The year of elections and falling interest rates

The global growth outlook looks set to pick up after a sluggish start; China will try to stimulate its way out of a property crisis; inflation continues to fall; interest rate cuts look increasingly likely (though perhaps slightly later than markets are currently pricing in) and the Dollar is likely to weaken.

But before I take a deeper look to the year ahead, let me reflect on a few themes from the last year. 2023 kicked off on a cautious note as the slew of interest rate hikes introduced in 2022 to combat rampant inflation weighed on the global economy and broader recession was the consensus view.

Major equity benchmarks would’ve taken a proper hit if it wasn’t for the emergence of two mega themes, namely:

1. Generative AI going mainstream. This resulted in US mega-cap and select semiconductor makers soaring, though market breadth was non-existent. 
2. The second was regulatory support for and broad-based adoption of weight loss drugs. Wegovy and Ozempic are now household names and Novo Nordisk overtook LVMH as Europe’s largest company by market cap.

As the year progressed, it became increasingly clear that: inflation was falling; geopolitical tensions weren’t fading and the world continued to fragment into competing trading blocs with very clear and competing vested interests.

But most important of all, that US economy and labour market were proving a LOT more resilient than anyone had expected.

This better-than-expected growth and a Fed pivot drove outsized bond and equity market returns in the fourth quarter.

Turning to 2024, the one macro dynamic that keeps me up at night is that the market is currently pricing in BOTH a soft landing AND about 150bps in Fed rate cuts. I see these as mutually exclusive.

Overall, we forecast global GDP growth of 3% this year. This is reasonable and in line with average levels the decade before Covid-19. If this forecast plays out, I cannot see how we get anything like the quantum of rate cuts priced in and the market is waking up to this as we kick off the year with yields backing up.

The second scenario is that we get the 150bps in rate cuts, but I can only see this (and probably more) playing out if we see a proper growth shock.

Equity markets can withstand elevated inflation levels, but recession is a return killer and we would far prefer a reasonable growth, higher-for-longer narrative.

In summary, the euphoria of the end of last year across bond and equity markets looks overdone and we are calling for a near-term pullback in equities and bonds. Total return prospects for the year look reasonable, if not super exciting and it feels like a stock pickers market (especially in the US) given last year’s strong re-rating at index level.

2024 themes

Onto the key themes for 2024, let me summarise our main top-down calls:

1. Global growth gathers pace after a lacklustre start to 2024. We are looking for global growth of 2.9%, down from 3.1% in 2023. But this masks an acceleration in the second half of this year as lower inflation and rate cuts boost spending power and investment.

2. China struggles to overcome its property slump. Stimulus measures by the authorities are likely to bear some fruit, but we suspect the rumoured 5% growth target may not be met in full as fiscal constraints on local authorities bite and competition in traded goods from a buoyant Indian economy is strong. 

3. The falling trend in global inflation persists, driven by core prices. Improved supply chains and falling vacancies look set to bring a sustained return to target inflation within sight, helped by the indirect effects of cheaper energy on core prices.

4. Policy rate cuts begin, but a little later and by less than priced in. NB per the point we make above. Central banks likely want to proceed cautiously, to begin with, absent an unforeseen crisis.

5. There looks to be some, but not much, scope for further falls in bond yields. Uncertainty about neutral rates and fiscal concerns could limit declines in yields.

6. The US dollar may move lower as global growth recovers and rates are cut. A potential wildcard is elections, chief among them the US presidential election. 

Risks abound

With the above in mind, I would be keeping an eye on the below:

· 2024 is a massive year on the election front. There are around 40 democracies that will go to the polls this year representing 41% of the global population and 42% of global GDP. Towards the back end of the year, we have the US election that will again be huge for obvious reasons. Politicians will do whatever they can to remain in power, government spending will no doubt ramp up into elections and this must factor into broader fiscal deficits that are already an issue for many. 

· War and geopolitical tensions. On the former, I continue to believe that there’s a higher probability of a de-escalation than the inverse. The West’s appetite to fund wars is waning, which I think means we see a negotiated settlement with Russia to save face. In The Middle East, there are just so many monied vested interests in de-escalating the situation. On the tech front, I think the inverse is true. The race for tech supremacy is here to stay and you’re already seeing the knock-on impact of trade bans or tariffs on chips and electric vehicles, and on traditional products like French brandy or Apple phones.

· On the weather front, it’s important to reflect that we are transitioning from La Niña to El Niño. The latter brings warm and dry conditions that reduce winter heating demand (Northern hemisphere) and increase summer cooling requirements (South) which should be negative for energy markets. But it also means that we’re likely to encounter water shortage issues and all this implies for geopolitics.

· The possibility of high-profile casualties across the private equity and commercial real estate sectors and what this means for listed equities. The big global asset allocators are still in risk-off mode and are happy to park gargantuan amounts of cash in low-risk, decent-yielding fixed-income products until they are firm that the rate environment has turned. These same asset allocators are however limit-up private equity / private credit / “private-everything” and commercial real estate (where real cracks have formed) and I believe that listed equities must be a huge beneficiary of flows when the first-rate cuts are signalled. 

· The great China debate. China’s pros include valuation, growth prospects off a low base and government efforts to address investor concerns about the game industry. Cons include an uncertain regulatory outlook, Taiwan tensions, and the possibility of lower targeted GDP growth.

· Further consolidation in the global streaming industry (though I think it’s going to be a big year for M&A more broadly). Netflix’s deal with the WWE provides a clear roadmap of where streamers must invest to lure advertising spend.

South Africa outlook

With the above in mind, let’s look at what this means for the South African economy and companies. I believe the risks are balanced going into the elections and there’s not much to get excited about in the short term, but this could change in the second half of the year.

Looking at the positives, the macro environment is generally supportive. Lower yields should provide some support for our risk-free rate and growth prospects for our largest trading partners (China and Europe) should improve off a bashed-up base. 

The loadshedding narrative should also improve. That said, I think we were all spooked by the spike in outages in December and I think a stage 3 and lower outcome is already priced in for this year.

We also think a left-leaning coalition between the ANC and EFF is increasingly unlikely and this mitigates some of the tail risks. Coalition politics appears to be the way forward, but we need to find a way to break the decision-making paralysis and infighting that has plagued many municipalities.

On the negative side, Transnet appears to be going from bad to worse. On its own, Transnet’s inefficiency cost our economy about 5% in real economic growth last year.

The broader reform narrative can’t get out of first gear and with elections around the corner, the ruling party is unlikely to be focused on anything else.

There’s very little incentive for global investors to put on big positions before elections and this means that liquidity is likely to remain an issue. 

We also continue to worry about our deteriorating fiscal position despite a term of trade that has held up a lot better than expected. 

The bottom line is that the growth prospects look improved off a very low base but the lack of a compelling reform narrative plus the election uncertainty means that we are likely to remain at the mercy of the global commodity and rates cycle for at least the first half of this year. There is some justified excitement about China stimulus that could buoy the JSE All Share Index in the short term, but I think SA Inc returns are likely to be weighted to the backend of the year after the election dust settles and we move on.

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