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Friday, December 29, 2023

Crystal Ball: What global institutions are forecasting for 2024

Wishing all readers, a joyful holiday season and a happy new year.

J. P. Morgan: Too early for a victory lap

As we head into 2024, a combination of solid activity and falling inflation has seen the market narrative increasingly shift towards the prospects of a soft landing.

• We are a little more skeptical. Even though Western economies may be less rate-sensitive than in the past, we expect that the “long and variable lags” of monetary policy transmission are at least part of the better explanation for the economic resilience seen so far.

• We think it's too early for the central banks to declare outright victory over inflation, and anticipate that rate cuts in 2024 are unlikely to pre-empt economic weakness.

• We therefore think interest rates could be set to fall later than the market currently expects, but eventually they may also fall further than predicted.

• We believe investors should focus on locking in yields currently on offer in the bond market. Targeted alternatives could augment the role that bonds play as diversifiers against different risks. In equities, potential pressure on margins warrants a focus on quality and income.

Goldman Sachs: The Hard Part Is Over

The global economy has outperformed even our optimistic expectations in 2023. GDP growth is on track to beat consensus forecasts from a year ago by 1pp globally and 2pp in the US, while core inflation is down from 6% in 2022 to 3% sequentially across economies that saw a post-covid price surge.

• More disinflation is in store over the next year. Although the normalization in product and labor markets is now well advanced, its full disinflationary effect is still playing out, and core inflation should fall back to 2-2½% by end-2024.

• We continue to see only limited recession risk and reaffirm our 15% US recession probability. We expect several tailwinds to global growth in 2024, including strong real household income growth, a smaller drag from monetary and fiscal tightening, a recovery in manufacturing activity, and an increased willingness of central banks to deliver insurance cuts if growth slows.

• Most major DM central banks are likely finished hiking, but under our baseline forecast for a strong global economy, rate cuts probably won’t arrive until 2024H2. When rates ultimately do settle, we expect central banks to leave policy rates above their current estimates of long-run sustainable levels.

• The Bank of Japan will likely start moving to exit yield curve control in the spring before formally exiting and raising rates in 2024H2, assuming inflation remains on track to exceed its 2% target. Near-term growth in China should benefit from further policy stimulus, but China’s multi-year slowdown will likely continue.

• The market outlook is complicated by compressed risk premia and markets that are quite well priced for our central case. We expect returns in rates, credit, equities, and commodities to exceed cash in 2024 under our baseline forecast.

• Each offers protection against a different tail risk, so a balanced asset mix should replace 2023’s cash focus, with a greater role for duration in portfolios.

• The transition to a higher interest rate environment has been bumpy, but investors now face the prospect of much better forward returns on fixed income assets. The big question is whether a return to the pre-GFC rate backdrop is an equilibrium. The answer is more likely to be yes in the US than elsewhere, especially in Europe where sovereign stress might reemerge. Without a clear challenger to the US growth story, the dollar is likely to remain strong.

Morgan Stanley: Threading the Needle

Investors face tough choices in an imperfect world but can look for opportunities in fixed income while remaining cautious on emerging markets and commodities.

Investors will need to make deliberate choices in 2024, paying close attention to monetary policy if they want to avoid a variety of potential pitfalls and find opportunities in an imperfect world of cooling but still-too-high inflation and slowing global growth.

Markets have already baked into asset prices the idea that central banks will manage a smooth transition to reduced levels of inflation—meaning there’s limited runway for increased valuations. But 2024 should be a good year for income investing, with Morgan Stanley Research strategists calling bright spots in high-quality fixed income and government bonds in developed markets, among other areas.

2024 is likely to be a “tale of two halves,” with a cautious first half giving way to stronger performance in the second half of the year.

For the first half of 2024, strategists recommend that investors stay patient and be selective. Risks to global growth—driven by monetary policy—remain high, and earnings headwinds may persist into early 2024 before a recovery takes hold. Global stocks typically begin to sell off in the three months leading into a new round of monetary easing, as risk assets start pricing in slower growth. If central banks stay on track to begin cutting rates in June, global equities may see a decrease in valuation early in the year.

