Note Précis Oct. 27,2023: Q4/2023 – Market Joust Against Momentum.
We expect a capital market joust encompassing a higher risk premium against the momentum tilt that had accompanied the emergence of quantitative ease from 2008 and which still periodically flares. As valuation imbalances are addressed, we expect linkages between FICCs and equities to rise and elevated volatility. Quality and diversification appear called for. It contrasts with the solace from monetary and minimal rate largesse.
Political economy and geopolitical events are far from exogenous to investments. Rather than the assumptions of being all knowing that often characterize momentum peaks, the role of risk premiums is to cushion against the unknowns. In trade and geopolitics, the tensions between the United States and China range from cyber security to proprietary technology to the security of trade channels. Separate but linked appear tensions between China within the Indo Pacific space. The war in Gaza has expanded the foot print of conflict. Tensions flare from the Caucuses to South Asia. The Ukraine war changes defense assumptions in Europe. With the peace dividend hypothesis obsolete, already ratcheting up are defense requirements. Climate change and Health pandemic issues remain salient as well.
Many governments did not use the quantitative ease period to strengthen fiscal balance and instead extended deficits, now worsened for many. The period of September to October often used to address economic and fiscal expectations by the authorities appears in 2023 to envisage slow and bifurcated global GDP annual growth of 2 ½ – 3% into 2024. In the OECD, inflation seems slowing but well above 2%. Further Fed Funds rate increases to 6% seem likely with overflow elsewhere. Unlike 2008 to 2021, looming is potential currency turmoil, among even major economy countries. In an upcoming U.S. election year, trade tensions loom such as in North America on materials with the CAD already down to 1.38/USD and on global manufacturing with the weakening Yen to150/USD and the RMB to 7.2/USD.
With 10 year U.S. Treasury note yields now hovering to 5%, we expect the rationalizing of yield tranches, already underway. In Japan, now being with stretched ring fence of low fixed income yields. In Europe, after the lunge up in German Bund Yields, spreads for Italy government issue have increased to also now above those of U.K. Gilts. In low quality corporate fixed income, after lag arguably due to liquidity, BBB yields now approached 12 month highs. We see this fixed income change as still in evolution. In asset mix, we see favor for shorter duration in fixed income and for precious metals as diversifier.
In equity markets at joust with momentum, valuation globally is not low with the S&P 500 at close to 20x trailing operating earnings. Our earnings expectation for 5% growth in 2024 is below consensus of 10%. In equities redress is likely to encompass markets globally with geographical rotation secondary to bifurcation of delivery within sectors to favoring quality and balance.
For balance within growth, we would cap information technology at 25% to favor Consumer Staples at market and Healthcare at overweight. We forgo Consumer Discretionary within the cyclicals to overweight Industrials on defense and infrastructure imperatives on climate change and logistics imperatives. We overweight Energy on change likely to evolve over decades. Materials we would overweight on strategic food and raw materials alongside precious metals in volatile capital market.
Among interest sensitives, in otherwise underweight Real Estate, we favor for the industrial segment. Conditions of stability of demand and in allowed rates of return seem tentative so we underweight Utilities. Restructuring financial services including stronger capital levels are likely to be a crucial benchmark as well.
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