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Navigating Shifting Global Markets in 2024, Risks and Opportunities: January 2024 Market Commentary

January 9, 2024

Global Macro: Cooling economy into a “soft landing”

We anticipate the current post-Covid economic cycle to end this year in a so-called “soft economic landing”.

In our view, this will translate into:

Lower: Growth, Inflation, Interest rates, US dollar
Higher: Bonds, Gold, Chinese renminbi, Japanese yen

While volatility may be seen in stocks and currencies, we believe the equity market will eventually reflect the onset of a new bullish economic cycle commencing from 2025, particularly in response to central banks’ rate cuts in 2024.

In the wake of significant interest rate hikes during 2022 and 2023, we observe a global trend of diminishing inflation and economic growth. In 2024, central banks are confronted with a challenging decision. Persistently high interest rates could precipitate a worldwide recession, a scenario already unfolding in Europe. Conversely, premature rate reductions risk reinvigorating economic activity to a degree that might lead to a resurgence of inflation, potentially surpassing the target inflation rate of 2%.

Global growth reached 3.2% in 2023. We expect it to decelerate to 2.6% in 2024 as Western economies, corporations, and households grapple with high refinancing costs.

As all central banks, including the US Federal Reserve, the European Central Bank (ECB), and the People’s Bank of China (PBoC), are expected to cut rates to bolster economic growth, the equity market will likely anticipate lower financing costs from 2025 onwards. This may partly offset the negative impact from declining earnings and the increase of corporate defaults in 2024.

Meanwhile, we believe the risk landscape in 2024 will intensify, both at a geopolitical level, with the wars in Ukraine and Palestine still raging with no end in sight, and at a macroeconomic level, with the risk of central banks maintaining high interest rates for too long.

These compound risks have already begun to impact shipping costs, exacerbated by the recent attacks on commercial ships in the Red Sea, prompting detours via the Cape of Good Hope, with European economies bearing the brunt of these geopolitical disruptions.

In the US: Resilience

The December US labor report showed nonfarm payrolls increasing by 216,000, thus beating market consensus. Growth is expected to moderate from 2.4% in 2023 to 1.6% in 2024, as higher interest rates and tighter monetary policy work their way through the financial system. Economists expect US consumer spending to begin to slow down, impacted by a resilient but overall declining labor market, which weighs on real disposable income, while elevated rates put further pressure on debt servicing costs.

In Europe: Sliding towards zero growth

As in 2023, growth in the Euro Area is anticipated to be close to zero in 2024, reflecting the ongoing effects of higher financing costs and energy supply shocks, especially in Germany. The Eurozone Composite Purchasing Managers’ Index (PMI) remained flat at 47.6 in December, below the market consensus of 48.0 (< 50 means contraction of the economic activity). This reading marks the seventh consecutive monthly reduction in business activity across the bloc, with manufacturing output decreasing for a ninth consecutive month. Inflows of new orders have declined for seven months in a row.

In China: Stabilizing growth at 4.9% in 2024 with strong positive trade balance of USD 70bn per month

We anticipate China’s economic growth in 2024 to be similar to that in 2023, that is, slightly below 5%. The Caixin China General Service & Manufacturing PMI increased in December 2023, beating market expectations. It was the 12th straight month of growth in services activity and the fastest expansion since July, mainly boosted by a solid rise in new business. New orders grew the most in seven months, with export orders rising for the fourth consecutive month and hitting the highest level since June. Meanwhile, employment went up for the first time in three months. Overall, sentiment has improved to a three-month high amid hopes of stronger economic conditions and a rise in customer spending.

Financial Markets: Global year end rally

Stocks, bonds, and gold experienced significant increases in December. Investors around the world hold on average the most concentrated investments ever in US assets, including both stocks and bonds. This creates a latent risk for US assets as investors may decide to further diversify their holdings into other regions.

Equity: In December, global equity markets rallied around 5% on average, given declining long-term interest rates and the prospects that recession could be avoided in the US and growth would remain substantial in large Asian economies (e.g. China) as well as developing ones (e.g. India). Equity performance was strongly positive in both the US (S&P 500 +4.4%; Nasdaq 100 +5.5%) and Europe (Euro Stoxx 50 +3.2%), while Chinese stock performance was negative (HSCEI -1.5%). Fixed Income: The 10-year US yield declined 49bps to 3.87% while the 10-year German yield lost 55bps to 1.90%. Amid this “risk-on” mood, High-Yield bond prices rose 3.4% in USD and 2.8% in EUR. Currencies: Most currencies strengthened versus the USD as US interest rates declined. Commodities: Gold went up, reaching its all-time high of USD 2,135/ounce, underpinned by collapsing long-term interest rates. Oil prices dropped 5.7% amid increasing global supply as well as uncertainties about US and Chinese demand within the slowing economic environment.