In the second half of the year, however, falling inflation should lead to monetary easing, bolstering growth. “We think near-term uncertainty will give way to a comeback in U.S. equities,” says Mike Wilson, Chief Investment Officer and Chief U.S. Equity Strategist for Morgan Stanley. And Wilson expects earnings growth to remain robust into 2025: “Positive operating leverage and productivity growth from artificial intelligence should lead to margin expansion.”

Emerging-markets equities face obstacles, including a strengthening dollar and lackluster growth in China, where policymakers face the triple challenges of debt, demographics and deflation.

One global bright spot is high-quality fixed income. Yields on a broad cross-section of U.S. corporate and government bonds reached 6%, the highest since 2009. U.S. Treasury and German Bund yields are the highest they have been in a decade, and Morgan Stanley forecasts 10-year yields on U.S. Treasurys at 3.95%, and DBR at 1.8% by the end of 2024.

Bank of America: The Year of the Landing

A global shift to rate cuts: Inflation to gradually move lower across the globe, allowing many central banks to cut rates in the second half of 2024 and avoid a global recession. Head of US Economics Michael Gapen expects the first Fed rate cut in June and the central bank to cut 25 basis points per quarter in 2024.

The 3Ps = the 3Bs: Bull markets of 2024 will be the “3Bs”- Bonds, Bullion & Breadth. He believes the risk of a hard landing for the economy is higher-than-expected and that he awaits the classic combination of bearish investor positioning, recessionary corporate profits and easing policy—the “3Ps”—before he flips to being a full bull.

S&P 500 forecast to end 2024 at 5000, an all-time high: Bullish on equities—not because the Fed is expected to begin cutting rates next year, but because of what the Fed has already done and how corporates have adapted. EPS can and has accelerated as GDP slows, and reshoring has been identified as a tailwind by companies.

Expect Brent crude to average $90, commodities to restock: OPEC+ has been cutting supply since 2022 and will likely keep at it in 2024. Oil demand growing by 1.1 million barrels per day in 2024 as emerging markets benefit from the end of the Fed’s monetary tightening cycle. Yet Brent and WTI prices should average $90/barrel and $86/barrel, respectively. Recession, faster-than-expected US shale growth, and lack of OPEC+ cohesion are downside risks to oil prices. Lower rates should boost gold and lead to restocking in industrial metals.

Japan inflation persists: Expects an improvement in consumer spending and forecasts inflation to remain above consensus, which is a positive in the case of Japan. Our strategists expect progress with corporate reform, evidenced by the highest number of companies raising guidance in ten years.

Rate cuts and a peaking US Dollar are a positive for Emerging Markets: EM returns in the 12 months after the last Fed hike in a cycle tend to be highly positive and positioning is light across EM assets. China economic growth should stabilize. Our fundamental FX team is more bearish on the USD than consensus as US GDP growth slows and the Fed begins to cut rates.

Seek quality yield in credit: Rates, earnings and issuance will likely challenge credit in 2024, causing our credit strategists to prefer quality. They believe investment grade offers the best relative value in credit. Loans offer more carry than high yield (HY) and HY credit losses are unlikely to be lower than loans.

Slowing investment spend a drag US economic growth: The impact of fiscal investment programs should dissipate. Our US economists expect consumption to slow down but not to crash. While capex has secular tailwinds, cyclical headwinds also exist, as evidenced by fewer CEOs expecting higher capex over the next six months.

US 10-year Treasury yield should remain elevated: Not bullish on 10-year bond prices for several reasons: the US fiscal stance has deteriorated, as has its net international investment position, and duration/inflation risk have become riskier.

Policy uncertainty could rise as elections will occur in countries that make up over 60% of global GDP: Our Research team expects heightened policy uncertainty amid increasing political polarization. Fiscal consolidation becomes difficult, having implications for rates.

UBS: Soft landing more likely

We expect both equities and bonds to deliver positive returns in 2024. Slowing US economic growth, falling inflation, and lower interest rate expectations should mean lower yields, supporting bonds and equity valuations, while the absence of a severe US recession should enable companies to continue to grow earnings.

