Back To The Future

Once again, that time of the year has arrived when investment strategists and economists peer into the crystal ball, unveiling their forecasts for the upcoming year. What is striking is the remarkable similarity with their outlook from a year ago when many market participants predicted a recession, a challenging equity landscape, and the end of the bond bear market. However, reality unfolded in a completely different manner. Nevertheless, as we approach the year 2024, the majority of experts are predicting an outlook almost identical to the previous year: a recession or, at the very least, a slowdown in growth in the first half of the year, leading to decreasing inflation rates. This, in turn, would empower the US Federal Reserve and other central banks to lower interest rates. Fuelled by this scenario and humbled by the lessons learned from their mispredictions a year ago, most investment experts foresee moderately higher stock valuations by the end of 2024, despite the recession forecast, and anticipate the end of the bear market in government bonds, ushering in a lower interest rate environment.

For equity bulls, this was a November to remember. The MSCI All-Country World Index surged by 9% over the course of the month, marking its best performance since November 2020, when news of a breakthrough in the development of a COVID-19 vaccine propelled stock prices skyward. In the United States, both the S&P 500 and the technology-heavy Nasdaq Composite enjoyed their most prolific month since July 2022, advancing by 8.9% and 10.7%, respectively. Across the Atlantic, the pan-European STOXX 600 ascended by 6.4%, while the Swiss Leader Index notched a 5.5% gain. In Asia, the Japanese Nikkei 225 saw an uptick of 8.5%, while the Shanghai Composite struggled to maintain ground with a modest 0.4% increase.

These market gains coincided with mounting bets that interest rates in the United States and the Eurozone had peaked and were poised to be lowered in the first half of the coming year.

Bond investors also found cause for celebration amidst these positive developments. The recent rally exerted downward pressure on yields of 10-year US Treasury bonds, sliding from a 16-year high of 5.02% a month ago to a low of 4.25% by the end of November. The yield dipped below levels seen on September 20, the date of the Fed’s last quarterly economic projections, which included a “higher for longer” message that subsequently propelled yields towards their peak.

In Germany, yields on 10-year government bonds retreated from an October peak of 3.02% to 2.39% by the close of November. The decline in yields was even more pronounced for Italian 10-year government bonds, which fell from 5.03% to 4.14%, narrowing the yield spread between Italy and Germany. In Switzerland, the yields on 10-year government bonds dropped from 1.23% to 0.82%.

A classic 60/40 portfolio – comprising of 60% equities and 40% bonds – would have yielded 9.6% in November, marking the highest return since December 1991 when the USSR dissolved.

Despite this impressive performance numbers, actual positioning in the futures market remains subdued, contrary to certain sentiment surveys. The speculative net positions in the S&P 500 futures contract from the Commodity Futures Trading Commission (CFTC) has remained negative. The CFTC publishes a weekly report known as the “Commitments of Traders” report. This report contains data on speculative net positions of traders in various futures markets, including the S&P 500. Net positions represent the difference between the total long (buy) and short (sell) positions held by speculators. If the net position is positive, it indicates that there are more long positions than short positions, suggesting a bullish sentiment. Conversely, a negative net position signals a bearish sentiment.

As the focus continues to center on the outlook of major central banks and the timing of potential interest rate cuts, the current spotlight is on the pricing of bond yields. In November, the 10-year US Treasury yields experienced their most significant monthly decline since August 2011. This stands out as one of the most crucial developments shaping overall market sentiment, and it remains to be seen whether the decline in yields will persist. Such a trend would, in turn, impact the dollar and stock prices. The markets have already priced in Fed interest rate cuts totaling 115 basis points and ECB cuts of 114 basis points for the entire year of 2024. The first Fed rate cut is anticipated in May, while the ECB is expected to cut in April.

We do not anticipate a global recession in 2024, at most a modest growth dip. Nevertheless, inflation rates are likely to continue decreasing, approaching the 2% target. The higher productivity witnessed in recent quarters, expected to extend for several more quarters, should contribute to this trend. These elevated productivity rates are supported by the reshoring trend with shorter and more stable supply chains, as well as investments in infrastructure and artificial intelligence.

Against this backdrop, an overweight position in equities appears sensible. For more risk-tolerant investors, Latin American stocks may be appealing for mainly four reasons:

1. In the scenario of escalating tensions between China and the US and the shortening of supply chains, Latin America should emerge as one of the main beneficiaries of the reshoring or nearshoring trend.
2. Secondly, Latin American stocks are reasonably valued, presenting an attractive investment proposition.
3. Additionally, Latin America is poised to benefit from a long-term commodity cycle, particularly in the agricultural sector.
4. Finally, the market momentum favors Latin American stocks. In 2023, the Mexican stock market has surged by 28%, Brazil’s IBOVESPA index by 22%, and Argentina recorded a remarkable 49% gain (all figures in US dollars).

Furthermore, a balanced allocation in long-term government bonds and gold investments could serve as a sensible strategy to capitalize on the anticipated declining interest rate environment while simultaneously mitigating potential risks associated with recessions and geopolitical tensions.