After posting the strongest two month rally in three years, global stocks ended 2023 just shy of record levels. Is it time to take chips off the table or is there room for additional gains?
In the first Global Strategy Meeting (“GSM”) of 2024, TRG’s analysts and portfolio managers tackled some of the developments that will set the tone for markets this year, ranging from the implications of elections covering nearly half the world’s population to prospects for sharp rate cuts in the U.S. and drivers of equity returns. The speakers agreed that the year’s starting conditions set a much higher bar for broad-based gains as the consensus seems to be already betting on a global soft landing (see Figure 1). And that means the more compelling opportunities in the year ahead are likely to rely on differentiation at the asset, country, and single-name levels, particularly with plenty of uncertainty derived from elections, economic crosscurrents, and geopolitical events.
The Global Election Wave
Seven of the world’s ten most populous countries will hold general elections in 2024, including India, Indonesia, and Mexico, plus some smaller yet strategically relevant emerging nations like Taiwan and South Africa. These elections, as well as contests in the U.S. and the European Parliament, add a new layer of uncertainty to an investment landscape that is already grappling with armed conflicts and economic crosscurrents. Given the large number of elections this year, managers running single-country exposure took the lead by conveying their views on the potential implications for policies and markets. The Turkey team flagged that the stakes of the Turkey vote was higher for the opposition, which runs the country’s major cities. Accordingly, the result wouldn’t derail the gradual shift towards more orthodox policymaking that delivered monetary tightening, tax hikes, and a weaker lira. With steps so far not sufficient to address the economy’s imbalances, however, the question is if the extent of adjustments could intensify after the vote. Another relevant market narrative, they thought, would be the fallout from the policy changes in a context of still-high inflation, which is likely to hit consumers’ real incomes and thus spending later in the year. Turning to Mexico and with the incumbent’s protégé enjoining a comfortable lead in polls, broad policy continuity appears secured – including in the trade openness that makes Mexico an attractive near-shoring platform. The top question mark is if the next president, assuming polls are right, will be able to set their own policy path away from the stance of the current administration, particularly a rethinking of today’s nationalistic, pro-hydrocarbon energy strategy. At least for the first year, speakers believed, major changes were unlikely, which should allow markets to keep focusing on the country’s solid growth outlook, prospects for rate cuts, and rising investment.
The Rates-Growth "Disconnect"
With U.S. markets moving to price in even more rate cuts, participants again debated the apparent disconnect between prospects for aggressive central bank easing and the stock market’s implied expectations for healthy earnings and nominal economic growth. At the turn of the year markets saw overnight rates declining to 3.9% by the end of 2024 (or little over six quarter-point cuts), a sharp repricing from 4.9% as of mid-October and at the low end of the December U.S. Federal Reserve’s (the “Fed”) 3.9-5.4% range of projections. Most participants thought that for these aggressive rate cuts to materialize the consensus had to be missing a future growth slump, much sharper disinflation or possibly both. In turn and absent a negative shock, that meant short-end interest rates seemed vulnerable as a March rate cut gets priced out. The latest batch of data, leading indicators, and economic surprises, on aggregate, continue to point to a gradual cooling in growth rather than a sharp slowdown; similarly with inflation, expectations suggest a slow easing in pressures over the course of the year. Others flagged that some of the optimism about lower rates was justified by the December Fed’s growing comfort with the inflation picture and its shift towards discussing the timing of cuts. The December minutes, however, indicated that policymakers are in no hurry to cut interest rates, thus making a March start unlikely. Pushing the first cut out further into the future, portfolio managers thought, wouldn’t be a challenge to equity markets insofar as economic growth held up well. In fact, analysis of Fed easing cycles since the mid-1980s shows that, on average, rate cuts are good news for both emerging and developed market stocks; however, stocks tend to falter if a recession follows the cuts, thus the need to keep a close eye on the health of the economy.
Earnings and Returns
With plenty of event risk from elections and conflict on the horizon, plus a healthy dose of lingering economic uncertainty, the last part of the discussion turned to drivers of stock-market performance and differentiation. While the inflation and interest rate narratives set the tone for markets in the past two years, participants returned to the importance of earnings growth as the primary determinant of long-term returns, in both absolute and relative terms. One noteworthy observation was that the link between GDP and earnings growth is not clear-cut. Regions and countries that exhibit faster GDP expansions, in other words, don’t always enjoy the strongest earnings growth and stock market gains. The China market is an example of this dynamic of high GDP growth and lackluster market returns, as well as a reminder that historically depressed valuations – the Chinese market derated materially – do not represent a catalyst. Regarding economic growth, analysts pointed out recent research indicating that strategies that rely on both upside surprises and expectations of GDP acceleration have historically delivered alpha. That is not the case when simply favoring faster-growing economies. As a portfolio manager put it, “equity markets care about changes and not levels;” identifying shifts in trend, moreover, often lead to more persistent outperformance. Examples are India and Mexico, two markets that outperformed the MSCI EM index in each of the past three years (see Figure 2). In India, companies and the market are benefiting from structural and cyclical tailwinds, particularly from reforms aimed at boosting investment. In Mexico, meanwhile, growth keeps surprising to the upside, underpinned by optimism about the nearshoring opportunity and prudent macro management. Identifying the common factors that drive lasting shifts in growth trends, accordingly, is an important differentiating factor for asset allocators, which some noted may become more relevant in an investment environment that is in flux due to trade and financial fragmentation, dislocations from conflict, higher interest rates, and other mega trends.
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.
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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. The information provided herein is neither tax nor legal advice. You must consult with your own tax and legal advisors regarding your particular circumstances.