HSBC: A problem of interest

Since the Fed started hiking interest rates in March 2022, global liquidity conditions have tightened materially, bringing inflation down, but it has now raised risks of an adverse growth outcome in 2024. Markets are unprepared for this scenario and continue to assume a ‘soft landing’ – that inflation can dissipate without harming growth prospects. However, we expect a rise in recession risk in western economies, while in eastern economies, some parts of Asia could face growth challenges but still provide diversification benefits and a relative bright spot.

In the longer run, we believe a shift to a ‘new paradigm’ is underway, with inflation and interest rates somewhat higher than during the 2010s. Our preference in this environment will be for a ‘defensive growth’ approach which includes pivoting to higher quality markets. We also suggest ‘intelligent diversification’ strategies.

Lazard: Stark contrast to 2023

• Rate hikes likely shifting to cuts as inflation falls to 2%.

• The Fed engineering a “soft landing” avoiding US recession.

• China sentiment improving despite the ongoing housing overhang.

• The Eurozone and UK teetering on the brink of recession as sticky inflation precludes easing.

• Japan exiting yield curve control and negative interest rates.

• The Ukraine war dragging on and Western tensions with China ratcheting higher.

• US elections becoming the focal point as a determinant of the geopolitical trajectory.

Invesco: Deploying cash

Economies have been more resilient than we expected during 2023 but we believe they are slowing. We also believe that inflation will decline, though less smoothly than in 2023, and that major Western central banks will start easing in 2024 Q2.

History suggests that once the Fed starts easing, it will move quickly. Defensive fixed income asset returns are likely to be boosted by high yields (or higher than for many years) and the decline in those yields that we think will go with central bank easing (implying bull steepening).

Risk assets may suffer in early 2024 as economies weaken and as we await clarity from central banks but we expect better performance as the year unfolds.

Assumptions:

• Global GDP growth will slow and then recover

• Global inflation will fall but remain above many central bank targets

• Major western central banks start cutting rates during 2024 Q2 (but continue QT)

• Long-term government yields will fall but yield curves will steepen

• Credit spreads will widen in the US but be mixed in Europe, defaults rise

• Bank loan spreads will be stable but defaults rise

• Equity and REIT dividend growth will moderate but yield movements are mixed

• USD will weaken as Fed tightening ends

• Commodities will be mixed as the global economy slows and USD weakens

Deutsche Bank: Geopolitics and corporate uncertainty

Two big ideas – geopolitics and corporate uncertainty – pervade all the key themes that we present as our top ten for 2024. We elevate these two mega-themes as they are the key drivers underlying much corporate and investment decision making in the new year.

The big focus of 2024 will be the slew of elections around the world. We expect some volatility around these, particularly if markets become nervous about fiscal spending promises. But when we take a step back, the most important aspect of the elections may be observing any increase in populist views from both sides and examining how they may realign trade relations between countries.

For corporates and markets, the key point many investors underestimated in 2023 (at times, us included) was how long corporates would remain nervous as uncertainty remained high. That fact kept a lid on things this year.

In 2024, however, we expect more activity. Corporate uncertainty has dropped and there is greater visibility on the trajectory of economic and market indicators.

The year may still include an economic slowdown but that may not be the key thing that drives markets.

Thursday, December 28, 2023

2024: Market Outlook and Strategy

In my view, the stock market outlook in India, in the short term of one year, is a function of the following seven factors:

Macroeconomic environment
Global markets and flows
Technical positioning
Corporate earnings and valuations
Return profile and prospects for alternative assets like gold, real estate, fixed income etc.
Greed and fear equilibrium
Perception of the political establishment

The outlook for these seven factors for the next twelve months is as follows, in my view—

Macroeconomic environment – Neutral

My outlook for the likely macroeconomic environment in 2024 is as follows:

(a) Inflation: Consumer inflation may average well within the RBI tolerance band of 4% to 6%. However, food inflation may continue to be erratic and cause occasional violations of the upper range.

