Last year ended very well, defying all predictions for a recession - prognosticated by 85 per cent of economists polled by Bloomberg in late 2022 - and for tepid market returns (strategists’ average S&P500 2023 forecast then was +5 per cent. It gained 24 per cent).
All asset classes ended last year in the green, with 80 per cent of the returns of a diversified portfolio happening during the ‘rally of everything’ from November.
Our 2024 Global Investment Outlook will officially be released next week. Unlike some of our esteemed competitors who release theirs in October, we prefer to write in January. This allows us to be aware of the rally, and most importantly, as always, we report on our full-year results.
They were actually quite satisfying: no genius, we simply stayed invested, not succumbing to the temptation of radical bets in what we had called the Year of Unpredictability.
After this unpredictability, 2024 is all about reality-checks. Is growth really resilient, is inflation really moderating? How will central banks react? Will geopolitical tensions abate, or worsen, with major elections happening all around the world?
2024 is the year of answers to the big questions of 2023. It has already started.
First, the US economy continues to impress. The positive trends in employment and consumption are immaculate, with only a marginal deceleration in December, still exceeding expectations.
The just released Q4-23 US GDP growth, at 3.3 per cent annualized against Q3, was much stronger than the median forecast of 2 per cent. In Q4, the core PCE, the Fed’s preferred measure of inflation, came in at 2 per cent.
Yes, 2 per cent, the magic number, the Fed’s target!
Admittedly, it’s not 2 per cent over 12 months yet, but we’re far off the 5 per cent of Q1-23. The scenario of a perfect soft landing, with resilient growth and declining inflation, is intact.
This is not just December: consumer sentiment from the University of Michigan surprised to the upside, and so did the flash PMIs, signaling further expansion. US exceptionalism continues, with a recent all-time high in the S&P500.
Europe is still flirting with recession, but stabilizing, with the UK being a bright spot. Finally, between rumors of a market-support package and an actual easing from the central bank, Chinese equities rose for three consecutive days last week.
How much more of an upside?
A perfect picture? Investing is not just about what happens, even if it beats economists’ forecasts. It’s also about what is discounted by valuations, and how participants as a whole are positioned. And this is where 2024 gets more complicated. The scenario that is so far unfolding is extremely consensual, and consequently generously priced-in by several asset classes.
The fundamental upside potential is clearly not massive. And as sentiment and positioning are close to unanimity, constant validation is required to keep markets rising.
We share the central scenario, but believe that it will be challenged by data and events, especially with elections and geopolitical tensions, which will generate material volatility. There is even some ambiguity in the scenario itself.
The best example is the trajectory of the US Fed’s policy rates. The central bank’s own projections include 3 cuts of 25 basis points each, starting around the middle of the year, consistent with their macroeconomic expectations.
As long as growth is steady, they see no need to cut too early and risk a rebound in inflation. By contrast, future markets are discounting between 5 to 6 rate cuts. The implicit view is that the Fed doesn’t need to maintain high rates, given the trend in inflation.
Watch out for the US Election
To add to the confusion, inflation expectations from inflation-linked bonds prices are actually rising. Misalignments mean volatility ahead, especially with a critical US election in November.
Inflation is a key concern for US voters, the Fed has reasons to be cautious. But the allure of stock markets also matters, not even mentioning employment. Recession risk would be a good reason for more rate cuts, but this is not what stock markets are priced for.
Complex liquidity factors are also at play: between the US government’s need to borrow to fund its deficits and the Fed’s willingness to reduce their balance-sheet, with an impact on banks’ reserves. The delicate liquidity balance in the financial system is another source of potential turbulence for markets.
Unsurprisingly, then, that the start of the year is hesitant, and that the widely acclaimed ‘all time high’ in US stocks is actually a mere +2.5 per cent so far in 2024, while bonds’ returns are so far negative – and China remains the worst performing large region despite its recent rally.
The good news is that with a limited room of maneuver for central banks, we believe that fundamental analysis, selectivity and diversification should work well to enhance what we anyway see as modest expected returns.
We will share more details next week with the (arguably late) release of our (definitely, but always temporarily) up-to-date 2024 Global Investment Outlook.