Or are asset prices already reflecting the bulk of recent positive developments? Those questions, plus the themes and risks that will set the tone for 2024, were at the center of the discussion between The Rohatyn Group’s (“TRG”) macro analysts and portfolio managers at the most recent global strategy meeting (“GSM”). The team analyzed the factors that catalyzed the recent rally and what they could tell us about the prospects for additional gains. Long-term yields holding below their October highs, lower volatility, and relative stability on the geopolitical front could keep supporting market sentiment, most participants agreed. But this outlook has some risks: the apparent disconnect between aggressive pricing for U.S. rate cuts in 2024 and a generally constructive outlook for economic and earnings growth was one recurrent source of concern.
A November to Remember
In the GSM a month ago, TRG consensus singled out two conditions needed for emerging market assets to perform, both of which consolidated during November: long-term U.S. yields holding below their October highs and relative stability in geopolitical tensions. At the time, the foundation for the inflection in yields seemed already in place after the announcement of lower-than-expected U.S. government funding needs for the rest of 2023 and the dovish tilt by the U.S. Federal Reserve (the “Fed”) on November 1, when it acknowledged that tighter financial conditions were “likely to weigh on economic activity.” Thereafter, just about every macro development supported the case for lower yields and for a soft landing in the U.S., while the conflict in the Middle East remained contained. The disinflation story continued making progress – a wide range of metrics, including CPI, PPI, and wages surprised to the downside – while U.S. activity figures, including employment, indicated a healthy yet decelerating backdrop after the 3Qgrowth spurt. In fact, the wide gap between upside growth surprises in the U.S. and serial disappointment in China and Europe – which resulted in higher U.S. yields and jittery markets in the August-October period – narrowed materially (see Figure 1). Together, these factors sent long-term yields sharply lower, making November’s decline in 10-yearTreasury yields the second largest decrease in a decade, and the dollar weaker. Lower and less-volatile yields helped lift stocks, with strong gains in emerging and developed market benchmarks alike; correlations of stock-bond returns, in fact, remain at historically elevated levels. While asset re-priced meaning fully stronger over the month, participants agreed that the recent shift away from U.S. “exceptionalism” (as the economy cools off and the Fed stays on hold) represented a healthier backdrop for EM assets going forward.
Are rate markets right?
One notable aspect of the recent market rally involved the large repricing of expectations for Fed cuts in 2024, from roughly two and a half quarter-point moves as of late October to over five cuts by the end of November (see Figure2). The discussion shifted to the apparent inconsistency and inherent tension between the equity market’s implied expectation of continued high nominal GDP plus healthy earnings growth (and, by extension, that the Fed could be slow to ease) and the pricing of around 125bps of cuts next year. Aggressive rates cuts, in turn, appeared to be a bet on either meaningful inflation relief or growth weakness, or both, which are not quite fully apparent yet from incoming data or consensus expectations.*
On the rates side, some participants flagged many instances of when aggressive rate cuts in 2023 proved to be premature, which may warrant caution at the front end of the curve where pricing hints at recession-like cuts that are unlikely to happen if equity markets prove correct. Equity specialists noted examples of when rate cuts were priced out and didn’t necessarily lead to a derating of stocks, such as the period after March’s regional bank turmoil. Last, one test will come in mid-December with the Fed’s meeting, when policymakers may lay out the conditions that might lead to rate cuts. One area of interest is the Fed’s thinking about fine tuning of its policy stance as inflation keeps falling, as widely expected. Another was if the Fed would push back and reiterate its “higher for longer” message after the easing in financial conditions from their late October peak. Most participants thought markets were overly aggressive in the pricing of rate cuts as a growth slump did not seem to be in the cards.
Market and EM implications for 2024
The last section of the GSM discussion dealt with the outlook for 2024. In many respects, what investors expect for next year resembles what, in late 2022, they predicted would happen in 2023. In the U.S., consensus sees slower activity and back-loaded rate cuts – neither of which materialized in2023. The dollar is seen moving weaker, partly reflecting yen appreciation as the Bank of Japan scraps its negative-rate stance. Last, the consensus again sees 10-year yields moving lower – for end-2024 close to 3.9% from 4.2% currently. Prospects for China, by contrast, are a far cry from the post reopening optimism of a year ago; instead, more sub-par expansion is expected as the government’s timid stimulus measures fail to sustainably boost growth. Elections will take center stage in 2024, forcing investors to keep a close eye on their implications for policies and geopolitics. Taiwan’s vote in January is a critical one in the context of rising Sino-American tensions. The outcome of recent state elections suggests that India’s vote, expected in April-May, will result in a victory for the incumbent party and thus policy continuity in one of the more compelling secular stories in EM. Similarly, the incumbent holds a comfortable lead in June’s Mexican election; the main question is if the next president will have space to set a policy path that diverges from the current one. The outcome of November’s U.S. election will have wide global implications. With markets pricing in a soft landing in the U.S., participants saw a constructive near-term outlook for EM assets. Thereafter and with the most difficult part of the macro adjustment behind – major central bank tightening is done as disinflation keeps making progress – portfolio managers posited that markets may transition from the current beta-driven environment to one where differentiation and idiosyncratic factors again drive performance in 2024.
* Consensus expectations means the Bloomberg consensus expectations unless otherwise specified.
DISCLAIMER
The information provided herein is for educational and informational purposes only, and neither The Rohatyn Group nor any of its affiliates (together, “TRG”) is offering any product or service hereby. The information provided herein is not a recommendation, offer, or solicitation of an offer to buy or sell any security, commodity, or derivative, nor is it a recommendation to adopt any investment strategy or otherwise to be construed as investment advice. Any projections, market outlooks, investment outlooks or estimates included herein are forward-looking statements, are based upon certain assumptions, and should not be construed as an indication that certain circumstances or events will actually occur.
Other circumstances or events that were not anticipated or considered may occur and may lead to materially different outcomes. The information provided herein should not be used as the basis for making any investment decision. Unless otherwise noted, the views expressed in the content herein reflect those of the participants in the GSM as of the date published and are not necessarily the views of TRG. In fact the views of TRG (and other asset managers) may diverge significantly from certain of the views expressed in the content herein. The views expressed in the content herein are subject to change without notice, and TRG disclaims any responsibility to furnish updated information in the event of any such change in views. Certain information contained herein has been obtained from third-party sources. While TRG deems such sources to be reliable, TRG cannot and does not warrant the information to be accurate, complete or timely, and TRG disclaims any responsibility for any loss or damage arising from reliance upon such third-party information or any other content provided herein.
Exposure to emerging markets generally entails greater risks and higher volatility than exposure to well-developed markets, including significant legal, economic and political risks. The prices of emerging market exchange rates, securities and other assets are often highly volatile and movements in such prices are influenced by, among other things, interest rates, changing market supply and demand, external market forces (particularly in relation to major trading partners), trade, fiscal and monetary programs, policies of governments and international political and economic events and policies. All investments entail risks, including possible loss of principal. Past performance is not necessarily indicative of future performance. Certain information contained herein is based on projections and models performed by a third party. Financial projections and models are subject to great uncertainty, and actual results will most likely vary from these projections and models, and such variations maybe material and adverse. Forecasted numbers are based on the creator’s beliefs, assumptions, current expectations, estimates, and projections about the economy and various other matters – there is no guarantee that the projections or assumptions will be achieved.
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