(b) Fiscal Deficit: The fiscal situation of the central government may remain comfortable as the tax collections remain steady and revenue expenditure is controlled further. I do not expect any significant deterioration in fiscal conditions due to elections scheduled in 2024. No major tax/duty concessions are expected. Any major improvement in fiscal balance would depend on acceleration in asset monetization. The outcome of the general election will be a key factor in this regard.

(c) Rates: Expect benchmark yields to average in the 7.00% +/- 30bps range. The RBI may remain on pause in the first half and may deliver a 35-50bps cut in the second half depending upon the monsoon and global trend. No major change may be seen in deposit and lending rates as the liquidity remains tight and credit demand remains elevated.

(d) Current Account: Expect the current account balance to stay negative for most part of the year as import growth continues to outpace exports. The deficit may average around 1.5% to 1.75% for2024.

(e) Savings: Household savings may grow at an even slower pace as real wage growth remains poor. Aggregate corporate savings may also decline as capacity utilization increases and corporates embark on capex plans.

(f) Investment: The government investment expenditure may slow down in 1H2024 due to fiscal constraints and election-related restrictions. Private capex may maintain its 2H2023 trajectory. Overall, investment growth may see decent growth in 2024.

(g) Exchange Rate: USDINR may average close to INR83.5 +/- 1 range on a negative current account and elevated inflation.

(h) Growth: The real GDP growth for FY25 may average around 6.25% +/- 50bps despite a slower global economy. Strengthening of El Nino and a poor monsoon could impact the growth negatively by 50-60bps.

Overall, the macroeconomic outlook is neutral.

Global markets and flows - Neutral

Markets: The global analysts and economists are nearly unanimous on the growth recession in 2024. Most markets are currently pricing sharp rate cuts and monetary easing to mitigate the impact of economic slowdown. Any disappointment on this count may impact global markets adversely.

Flows: The outlook for USD is now negative as Fed is expected to deliver aggressive rate cuts. Flows towards emerging markets may accelerate in 2024 as cheaper money in developed market begins to chase yield again.

Technical Positioning - Negative

In my view, the benchmark indices are poised for a decent technical correction. and offer a negative risk-reward at the current level. A correction of 8-10% would make the market attractive again.

Technically speaking, Nifty may move in a wider range of 17390-23063 in 2024, averaging above 18880. Buying below 19400 will carry a positive risk reward.

Corporate earnings and valuations - Neutral

The earnings momentum may slow marginally as banks, energy and metal earnings growth peaks in FY25. No major acceleration in earnings is expected from FMCG companies. Power, IT Services, and Pharma are the notable sectors that are expected to delta in earnings. Overall, expect a 15% earnings growth, which may be lower than the current consensus expectation.

The visibility of the improved margins sustaining is decent. Higher capacity utilization may warrant capex, hence the beginning of a re-leveraging cycle from FY25. RoE therefore may not improve materially in next couple of years.

The present forward valuations are marginally higher than the long-term averages based on still marginally optimistic earnings forecasts.

Alternative return profile - Neutral

Real estate: Real estate prices may not rise materially in 2024 as higher interest rates, withdrawal of tax incentives, and slowdown in demand due to slower employment growth may weigh on demand.

Gold: The gold prices have recently rallied on the back of expectations of aggressive rate cuts by central bankers and persistent buying by some large central banks. A weaker USD may further support gold prices in 2024. However, there is little to suggest any major rise in the global gold prices. Save for a major geopolitical escalation, gold offers a neutral to marginally negative risk reward from the present level.

Cryptocurrencies: In the past few years, Cryptocurrencies have emerged as a notable alternative asset class. Being a new asset class the level of understanding and awareness about this asset class is still low, though the participation has risen exponentially. This combination of low understanding - high participation makes it highly volatile. Nonetheless, its popularity remains high and this trend may continue in 2024 as well.

Fixed income: The corporate bond yields and deposit rates may see some downward bias in 2024, as policy rates peak and begin to descend. The yield gap that favors bonds presently may be sustained for most part of 2024.

Overall, in my view, the return profile of alternatives is neutral for equities.

