Delta #1 2024: a looming echo of 2022?

Will high rates outlast what the market has priced in?

Fewer than ten days in, 2024 is already shaping up to be an eventful year. Conflicts continue around the world, and the French PM has resigned ahead of a reshuffle.

Meanwhile, government debt in developed markets has grown to levels unseen outside pandemic proportions, with governments in the US and UK ratchet up spending ahead of the coming elections.

We find ourselves at a crossroads of macroeconomic uncertainty.

Historically, such profligacy has been the harbinger of inflationary pressures and market skepticism. Experienced investors will no doubt recall the stagflation of the 1970s.

Even as inflation has gradually wound down in the US to inch closer to normal levels, it is still higher than historic levels in Western Europe, especially when compared to the decade prior.

Unchecked, the current trajectory may mark a return to an era where inflation and debt constrict economic growth and investment returns.

There is a real risk of the US economy underperforming expectations in 2024 as much as it had outperformed in 2023.

The December US jobs report also proved a stronger-than-expected labor market. Given all this, if inflationary pressures persist, the Fed will have limited motivation to commence the rate reductions investors appear to have priced in towards the tail end of 2023.

Nonethless, the market is maintaining its optimism, with the S&P 500 rising 1.41% today, and close to all time highs. Big tech has been on a roll yet again.

As Seth Klarman likes to say, ‘the most beneficial time to be a value investor is when the market is falling’, and the intrinsic value of assets becomes paramount.

Once gravity re-asserts itself, any market mispricing presents opportunities for the astute investor.

What might all this mean for the forward-looking investor?

• China looking cheap: While Japan equities saw some of their strongest growth this side of the millenium, China stocks, ADRs and HK stocks ended 2023 as among the worst performers in the world. Pessimism has taken hold after the post-pandemic recovery stalled, and stimulus measures remained restrained. The Hang Seng Index trades at below book.

• Long inflation (and long short duration): with conditions for inflation potentially rematerialising, TIPS may start to look attractive again. If stagflation does somehow end up presenting itself, TIPS would should still be relatively well-positioned.

The current economic conditions, marked by the debt burden, also present risks. The Royal Bank of Canada, anticipates that net issuance of US government bonds in 2024-2025 would in fact exceed the heights of the pandemic.

Naturally, the Fed’s response will be a critical determinant. While the US economy remains relatively robust for now, Europe, especially the UK, may well slide into stagflation.

However, the market is showing signs of disequilibrium - would it be the calm before the storm?

Looking forward, as we navigate through Macron's gambit in France and the global inflationary milieu, investors must remain vigilant.

As always, being prepared for multiple contingencies with a proper asset allocation will be key. When fiscal expansion is combined inflationary concerns, we are almost certain about one thing … uncertainty.

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Disclaimer: The information provided in this newsletter is for informational purposes only and should not be considered as financial advice. The opinions expressed are those of the author and do not constitute a recommendation to buy or sell any securities or investments. The author may have positions in the securities mentioned or discussed in this newsletter. These positions may change at any time and without notice. The author and the company make no representation or warranty, express or implied, regarding the accuracy, completeness, or reliability of the information contained herein. Readers are urged to conduct their own research and consult with a qualified investment advisor or professional before making any investment decisions.