It is difficult to forecast what 2024 will look like when 2023 is not yet over. Simply put, given the stock and bond market volatility, we do not know what the starting point for equity valuations and rates will be in the next 30 days.
At the beginning of the year, we said that volatility and geopolitical uncertainty will persist.
Stocks and bonds were nearly flat by the end of October and are now up 10 per cent and 5 per cent respectively in just 30 days. That is volatility.
We now have not one, but two wars with potential geopolitical consequences. That is uncertainty.
Geopolitical tensions and geoeconomic fragmentation will linger
We finish 2023 with two major wars, as well as increasingly tighter global trade conditions.
Slow growth and increasing borrowing needs will conserve the competition between key economic actors, incentivising governments to use any economic means at their disposal.
As the pursuit of economic influence and the technological edge between China and the US intensifies, western-based supply chains will continue to shift away from China (a very long and arduous process) and into other countries, such as India.
No sustainable bull market until QT stops
While we often do not notice a bull market until mid-way into the next bear market, quantitative tightening prevents sustainably high equity returns.
Quantitative easing was the foremost driver of equity performance for the 14 years prior to 2022. It stands to reason that the opposite - QT - by and large precludes a lasting equity bull market.
With rate cuts now considerably priced in, it would take a significant catalyst for the next leg-up that would bring equities near their all-time highs.
As conditions are not dire enough to initiate a bear market (bar a serious financial accident) and QT prevents a lasting bull market, equity markets will very likely continue to range-trade, even with a slight upward tilt.
The movement is likely to have a clear floor due to residual liquidity and decent fundamentals and a clear ceiling as animal spirits remain caged due to the persistent liquidity drain.
Something may yet break. Central banks will probably react fast
Real rates (ex-inflation), which matter for the economy, continue to rise, as nominal rates stay steady and inflation is falling.
All other things being equal, monetary conditions should thus continue to tighten until inflation has dropped sufficiently to force central banks to climb down from the peak, towards the natural rate of interest.
This means economic conditions will continue to deteriorate for the foreseeable future.
The combination of an economic slowdown and the abrupt end to the previous regime may uncover unexpected weaknesses in some corners of the market, like commercial real estate, much like it did with US peripheral banks earlier in the year.
Rates will begin to come down in mid/late H2 in the US. Europe will follow
The rate outlook is murky and data/event-driven. As such, the market’s confidence level in predicting rates is low. US markets are pricing in rate cuts beginning mid-2024.
While it is possible, especially if we see a financial accident, our main scenario suggests rate cuts cannot begin until later in the year.
Geoeconomic fragmentation considered, we believe that rate-cutting cycles between Europe and the US will not be synchronised.
