike.

Here are three questions investors should consider in 2024:

• Will a decline in global liquidity create market dislocations?
• Where will investors land when cash gets put back to work?
• Is now a good time to give small caps a closer look?

As yields and interest rates around the world have risen, investors have been rethinking risk premiums and, as a result, have been slow to deploy fresh capital across certain asset classes. With investment cash flows stalling, less new money coming into markets, and a general reassessment of risk, the system slows. Already we have seen shadows of this trend as fundraising across private markets has been both weaker and slower than past vintages. Liquidity matters.

With a slower system of liquidity, we may see lower prices/values across asset classes. But we are also likely to see "dislocations" which may create opportunities for our clients when these trends play through.

A prime example would be the real estate market. Across the commercial market, rising interest rates have led to dented valuations and increased challenges for an already-highly leveraged group. As cash flows dry up, vacancies increase, building values fall, and equity and mezzanine loans disappear, investors will potentially see reduced cash returns from their existing investments. Similarly, for residential homeowners, housing prices have failed to adjust to the new higher-rate environment, leaving some to reflect on their own personal net worth.

As investors look to absorb their losses and hold available capital to support their existing investments, the result is a reduction of market liquidity or a pull on capital available for new investments.

This pullback in liquidity across real estate and other asset classes will likely create dislocations in markets, and create opportunities for our clients.

As the amount of money sitting in short-duration investments, cash equivalents and money market funds, which have gained $1 trillion in assets over the past year, reaches new highs, investors may point to their commitment to yield and their risk aversion as reason enough to settle in, for now.

After all, if simply holding cash can elicit 4% to 6% returns, for retail and institutional investors alike, with very little risk, what's the rush to explore other asset classes? This is especially true if investors find high-conviction ideas are slow in coming and the thought of too much duration daunting.

However, with so much capital waiting on the sidelines, when allocations eventually do move back toward risk — and they will — where will they land? Will the approach be conservative or aggressive? Will the pace be a crawl or a run?

In my opinion, a conservative approach pairs well with normalization and a return to markets will likely come in stages. In the period ahead, this could mean returning to markets via fundamentals first like credit; followed by a move to value then quality; to growth, higher growth, and then beyond.

As an investor, what it surely means is that now may be a good time to focus on an allocation plan.

Trends can change over time, too, and one that has been building over the last several years is the growing dispersion between overvalued and undervalued, or large-cap stocks over small-cap stocks, a good example of just such a shift in course.

In a world where globalization is game-changing and scale has its efficiencies, large-cap companies have, up until now, benefited from many outsized advantages like pricing power, regulatory reach, logistical control, and supply chain access, to name just a few. For years, large-cap companies have been able to lean into their size and dominate markets.

However, I believe that the trend toward deglobalization and advances in technologies, including artificial intelligence, are now helping small- cap companies gain ground vs. large-cap companies. For example, the very local nature and size of small-cap companies allow them to be nimble and fast as reshoring efforts gain steam, beating multinationals as they lumber to unwind and adjust. Similarly, new technologies like AI are helping with optimization, democratizing an environment that has long been one-sided.

So, what does this shifting trend say about valuations, then, when we think of value as the ability to create efficiencies and efficiencies are no longer an unequal reward? Will premium come out of price for large caps? Will the playing field level for small caps, which for years have suffered relative to their peers? Today, as we rethink the valuation differentials between large and small, and we look to uncover attractive opportunities for our clients, select small-caps begin to shine.

Trends are important to identify and understand and, ultimately, for investors to benefit from. As an active manager, this is where deep fundamental analysis and bottom-up research come in, setting the foundation for critical thinking and building differentiated perspectives on the future profitability of companies and underappreciated markets. All of this is meaningful as we look to position our clients to better take advantage of the opportunities presented by today's market trends.

Looking ahead, bottom-up research and consistent engagement — the hallmarks of active management — will be crucial in identifying the best opportunities for investors during these times of change and uncertainty.

Evan Russo is CEO of Lazard Asset Management, based in New York. This content represents the views of the author. It was submitted and edited under Pensions & Investments guidelines but is not a product of P&I's editorial team.