Greed and fear index - Negative

Historically, the most successful, though intuitive, indicator of greed overtaking the fear in the stock market is the outperformance of small-cap stocks over large-cap stocks. The volatility index, another gauge of fear, has however inched higher in the recent weeks.

The sharp outperformance of smallcap stocks in 2023 indicates that greed dominates the sentiments presently. This sentiment may change in 2024 when the global news flow becomes ominous. The Greed and Fear balance therefore is unfavorable presently.

Perception about the political establishment - Positive

Strong commitment to promote manufacturing in India; the positive outcome of thrust on self-reliance, controlled fiscal balance, and recent election victories are keeping markets’ perception about the political establishment positive. A strong performance in the general elections may further strengthen the positive perception.

Outlook for Indian markets

Given the positioning of the above seven key factors, my outlook for the market in 2024 is as follows:

(a) Nifty 50 may move in a large range of 17390-23063 during 2024. It would be reasonable to expect a high single-digit return for the year on diversified equity portfolios.

(b) The outlook is positive for Non-bank financials, Fossil fuels, Construction materials, Capital goods, Infrastructure, Technology, Pharma, and Modern retail. Outlook for automobile is neutral. Large-cap stocks may outperform. Closely watch chemical space for the revival of fortunes.

(c) Benchmark bond yields may average 7.00% +/- 30bps for the year. Shorter end yields may continue to do better in 1H2024, while longer duration may do better in 2H2024.

(d) USDINR may average close to 83.5+/- 1 and move in the 81-85/USD range.

(e) Residential real estate prices may appreciate marginally and remain generally remain stable. Commercial real estate may continue to perform better.

Some key risks to be monitored for the market in 2024

Development of El Nino adversely impacting monsoon; and unusual rise in rural stress.
Worsening geopolitical situation in Europe and Asia.
A large credit event causing market freeze.
A deeper than expected recession in developed economies that may spill into 2025 as well.
Sharp rise in commodity prices due to production/logistic disruptions; restocking; displacement of USD etc.
General election results contrary to expectations.

2024: Investment Strategy

Asset allocation

2024 may be a challenging year for investors. The volatility and uncertainty may increase materially requiring investors to focus on capital preservation while attempting to generate reasonable returns. At the same time, the market may offer attractive opportunities to build a good portfolio for the period beyond 2024.

I shall maintain a standard allocation in 1H2024 and engage in active trading in my equity and debt portfolio to optimize return using the benefit of large swings. However, in 2H2024 I would look for opportunities in the emerging themes for the next decade and build a long-term portfolio. Maximizing return will not be my primary focus in 2024.

My target return for the overall financial asset portfolio for FY24 would be 11%.

Equity investment strategy

I would maintain 60:20:20 mix of large, midcap and smallcap stocks.

(a) Target 9% price appreciation from my core equity portfolio and 18% earning from my trading portfolio;

(b) I shall be overweight on Non-bank financials, Fossil fuels, Construction materials, Capital goods, Infrastructure, Technology, Pharma, and Modern retail.

Miscellaneous

I have assumed a relatively stable INR (Average around INR83/USD) and slightly lower short-term rates in investment decisions. Any change in these assumptions may lead to a change in the strategy midway.

I would continue to avoid directly investing in high-valuation new economy businesses like digital platforms and Fintech. I will also avoid international equities and gold.

Wednesday, December 27, 2023

2024: Trends to watch

The first day of January of the Gregorian calendar is widely celebrated as “New Year” globally. Scientifically speaking, this is just another point in ad infinitum; and no different from the millions of other similar points in the history of mankind. Nonetheless, we celebrate it as a new beginning, after every twelve Gregorian calendar months. The idea perhaps is to take a break from the routine and reflect on events of the past twelve months to review, reassess, revise, retreat a bit if required, and resume. It is common for people to take a pledge on this occasion, to take corrective measures for improving their lifestyles and behavior, and to set new goals for themselves.

In the financial markets also, it is a tradition to use this occasion to reflect on the market behavior during the past twelve months, outline the events to be watched over the next twelve months, and make an assessment about what may work best for investors and what may not.

