2024's trilemma: Inflation, stagflation or soft landing

Forget crystal balls; success in 2024 hinges on navigating a changing landscape moulded by tightening monetary policies and shifting power dynamics in 2023. 

While a base case scenario paints a picture of gradual growth, hidden currents of risk and opportunity swirl right beneath the surface. This 2024 outlook dissects the key trends and challenges market investors can navigate to unlock potential success in the year ahead.

US: Soft landing, but watch out for inflationary tailwinds

Excess consumer savings are waning, and higher interest rates are impacting demand for goods, services, and housing. While a temporary weakening of US quarterly Gross Domestic Product (GDP) growth is expected at the beginning of 2024, a full-blown recession is not anticipated by a wider set of economic analysts. 

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The Federal Reserve foresees continued moderation of overall inflation and slower economic growth in 2024 before reaching its 2% Consumer Price Index (CPI) target by the fourth quarter of 2026.

The Federal Reserve, playing a delicate balancing act, eyes both slowing growth and persistent inflation. Their recent pause on rate hikes hints at an acknowledgement of sluggishness, aligning with core Personal Consumption Expenditure (PCE) readings potentially dipping below projections. 

However, memories of transitory inflation remain fresh, and worries about resurgent price pressures due to exceptional growth or potential oil shocks linger. As Jerome Powell himself warns, further rate hikes haven't been ruled out. Three quarter-point rate cuts are on the table for 2024, according to Federal Open Market Committee (FOMC) December minutes, but it’s uncertain when they will be implemented.

Adding to the complexity is the shifting landscape of Treasury yields. The Fed’s reduced buying power and ballooning US budget deficit create a perfect storm for rising long-term rates. Waning foreign demand for Treasuries and Japan’s loosening of yield curve control further fuel the upward trajectory. Nevertheless, it’s crucial to remember that these yields are merely correcting from historically low levels and a prolonged inversion. US equity markets are poised to navigate the initial half of the year, drawing guidance from underlying fundamentals and economic data releases, with potential shifts or geopolitical uncertainties looming thereafter.

China: Growth slump meets long-term goals

2024's initial optimism for a post-pandemic China sputtered out as an extended housing slump, rising youth unemployment, and regulatory uncertainties slammed the brakes on the market. With construction and real estate long fuelling the engine of the economy, the property crisis ripples deep, triggering significant equity selloffs.

A glimmer of hope shines from a potential yuan rally in 2024, the first in three years. A narrowing interest rate gap could stanch capital outflow, as predicted by a Bloomberg survey. However, limited rate cuts and an unclear bailout for the property sector cast shadows on the rebound. Foreign investors remain on the sidelines, awaiting decisive government action before diving back in. Despite challenges, Chinese leaders express unwavering confidence in their long-term vision for the nation's economic transformation. Structural reforms target common prosperity and sustainable growth, exemplified by China's commitment to peak carbon emissions in 2030 and achieve carbon neutrality by 2060.

Japan to finally end interest rates

The yen faces renewed pressure following a significant New Year's Day earthquake in Japan, complicating the Bank of Japan's efforts to eliminate negative interest rates this month. While it's not likely that there will be changes in January, most people expect the negative interest rates to end in April or later in 2024. This suggests that there could be increased volatility in the value of the Japanese yen.

Eurozone, UK: Battling inflationary pressures 

The UK and Europe are expected to experience a mild recession and minimal growth in 2024, characterised by slower growth and stubborn inflation. 

Inflation has been more persistent in these regions due to their heavier reliance on commodities and energy imports. Energy and commodity prices are expected to stay above pre-crisis levels, influenced by geopolitical uncertainties and anticipated US rate cuts. Consequently, key interest rates in the EU and the UK are projected to remain higher for longer to control inflation.

Higher interest rates tend to have visible effects on government debt, leading to a continued rise in national debt. With substantial debt from the pandemic and the conflict in Ukraine, the capacity of EU and UK governments to stabilise their economies is diminishing. Limited options for additional fiscal stimulus result in a stagflation scenario, unlike the US, where growth remains resilient and inflation is under control.

Emerging markets: Standing on their own

As interest rates in the US cool and the dollar eases its grip, JP Morgan predicts a resurgence in emerging markets during the latter half of 2024. This momentum is fuelled by a global shift in supply chains, escaping the long shadow of China's dominance.

Beneficiaries of this realignment include regions like Latin America, Europe, the Middle East and Africa (EMEA), the Association of Southeast Asian Nations (ASEAN), and India. These rising stars offer a potent cocktail of cost-effective labour, robust manufacturing, and a treasure trove of essential commodities. Boasting a bustling manufacturing scene, a vast workforce, and natural resources like energy, copper, and lithium (the lifeblood of electric vehicles (EVs) and renewables), Latin America shines as a prime contender.