Equities: Risk-on mood as interest rates keep declining

Global equity markets returned around 20% in 2023, following the year-end rally. Given the declining growth and high interest rates environment, we favor quality large-cap dividend-yielding stocks with ample free cash flows for dividend coverage as we believe they enjoy a good risk-reward ratio.

In the US: Richly valued

The S&P 500 returned 24.2% in 2023 while the Nasdaq 100 had its best year since 1999, advancing 43%. Part of the reason for this resilience was the growing confidence in the potential for artificial intelligence (AI) to boost profits. The visibility of generative AI, following the launch of ChatGPT at the end of 2022, was a dominant theme for 2023. Top tech firms were the biggest winners, with the “Magnificent Seven“ gaining 107%.

In Europe: Subject to geopolitical and recession risks

The Euro Stoxx 50 rose 17.4% in 2023. While growth in the region was close to zero and even negative in some areas, the Eurozone has avoided the deep recession that many investors considered likely. In 2024, we favor large caps with solid balance sheet, stable revenue, healthy free cash flows, and dividends. These are expected to be resilient companies, which have the potential for high growth through innovation.

In China: High remuneration for equity investments (i.e. compelling risk premium)

China’s economy and US-China geopolitical tensions are the key drivers for Asian equities. The Chinese equity market lost 13.8% in 2023, as the nation’s recovery from pandemic restrictions was weaker than expected and government stimulus measures failed to impress investors.

The risk premium of Chinese stocks (i.e. the difference between stock dividend yields and bond yields) has reached 6%. This means that, by holding stocks, investors can receive an annualized income of 6% higher than by holding bonds. Historically, such occurrences were often a precursor to a rally in the Chinese stock market. We note Chinese stock valuations are at an all-time low, both in absolute terms and relative to other equity markets.

We believe China’s stock price downward retracement is an opportunity for long-term investors looking for asset growth, substantial income, and de-correlation with Western markets. Given attractive equity valuations and earnings upgrade expectations, we believe mainland Chinese and Hong Kong equity valuations have the potential to increase substantially within the next 12 months.

Currency outlook: US dollar follows declining US interest rates

EURUSD: Entrenched in the [1.05; 1.10] range in early 2024

EURUSD started the year weaker, giving back some of its December gains and declining below the 1.10 mark, back to its long-term trading range of [1.05; 1.10]. Growing skepticism about early Fed cuts, coupled with increased geopolitical risks in Ukraine and the Middle East as well as weak economic data, resulted in a slide of the EURUSD pair. The economic vulnerabilities in Europe could translate into more EURUSD weakness in the short term.

USDRMB: Declining from its all-time-high resistance of 7.30 with the risk of breaking below 7.0

The last two months of 2023, USDRMB started to show weakness and broke its 7.30 support, which is close to the all-time high. As US interest rates and growth are expected to decline in 2024 versus a relatively stable China, market participants anticipate a lower USDRMB in 2024 with the risk of USDRMB falling towards its level of last year (6.70), then 6.30. That is why we believe it makes sense for corporations exposed to the weakness of USDRMB, such as manufacturers in China or purchasers of Chinese goods, to protect (hedge) against a drop in USDRMB.

USDJPY: Likely to fall from its all-time high in 2024 as the BoJ exits its negative rate policy

This month’s key Japanese data included the Tokyo core CPI (i.e. inflation). We believe inflation should continue to ease from its recent high of 4% but stay within an elevated range of 3–4%, which is well above the Bank of Japan’s (BoJ) official 2% target. Monthly wage growth is running at around 1.6% year on year on a 12-month rolling basis, the highest in 26 years, which will push the BoJ policy towards normalization over the course of 2024. As such, we anticipate an exit from the negative interest rate policy. When this happens, the market reaction may be violent and USDJPY may revert to last year’s level, closer to 120, i.e. USDJPY could experience a fast 20% drop in 2024.

