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2024: The Start of a Rate Easing Cycle

05.01.24

By Ilan Furman, CFA

2024 marks the start of a rate cut cycle by global central banks as inflation comes under control. This is a positive development both for equities and bond markets.

However, the challenges that weighed on markets in 2023 persist into 2024: high rates, inflation and geopolitical tensions. Another challenge in 2024 is global growth, which is expected to slow.

The following review examines key drivers for equities and bonds performance in 2024.

2023: Performance Summary

On the backdrop of negative estimates at the start of 2023, the market rallied and proved early estimates wrong: In 2023, leading indices like S&P 500 and Nasdaq are up 24.73% and 44.52%, respectively.

Nasdaq, S&P 500 and Emerging Markets 2023 Performance

 

Emerging markets equities continued to significantly underperform developed market equities, rising 5.2% for the year, mainly driven by weak economic activity in China, which accounts for almost 30% of the emerging markets index.

2023 started with a subdued mood for markets given high interest rate levels, geopolitical tensions and fear of recession.

In March 2023, financial markets sold off due to banking crisis concerns. Though Silicon Valley Bank and Credit Suisse fell, a banking crisis was contained. In addition, as the year progressed, the U.S. economy proved stronger than expected despite major rate rises.

2024: Review of Key Drivers

Considering the market rally witnessed in 2023, coupled with top down concerns, the main outlook for 2024 is the need to be cautious and selective. Recent rally (December 2023) implies that valuations and rate cut expectations may be over optimistic.

On top of our ongoing quality bias, we highlight three investment themes for 2024:

Interest Rates 

The key focus in 2024 will be the expected interest rate cuts by central banks around the world with main attention directed to the U.S. federal reserve bank.

This comes following the 11 rate rises, starting in March 2022 and ending in July 2023, that lifted the benchmark interest rate to a 22-year high of 5.25-5.5%. In 2023, bond yields reached their highest levels in more than 15 years.

Bond yields remain attractive from an absolute return perspective (still focusing on hold to maturity duration) with rate cuts that can lead to capital gains in the next 12 months.

In mid-December, Fed Chair Jerome Powell held rates steady at 5.25-5.5% and mentioned that rate cuts are just a question of timing.

This triggered a market rally.

U.S. Benchmark Interest Rates

 

Fed committee members expect at least three rate cuts in 2024, assuming an overall 75 bps cut in 2024.

Following the rally, the market is already pricing in a more aggressive cut. This expectation can materialize if inflation declines faster than expected.

Inflation

Inflation, which spiked to a 40-year high in mid-2022, is cooling off globally.

% Change in CPI

From 2021, inflation is a global issue with upward pressure on prices driven by several factors. The main one being the pandemic and post-pandemic era which created both demand and supply shocks. Demand soared as countries were exiting lockdowns and supply shrank due to global supply chain issues. Then, in early 2022, the Russia-Ukraine war fueled inflation with higher prices for oil, fertilizers, natural gas and food.

According to the IMF, global inflation is forecasted to decline steadily, from 8.7% in 2022 to 6.9% in 2023 and 5.8% in 2024, due to tighter monetary policy and lower commodity prices.

In the U.S., fed officials see core inflation falling to 3.2% in 2023, 2.4% in 2024 and gets back to the 2% target by 2026. The market is already speculating a faster trajectory.

There are signs that inflation can decline faster than expected. On the other hand, geopolitical tensions continue to interfere and cause supply chain disruptions. Only recently, we saw that following Houthi attacks in the red sea shipping costs increased significantly.

Growth

Leading indicators generally show a loss of growth momentum heading into 2024. Expected growth in the U.S. is weaker in 2024 than 2023. The growth outlook for the eurozone is deteriorating and in China, tighter financial conditions are negatively impacting growth.

Global Growth expectations

According to the IMF, global inflation is forecasted to decline steadily, from 8.7% in 2022 to 6.9% in 2023 and 5.8% in 2024, due to tighter monetary policy and lower commodity prices.

In the U.S., fed officials see core inflation falling to 3.2% in 2023, 2.4% in 2024 and gets back to the 2% target by 2026. The market is already speculating a faster trajectory.

There are signs that inflation can decline faster than expected. On the other hand, geopolitical tensions continue to interfere and cause supply chain disruptions. Only recently, we saw that following Houthi attacks in the red sea shipping costs increased significantly.

Growth

Leading indicators generally show a loss of growth momentum heading into 2024. Expected growth in the U.S. is weaker in 2024 than 2023. The growth outlook for the eurozone is deteriorating and in China, tighter financial conditions are negatively impacting growth.

Global Growth expectations

2024 is a Global Election Year

In 2024, elections are expected in 64 countries (plus the European Union), representing almost 50% of global population. This will add volatility and uncertainty to the investment landscape.

Geopolitics

Unfortunately, geopolitical tensions seen in 2023 are likely to persist through 2024.

The U.S. presidential election, the Israel-Hamas and Russia-Ukraine wars, and the ongoing rivalry between the U.S. and China and the latent China-Taiwan tensions could all have global market repercussions.

AI

AI will continue to enable value creation across a range of sectors. Investors’ focus to date were the likely beneficiaries from AI hardware and platforms, but the potential impact of AI can spillover across sectors. For example, some companies can benefit from significant margin improvement by implementing AI tools.

Investments Ideas and Themes for 2024

Considering the drivers discussed above, 2024 is expected to be a challenging year for the markets, with selection and caution key.

With rates expected to remain high and growth slowing down, we are still cautious with banking and real estate sectors.

Highlighting Three Investment Ideas We Like in 2024:

  • Sector: Cybersecurity
  • Geography: Brazil equities
  • Sector: Energy (traditional and renewable)

Brazil Equities

Brazil offers an interesting combination of high interest rates and low valuation. Interest rate in Brazil (SELIC) was set at 12.75% in October 2023 with inflation under control. The market is trading at a low valuation of 8 times P/E. Rate declines with a relatively stable fiscal and political backdrop can lead to multiple re-rating.

The top names include: RaizenNu Bank and Equatorial

Cybersecurity

The cybersecurity space is expected to continue and significantly outgrow general GDP. Many of the companies offer a nice combination of growth and high level of recurring revenues.

The top names include: DocuSignZscaler and Palo Alto Networks

Energy

In Energy, we like to look on the broader universe including both traditional and renewable energy sources.

In the traditional energy companies, ongoing geopolitical tensions in oil producing regions like Russia and Middle East are likely to lead to price increase. The renewable space continues to be interesting and offers profitable growth aimed to meet clean energy targets.

Many of the companies in the sector are trading at attractive multiples – below book offering a dividend yield of at least 3.5%.

The top names include: ShellBP and Delek US

More recently, high end fashion brands are using AI to support growth, operational efficiency, client relationship and many areas of the design. For example, Gucci and the entire LVMH group is starting to embrace different AI initiatives.

Investing in Luxury Brands 

Investing in strong luxury brands, especially in the current macro environment, is interesting considering their brand recognition, pricing power, resilience in economic downturns, and growth potential.

The brand recognition and pricing power are quite significant barriers to entry, supporting the high profitability of these brands.

In line with the sportswear apparel trend in Luxury goods, Lululemon received an outperform rating and an overall score of 76.

The company focuses on yoga and athletic apparel, and its products often incorporate high-quality materials and innovative design features. The company was founded in 1998 and expanded rapidly to reach a global footprint.

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