Following the tradition, I have also reviewed the current conditions and shortlisted the following factors and trends to watch over the next twelve months. I believe that these factors and trends, inter alia, may materially impact the markets in the next twelve months and beyond.

Interest rates

At this point, it is a common belief that the current interest rate cycle that started in the Spring of 2022 has peaked in 2023, and we shall see a decline in rates during 2024. However, the views diverge about the trajectory of rate decline. A strong view is that to avert a recession, central banks may resort to accelerated rate cuts in 2024 and 2025. Other views include a calibrated rate-cut policy; a slow start in 2024 and rates bottoming much above the lows seen during the previous couple of cycles. A minority view is that consensus may be wrong about the rate trajectory and we may see higher rates for much longer than what the majority believes presently.

Investors would need to watch the trend in interest rates closely during 2024. An accelerated rate cut may mean (i) massive money flowing back to bonds; (ii) massive short covering in bond markets; (iii) USD strengthening; (iv) growth reviving in developed markets and (v) carry trade coming back in vogue as smart money travels to emerging markets in search of higher yields.

Disinflation vs deflation

2023 has seen significant disinflation in most developed and emerging economies. Most central bankers have either achieved or are closer to achieving their inflation targets. Global growth, especially in advanced economies, commodity-dominated emerging economies, and China has taken a hit.

Presently, many European economies are struggling with stagflation. Japan is witnessing positive real rates after a decade. US COVID stimulus has faded, leaving consumers vulnerable. Higher positive rates are impacting discretionary consumption and investment in many other economies.

It is to be watched whether the current trend stops with disinflation or pushes the major economies to a state of deflation. Particularly, since the strong deflationary forces like the use of artificial intelligence to replace semi-skilled and skilled workforce; aging demographics, dematerialization of trade and commerce, etc. continue to gain strength.

In case deflationary forces gain material ground, we may see the policymakers loosening money policy to recalibrate controlled inflation. This will see the Japanification of major economies like China, the US, and the EU. Emerging markets and independent currencies (e.g., Bitcoins) could be major beneficiaries in such a case.

Impact of AI

We are ending 2023 with companies like Google and PayTM announcing a material reduction in jobs as they replace workers with AI tools. This trend is likely to accelerate in 2024. It is critical to watch how businesses, households, and governments adapt to this trend.

The transition will indubitably be challenging as the redundancy of workforce and businesses increases. We may also witness a serious rise in the cases of cyber crimes and proxy wars. Plenty of regulatory frameworks would need to be recalibrated to meet the challenge. This process may also disrupt the businesses.

On the other hand, many businesses might experience tremendous productivity gains and a rise in profitability.

Geopolitical challenges

As we draw curtains to the year 2023, the world faces multiple geopolitical challenges. It is likely that in 2024-

(i) NATO may decide to end (or materially diminish) support to Ukraine, forcing a truce at Russian terms leading to end of sanctions on Russia and strengthening President Putin.

(ii) Arabs, aided by China, Iran and Russia, striking Israel in a proxy war against the US in a critical election year.

(iii) China entering Taiwan

(iv) Conflicts at Northern and North Eastern Indian borders as both India and Pakistan elect their new governments.

Global asset allocation rebalancing

The direction of the Indian markets could be significantly influenced by the global asset rebalancing in light of the change in interest rate trajectory, movement in USD and JPY, geopolitical tensions, disinflation/deflation etc.

The money managers might change their allocation strategies for EM vs DM, Equity vs Debt, China vs Japan, Physical Assets vs Financial Assets, Gold vs Bitcoin etc.

Presently the consensus is favoring accelerated rate cuts. Equity valuations and allocations (value vs growth) are congruent to this view. The margin for error therefore is low.

India’s growth sustaining the momentum

In 2023, the Indian economy surpassed the expectations of most agencies including the RBI and IMF. However, some key drivers of the above expectation growth appear tired.

· Private consumption growth continues to lag, while the fiscal constraints are now visible on government consumption expenditure.

· Poor global growth is likely to reflect on the exports and remittances in 2024, exacerbating the pressure on current account and INR.

· The erratic weather conditions may continue to challenge rural productivity and demand.

