Note Précis Jan. 23,2024: Q1/2024 – Market Run On Wild Side. After the FOMC of December 13, 2023 and into early 2024, capital markets globally have run on the wild side ostensibly based on both early Federal Reserve (and others) ease and recovery. Such repositioning has appeared from equities worldwide to junk corporate fixed income; from benchmark U.S. Treasuries to emerging country fixed income aggregates. Globally, this momentum tinge seems overstepping ever rising geopolitics from wars to shipping risks to policy risk from a substantive election cycle already underway. It started in Taiwan, with May elections in India and then in November 2024 in the United States, with many others in between. Frictional risk exists from autocracies. Tensions appear amongst weak governments in Europe.
Evidence appears of bifurcated activity within annual GDP global economic growth of 2 ½-3% annually. In the OECD countries, inflation did peak in the summer of 2023 but is still well above 2% and appears in zigzag. Even if Fed Funds rates do not reach 6% as benchmark, the major central banks give little indications of rate cuts by mid-2024 and appear instead to be signaling a wait and see stance. In emerging countries appear the contradictory forces of high inflation and extended real estate leverage. Stress potential exists in currency markets.
Capital markets need to return to the fundamentals of quality of delivery and valuation. In late 2023/early 2024, reappeared a playbook of consensus earnings being cut but market valuations expanded on concept. Post the laissez faire of quantitative ease, little epiphany has appeared about self-restraint. The 2023 background has been egregious, including alleged blue skying via SPVs and shell companies. In 2024, more stringent regulation is likely. It would likely mean companies and countries (as seen in post banking crisis Germany and then Switzerland) having to tighten corporate operational and financial control.
Much as earlier when German Bund yields were below zero ostensibly on safety of capital, there recently appears decline in JGB yields to close to zero, likely on speculation of Bank of Japan policy reversion. Rather than currency alone providing return, we see events as being U.S. dollar and Federal Reserve driven, without early ease. In Fixed Income, we overweight the U.S. Dollar zone (including Canadian and Australian instruments in a basket for diversification), now market weight Europe (including Gilts for diversification). As currency hedge, we prefer to overweight precious metals in asset mix.
Amid elevated global tensions and central banks collectively looking to less quantitative ease, we expect sector imperatives to override geographical rotation. Heightened volatility is likely. We espouse diversification and operational and balance sheet quality as being paramount considerations.
Even in quality and for a coterie of equities with 30+ P/E ratios emergent from momentum, actual long term delivery is likely to be difficult. For growth, we have espoused a cap on Information Technology at 25% with diversification within, an underweight in Communications Services and an overweight in Healthcare.
Even as inflation likely peaked in the summer of 2023, compared to prior aspiration cycles, consumers appear globally faced with daily sustenance and living costs having increased.Also exist are anticorruption drives in emerging countries and logistic challenges to costs. Likely to be is sustained consumer focus on value and basics. We expect the stronger Consumer Staples to gain ground but are underweight the consumer. Instead, we prefer Industrials.
The Ukraine war and the Gaza war have in ferocity reinforced that the peace dividend is over. New facilities and weaponry are likely needed for drone and space asymmetrical applications. Climate change, availability of inputs and global logistics weaknesses are likely for civilian companies to have to build new facilities. Arguably not since the 1940s/50s has there been a need to strategically overweight Materials from food to rare, precious and base metals. Central banks embarked on exit from quantitative ease augur currency volatility favoring precious metals as an asset.
Instead of Utilities which we underweight for interest rate and cost reasons, the energy reality is likely to incorporate a variety of sources but revolved around crude oil pricing, likely $70/Bbl..WTI. It would be favorable mix for strong energy integrated companies with experience in managing the business of Energy.
We are underweight Real Estate awaiting restructuring from housing to office space to shopping malls but advantages are likely in efficiency built industrial space. Unlike during momentum fervor, the Financials are likely to be critical for capital markets but even 15 years post credit crisis, the overweight advantages likely lie in the strongest banks aggressive in restructuring and cost control.