Goldilocks and the five risks: What to watch in 2024
Investors have emerged from a year of incredible volatility with relatively strong returns. But there are plenty of headwinds to watch out for in the next 12 months.
After a year spent under the shadow of rising interest rates, slowing economic growth and tumult on global markets, it may seem like investors have had a tough year.
But Ajay Rajadhyaksha, global chairman of research at Barclays, has four good reasons why we should resist a glass half-empty view of financial markets.
Bulls and bears were divided in 2023. That’s unlikely to change next year. David Rowe
“Oil has stayed below $US90 a barrel almost all year, despite wars in Russia and now the Middle East. Home prices across the West have weathered elevated mortgage rates surprisingly well. Two of the three largest banking failures in US history occurred in the first half of the year, and the economy shrugged them off. Financial markets have endured a punishing bond sell-off without a hint of a systemic crisis, despite dire warnings to the contrary.”
It’s a remarkable list, and helps explain why the S&P 500 (the global proxy for risk) is up about 19 per cent for the year to date, the MSCI World Index is up 14 per cent and the local benchmark, the ASX 200, is up 1 per cent.
But Rajadhyaksha also reminds us that those with a bearish view (including this columnist) need to maintain an open mind about what 2024 could bring.
A year ago, it seemed every economist and strategist was calling for a recession in early 2023, followed by a rebound. Instead, the global economy has remained remarkably resilient, and investors have been taken on a rollercoaster ride – a big rally early in the year, followed by a sharp correction, and then an impressive year-end rally fuelled by hopes central banks have finished raising rates.
Will that optimism last into 2024? Much will depend on whether we get the Goldilocks soft landing that now looks within sight. Does inflation continue to fade? Can economic growth slow but not stall? And can the labour market soften, but not crack?
Here are five risks that investors should have front of mind as they think about the portfolios heading into yet another big year.
Interest rate pain will keep coming
Don’t expect the market’s obsession with interest rates to reduce in 2024, with three key questions in focus.
Firstly, do central banks (including the Federal Reserve and the Reserve Bank of Australia) need to raise rates further to kill off inflationary forces? Second, how long will it be before rates can start coming down? And third, will the lagged effects of previously delivered hikes show up in a more meaningful way?
The answer to the third question will decide the first two. The quicker central banks see previous hikes working – spending coming down, unemployment creeping higher – the sooner they will feel that inflation has been beaten, and beaten in a sustainable way. Those signs have been slow to arrive, but with the stockpiles of savings built up by households during the pandemic now all but spent down, interest rate pain is likely to become more obvious in the early parts of 2024.
Seth Carpenter, chief economist at Morgan Stanley, expects the Federal Reserve to begin cutting rates in June, and then keep cutting to deliver 1 percentage points of rate cuts in 2024 and 2 percentage points worth of cuts in 2025.
The outlook in Australia is harder to nail down. Micaela Fuchila, economist at Bank of America, says “below trend growth, relatively low unemployment and above-target inflation mean the Reserve Bank of Australia is likely to remain on hold throughout 2024″.
If she’s right, that will represent a serious test for the local household sector, where surging house prices have driven a surge in debt levels.
China remains a conundrum
One of the great mysteries of markets in 2023 is the incredible resilience of iron ore prices, which have climbed from a low of about $US98 a tonne in June to $US135 a tonne in late November. Given the weakened state of the Chinese economy, it’s a staggering rise, and one that has underpinned another good year of returns from Australia’s big listed miners.
But the outlook for China remains decidedly mixed. Ratings agency giant Fitch recently lowered its forecast for new Chinese home sales in 2023 to a fall of between 10 per cent and 15 per cent, and says “weakness in the property sector is feeding through to consumer demand and investment, which is weighing on the overall growth outlook for 2024”.
There are other risks too, including build-ups of debt in the local government and shadow banking sector. An ageing population and geopolitical tensions with the US will also worry investors.
But for all that, commodity analysts are actually quite optimistic that short-term iron ore prices can remain strong, with steel inventories largely depleted and the Chinese government seemingly less willing to curtail steel production for environmental reasons.
If iron ore prices remain strong, Australian miners should continue to deliver strong shareholder returns, even in a weakening global economy.
A private test
The great shift to private markets has arguably been the biggest story in capital markets over the past decade. After the rise of private equity, the last 12 months have been all about a surging interest in private credit, where a combination of rising interest rates and reduced appetite from commercial banks have opened the door for investors of all stripes to find double-digit returns.
But private markets face a fascinating test in 2024. Clearly, the ability for private equity firms to use leverage to juice returns is going to be more limited, placing a bigger focus on increasing valuations via operational improvements, which is inherently more difficult. Selling or floating private equity-owned businesses was more difficult last year, and this is likely to continue.
In private credit, the opportunities on offer have attracted a flood of new entrants. But will loans made in what has been described as a gold rush prove to be good bets in a slowing economy?
Trump and seven other pivotal elections
The US presidential election in November 2024 will captivate the world for months, with the potential for Donald Trump to make another run at the White House. But this is only a taste of what’s coming up: according to Bank of America, nations accounting for 80 per cent of global equity market capitalisation, 60 per cent of global GDP and 40 per cent of the world’s population have elections next year, including Taiwan, India, Russia, Indonesia, Britain and the European Union.
Most of these should go off without a hitch. But in a world where geopolitics is at the top of most investors’ lists of concerns, there is a chance for volatility at several points next year. Taiwan’s election in late January could be an early sentiment check.
Spotting the ‘pain trade’
In a column that has been largely about the potential risks ahead in 2024, it would be remiss not to point out that one of the biggest risks can be sitting on the sidelines in the hope that less risky investment conditions are just around the corner. Investors who (quite logically) did this in 2023 missed double-digit gains in the MSCI World Index.
So be wary of risks, but don’t forget the advice of legendary investor Charlie Munger, who died last week at the age of 99: time in the market is more important than timing the market.
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