· Private investment has shown decent signs of recovery in 2023. Higher positive real rates may adversely impact this trend.

· The general elections scheduled in March-April, may also delay some public and private investment decisions.

· Bank asset quality improvement appears to have peaked in 3QFY24. The RBI has repeatedly cautioned about rising stress in unsecured consumer loans. A significant rise in service sector layoff might adversely impact home and vehicle loans also. Though, the probability of any significant deterioration in bank asset quality in 2024 is negligible, the growth and margins may certainly be impacted. This might limit the credit growth and hence the growth momentum.

Thursday, December 21, 2023

2024: A new paradigm unfolding

From the events of the past few years, it is evident that the era of peace and global cooperation, which started in the aftermath of two devastating wars in the first half of the twentieth century and flourished after the end of the Cold War in the late 1980s, may be coming to an end.

In my view, the year 2024 will see a new paradigm unfolding in global economic, political, and geopolitical spheres. The new paradigm which would take a couple of decades to manifest fully, may inter alia see multiple axes and alliances emerging in the global order, competing with each other for supremacy. Consequently-

· Global trade may get fragmented into multiple trade blocs.

· A new monetary order may emerge that may include separate invoicing currencies for trades within different blocks and a couple of independent currencies for broader international trade. Unsustainable debt of the developed economies could be redeemed in unconventional ways, e.g., currency devaluation, partial write offs, mandatory roll over till perpetuity,

· The trend in the financialization of economies may reverse. Physical resource ownership and localized manufacturing may become the primary focus again.

· National boundaries may get redrawn or obliterated due to (i) territorial occupations to gain control of natural resources and enhance geopolitical influence; (ii) more alliances like the European Union, and (iii) voluntary consolidation like Germany.

· The incidence of war and hostilities may rise.

· Nationalism might triumph over globalization. Post WW2 global institutions and agreements like the UN, IMF, WTO etc., may become redundant. Migration of labour and sharing of knowledge may suffer badly.

· Global aid to poor countries which were exploited by the imperial colonists during the 18^th to 20^th centuries, may diminish substantially, unleashing a new era of starvation and disease.

· Global demography may see material change. The average life span in developed and larger developing economies may rise due to medical advancements, while the population may continue to decline.

· Population in poor countries may decline due to starvation and disease. There may be more incidences of pandemics originating from poor countries, especially in Africa.

· Technology apartheid could emerge as the most dangerous trend over the next decade.

· “Artificial intelligence” (AI) may become the new equivalent of the 1940s atom bomb. The technological advancements in generative AI may seek to supplement the declining demographics and present huge productivity enhancement potential. However, the rise of authoritarian regimes and hyper-nationalistic tendencies creates the potential for misuse; raising the specter of a potential repeat of the Hiroshima-Nagasaki type disaster.

These changes will of course create once-in-a-generation investment opportunities; though with materially enhanced risk.

Wednesday, December 20, 2023

2023: What worked and what did not

The 2023^rd year of the Christ is ending on a rather buoyant note for the Indian financial markets. The equity markets are at all-time high levels. Bond markets are now looking up, after challenging 18 months. Cryptocurrencies have yielded good returns. Gold has also been positive. Macroeconomic conditions have become supportive of the markets – prices are under control, currency stable, twin deficits under control, no overhang of government borrowing crowding out private capex, manufacturing growth is accelerating as capacity utilizations improve and PLI payments begin to flow in, and overall growth is the best amongst the global peer. The foreign flows have improved, while the overall domestic flows have remained strong. Corporate earnings remained buoyant led by easing raw material prices, improved domestic demand environment, deleveraged balance sheets, and materially improved asset quality for the lenders.

Stock markets – Capex theme finally catches up

The Benchmark Nifty50 has gained ~18.5% YTD2023. But the heightened action was witnessed in the broader markets where Nifty smallcap100 gained ~53% and Nifty Midcap100 gained ~45%, sharply outperforming the benchmark. The overall market capitalization of NSE increased ~26.6% to Rs355 trillion (US$4.28trn).

