Watch a short video in which David provides an overview of the markets in 2023, and shares his views on the outlook for the year ahead, here.
Interest rates and inflation: In our view, the primary driver of financial markets in the year ahead is likely to be the interconnected trio of interest rates, macroeconomic activity and inflation. As we saw in late 2023, markets reacted enthusiastically to the US Federal Reserve pivoting away from the ‘higher-for-longer’ mantra on interest rates to guiding towards interest rate cuts this year.
What we find fascinating is that debt or bond markets are pricing in substantial interest rate cuts in the US and Europe this year, with inflation coming down further to around the 2% target. At the same time, global equity markets are looking for an acceleration in earnings growth. On the surface, this appears perfectly reasonable, as lower rates should help economic activity and thus company profits.
Our concern, however, is that the extent of the US rate cuts being priced in (about 1.5 percentage points in 2024 at the time of writing) is typically only associated with recessionary environments. In our view, the scope for both equity and debt markets to be right this year is therefore low.
So far, the resilience of the US economy has surprised most economists. If the US can engineer a ‘soft landing’, where inflation returns to 2% and stays there but a recession is avoided, investors should do well. The problem is that such a scenario is far from guaranteed. The transmission of monetary policy to businesses and households has been particularly slow in the US, so we may yet see the lagged impact of this on growth.
With a wide range of reasonably feasible outcomes in play, we see 2024 as a year where appropriate portfolio diversification will be more vital than ever. Remember, this is not just to ensure one doesn’t take excess risk, but also that one is able to participate in asset classes and businesses that do well.
Test for democracy: 2024 will be a major test for democracy around the world. Almost half of the world’s adults will have the chance to vote this year, with the elections in India, the US, Mexico and South Africa among the more important events for our readers.
Markets tend to worry before elections, but we broadly see opportunities in such events. To quote Berkshire Hathaway’s Warren Buffett: ‘Uncertainty is actually the friend of the buyer of long-term values.’ Governments with fresh, clear mandates from their electorates have greater legitimacy and can thus act more decisively. And regardless of which party wins, uncertainty is reduced, which markets typically like.
Artificial intelligence (AI): AI was the major theme of 2023, and like any potentially game-changing technology, its impact will continue for a number of years.
According to US tech research firm Gartner’s classic ‘hype cycle’, the world’s expectations for any new technology typically become overhyped at first, after which a ‘trough of disillusionment’ sets in as interest wanes and implementations fail to deliver. This may then at a later stage be followed by greater understanding of the technology and then lastly, mainstream adoption.
One can debate where AI is now in the cycle, but two things are certainly clear:
- The level of hype is not at the extreme levels seen around the dot-com bubble, so there is still ample scope for AI stocks to do well.
- At some point, however, there will likely be a ‘trough of disillusionment’.
As is the case with all new technologies, there are far fewer people who truly understand AI than those who claim they do, creating a polarity of viewpoints. At the moment, the bulls are clearly winning, as is evidenced by the high prices of AI-exposed stocks. To use a gold rush analogy, the picks-and-shovels companies are doing best, for example, Nvidia.
In our view, however, in 10 years’ time, it’s the next wave of AI companies that will be the biggest beneficiaries. Recall that companies like Meta (previously Facebook) didn’t even exist at the time of the dot-com bubble, when ‘picks-and-shovels’ Cisco was among the world’s most valuable companies. We therefore need to keep our eyes wide open for the innovators who build applications on top of the infrastructure currently being created.
Geopolitical risks: Many market commentators speak about geopolitics being a key theme in 2024, but our thinking is tilting towards a relaxation of tensions in 2024. The Russia-Ukraine conflict appears contained, and the major players in the Middle East seem to have little appetite for an escalation of hostilities. At the same time, China and the US will likely be more focused on domestic issues and the sabre-rattling in that sphere should therefore quieten. While geopolitical risks will always be with us, we see the balance of probabilities pointing away from them as a major theme in markets this year.
Energy availability: On the energy front, the world currently has ample availability of both oil and gas relative to demand, so in the absence of a fresh shock, we see this as a positive for global activity. Energy is the master resource and when, as is the case now in the US, it is reasonably priced and abundant, all parts of the economy are able to spend less to create the same output. Unfortunately, the converse is true in South Africa, where electricity scarcity remains a negative for our economy.
US fiscal position: Our final global theme is one that may not play out in 2024, but which we believe will gain increasing traction over the next five years: the US government’s unsustainable fiscal trajectory. With government debt at ~125% of gross domestic product and a budget deficit of more than 6%, the path is unsustainable. At some point, something will have to give. We would expect debt investors to slowly start demanding greater reward for holding long-dated government bonds.
Outlook for South Africa: On home turf, we believe a key theme this year will be ‘less bad’. In areas such as electricity generation, ports and rail infrastructure, 2023 was such a poor year that there is wide scope for things to improve, even if they remain well below the levels seen in more functional economies. This should ease cost burdens on South African businesses, allowing profits to grow off a low base in an attractively priced market.
In light of the above, we at Sanlam Private Wealth continue to believe what the long-term data has shown us: that no one can accurately and consistently predict macroeconomic outcomes. We will therefore continue to construct portfolios for our clients that are robust and resilient in the face of a wide variety of potential scenarios. In addition, our focus will remain on choosing quality underlying assets at attractive prices.