Fixed Income: The start of 2024 is the opportunity to place cash in high-interest-rate deposits and bonds before central banks cut rates

As the US economy is slowing into 2024 and inflation is continuing to decline globally, the market believes that major central banks have finished hiking rates and will begin to cut rates this year.

Consequently, bonds rallied across the board at the end of 2023, led by a decline in government bond yields in both the US and Eurozone.

We believe there is a window of opportunity that we have not seen in the past 20 years where it is now possible to receive substantial income from cash deposits, with duration of 3 to 6 months (5.50% in USD and 4% in EUR). High interest rates can be locked for longer periods by investing cash in bonds from large investment grade banks, which can provide an income per annum from 5% to 6% net in USD or 4% net in EUR, with a duration of 3 to 10 years.

Commodities

Gold: Reached its all-time high of USD 2,135/ounce

Gold rallied 13.4% in 2023, reaching its all-time high of USD 2,135/ounce. It was fueled by declining interest rates, which lower the opportunity cost of holding non-interest-bearing assets such as gold. This level may be an opportunity for physical gold holders to lock this historically high level via hedging (protecting the downside). Gold hedging currently provides 4% net interest on the physical gold amount that is protected.

Gold continues to be an effective portfolio diversifier and we expect to see investor demand for gold accelerating. We now expect gold prices to rally past the current all-time high by the end of 2024.

Oil: Bearish trend with volatility

Oil prices declined 10.7% in 2024 amid increasing global supply as well as uncertainties about US and Chinese demand within the slowing economic environment. Going forward, we expect a slightly undersupplied oil market (–0.1 million barrels per day), with OPEC+ holding back production until midyear and only gently adding production in the second half. We expect non-OPEC+ production growth to slow to around 1.3mbpd. We expect oil demand growth of 1.4mbpd, slower than in 2023. The price of oil is currently below the level prior to the Hamas attack on Israel in early October.

Risks:

War escalation in Ukraine or Palestine: A worsening of the Russia-Ukraine war or Israel-Palestine war would affect Europe the most, and if the Russian army crosses the Belarus border, which is 150km north of Kiev, EURUSD could drop fast towards 0.90. In addition, the US and Asia could suffer a stronger economic slowdown amid surging commodity prices.
US-China tensions: US-China friction remains strong, with increasing tension around Taiwan and the South China Sea.
Recession: So far, the US has escaped recession although growth has been tepid, while in Europe anticipated growth lies within the [-0.5%; +0.5%] range. By contrast, Asia is experiencing stronger, sustainable growth, fueled by China’s slowing, yet solid growth of 4.9% in 2023

Opportunities:

Income from safe cash deposits: Cash can be safely placed in cash deposits and earn annualized net interest, e.g. over a period of 6 months: 5.50% in USD, 4.00% in EUR, 5.00% in GBP.
Income from Investment Grade bank bond issuers: Major banks are implicitly protected by central banks as demonstrated in the Credit Suisse crisis where actual bonds (not AT1) remained secured. Investors can enjoy a substantial yield from a diversified bank bond portfolio of 3 to 10-year duration: 5-6% in USD, 4% in EUR, 5% in GBP.
Compelling “risk premium” for Chinese stocks: We believe the Chinese stock price downward retracement is an opportunity for long-term investors looking for asset growth, substantial income, and de-correlation with Western markets. Given attractive equity valuations and earnings upgrade expectations, we believe mainland Chinese and Hong Kong equity valuations are likely to increase substantially within the next 12 months.
Physical gold hedging: The objective of the “Gold Hedge” Forward contract is to protect the physical gold value expressed in USD from gold price volatility while earning 4% net interest on the physical gold deposit amount.
Japanese yen: The JPY is extremely undervalued, with USDJPY close to its all-time high of 150. The anticipated change in BoJ’s monetary policy in 2024 could trigger a rapid yen re-appreciation of 20%.
Nuclear energy: We believe the nuclear sector will be instrumental in the world’s decarbonization efforts. To achieve fossil fuel reduction targets, the nuclear power industry’s safety standards need to be brought to the next level, for instance by using new technology to recycle uranium. New “green” nuclear energy is the number one priority of President Macron in France, while being high on the agenda in the US and China, which will build 150 nuclear power plants in the next 15 years.
Defense and security: The wars in Ukraine and Palestine have triggered massive investment in military defense and the overall security sector – including cyber, food, energy, and semiconductor supply security – in Europe and around the world.