Rising foreign direct investment (FDI) paints a vibrant picture for ASEAN, with Vietnam leading the charge. Major companies seeking diversification are setting up shop, with Vietnam's stellar growth becoming a textbook case. In the tech arena, Malaysia emerges as a champion of advanced semiconductor packaging and testing, while Singapore reigns supreme as a wafer fabrication hub. Indonesia's nickel wealth and Thailand's established auto supply chain make them vital players in the electric vehicle game.

Narendra Modi's recent electoral triumphs have bolstered India's already impressive growth, fuelled by global supply shifts and competitive labour costs. This translates to record highs for Indian stocks in 2024, with the Sensex and Nifty reaching dizzying new peaks.
While uncertainty may linger, the potential for a robust revival in emerging markets during the second half of 2024 appears tantalising. With lower rates, a weaker dollar, and shifting supply chains, these rising stars stand poised to grab the spotlight and redefine the global economic landscape.

Artificial intelligence: Spotlight on semiconductors

The recent advancement in AI is a game-changer for globalisation. It stands out as a key highlight for 2024 with profound implications for trading and investments. 

Generative AI is a type of AI algorithm that creates content based on existing data. It fuels innovation in various industries beyond tech—from transport and healthcare to education and retail. Notable beneficiaries include gaming firms, electric vehicle manufacturers, e-commerce players, and cloud providers.

Analysts forecast a positive outlook for the semiconductor sector in 2024. The industry is anticipated to sustain its recovery from the 2022 downturn and exhibit growth across all segments. Advancements in AI heavily depend on high-end semiconductor chips for processing and analysing data. Ongoing trade tensions between the United States and China in the semiconductor sector have created a supply-demand imbalance. This resulted in increased prices and margins for semiconductors, impacting the valuations of semiconductor companies.

As of 2023, the semiconductor industry has rebounded, and one significant factor behind this resurgence is NVIDIA Corp. (NVDA), a frontrunner in the expanding Graphics Processing Units (GPU) market for AI applications. Nvidia’s stock has surged more than threefold, making it the first chipmaker to achieve a market capitalisation exceeding USD 1 trillion. Another noteworthy player in the AI sector, Advanced Micro Devices Inc. (AMD), claimed the second spot among index components, experiencing a remarkable stock increase of nearly 130% this year.

Beyond chipmakers in the US, Singapore, and Malaysia, as mentioned earlier, other clear beneficiaries include Korea and Taiwan. Korean fabs are developing the next generation High Bandwidth Memory chips that will benefit from the widespread adoption of AI. Taiwan boasts a complete industrial supply chain that supports current and future AI industry trends.

Risks to monitor: Geopolitical, financial instability

In 2024, amid a crucial election year, global geopolitical tensions and risks are on the rise. Two major conflicts and elections in 40 countries, including major ones like the US, UK, and EU, contribute to the uncertainty. Morgan Stanley anticipates increased volatility in higher-risk assets compared to the previous year.

Investment channels and supply chains are intricately linked to the leadership of each country. Ongoing US-China tensions, the Russia-Ukraine conflict, and the persistent Israel/Hamas dispute are substantial risk factors.

Additionally, concerns about slowing economic growth raise questions about the fiscal sustainability of governments and corporate debt. Eastspring Investments, based in Singapore, takes a defensive stance in the US credit space, preferring US Investment Grade over High Yield corporate bonds. Their research indicates potential underpricing of corporate refinancing risks as the maturity wall expands in the coming years.

Both the EU and the US are grappling with a growing threat of defaults on commercial real estate loans, posing risks for financial institutions. Higher funding costs, potential regulatory capital weaknesses, and increasing risks associated with commercial real estate loans, coupled with weakened demand for office space, prompt a review of banks. Moody’s Investors Service has downgraded the credit rating of 10 smaller US banks and may extend this to major lenders like US Bancorp, Bank of New York Mellon, State Street, and Truist Financial, highlighting mounting pressures on the industry.

Despite a surge in bond yields, credit spreads have surprisingly not widened significantly. This phenomenon has played a role in minimising bankruptcies and job losses. Analysts across various top Wall Street banks foresee a slight deterioration in credit conditions in 2024, providing a buffer for companies, jobs, and overall economic growth against a more severe decline.

Conclusion

Navigating the changing investment landscape in 2024 requires a clear understanding of macroeconomic factors, asset allocation strategies, and the role of artificial intelligence within businesses and private assets.

In the initial half of 2024, the trajectory of markets is poised to be heavily influenced by ongoing economic fundamentals, as the ramifications of elections and potential credit risks are yet to be fully assessed. 

While investors can typically anticipate and prepare for various risks, the most significant threat often arises from an unexpected "curveball" — an event that catches everyone by surprise. Since these events aren't considered in market prices, they can cause major disruptions when they occur. Recent examples include the unforeseen COVID-19 pandemic and the war in Ukraine, both of which few investors expected. Recognising the unpredictable nature of the financial landscape, it's sensible to account for potential unforeseen challenges in 2024 as well.