The investment theme - capital goods, infrastructure, construction, and manufacturing were the top themes in 2023. Defense, clean energy, Real Estate, power, roads, railways, etc. - did exceedingly well. The materials (metals, cement, etc.); large private banks, services, and consumer finance were relative underperformers.

· Realty, Defense & Railways PSEs, PSU lenders, Power, and Clean Energy were the top themes for 2023.

· International equity funds and Gold ETFs were the worst-performing fund categories; smallcap funds were the remarkable outperformers.

· Most large cap funds managed to beat the benchmark Nifty50 by a decent margin.

· The valuation gap between broader markets and Nifty widened to 2018 levels when a sharp correction was witnessed in broader markets.

· Long-term (5yr rolling CAGR) Nifty returns are in double-digit for the unprecedented fourth year.

Earnings growth – all set for a sustained up move

Nifty EPS is all set to record a fourth consecutive year of double-digit growth in FY24. The earnings in the five years FY20-FY24e have grown at 14.4% CAGR. The outlook for FY25 and FY26 is also promising with consensus estimates suggesting over 15% CAGR over FY25-FY26.

Flows positive – Quality of domestic flows remain good

The overall institutional flows in the secondary markets remained positive consistently. Over all, FPIs pumped in over Rs 1.12 trillion (YTD 2023) in Indian equities; while domestic institutions were buyer to the tune of Rs1.74trn. The best part was the quality of flows. The entire Rs1.7trn of domestic new flows was through SIP route and hence sustainable and stable.

Debt and currency – bonds stable amidst global turmoil; INR marginally lower

Indian debt and currency markets were perhaps the most stable among the global emerging market and developed market peers. While the sovereign ratings of countries like the US and China witnessed adverse rating action, India’s sovereign rating remained stable with a case for upgrade. The benchmark yields ended lower for the year despite tighter liquidity and higher policy rates. During the year INR was down ~5% against USD and ~9% against EUR.

As the yields were mostly stable and the yield curve flattened, duration did not affect the bond returns. Most debt funds (including Liquid) on average yielded 6-6.5% return.

Commodities – deflation sets in

The year 2023 has not been good for commodities. With the global central bankers determined to reign inflation with aggressive, monetary tightening, demand slowing, and post-Covid logistic challenges easing materially, most commodities yielded negative returns in 2023. Natural gas, agri commodities (wheat & corn) crude oil, and base metals were notable losers.

· Precious metals managed to stay in positive territory but did not yield any return despite having all the reasons to do that.

· Energy prices have corrected back to the pre-covid period. Natural Gas and Crude Oil (despite higher production cuts by OPEC+) ended sharply lower. Natural gas prices are now lowest in three years. The latest inventory, consumption, and production forecasts for 2024 and 2025 are indicating further easing in energy prices over the next couple of years.

· Agri commodities corrected despite inclement weather conditions across geographies and continued hostilities in Ukraine and sanctions on Russia.

Cryptos – Gaining wider acceptance

Cryptocurrencies have been the best performing asset for the year. Value of Bitcoin, the largest and most popular cryptocurrency, has gained ~250% during 2023. Cryptocurrencies continued to gain wider acceptance from governments, regulators, financial institutions, market participants, and investors. Several smaller African and Latin American countries, like the Central African Republic, Uganda, Zimbabwe, El Salvadore, Paraguay, Venezuela, etc. have adopted cryptocurrencies in their monetary system, some even declaring bitcoin as legal tender.

Economic Growth – India best in the class

The overall economic growth is moderate as two of the primary engines of global growth the US and China stuttered. Germany and Sweden flirted with recession for most of the year, while the UK, France, and other European countries barely grew. In Latin America, Brazil managed to grow its economy by 3%, Argentina, and Chile were in recession, and other economies barely grew. The leading commodity-producing economies in Middle East Asia, Africa, and the Pacific (Australia) were either stagnant or contracted.

India - Best in the class

1HFY24 GDP growth (7.7% yoy) has surprised on the upside, beating the RBI estimates (6.8%) by a fairly wide margin. Most agencies and analysts have upgraded their growth forecasts for the entire financial year FY24 by 20-50bps. RBI had earlier estimated FY24 GDP growth to be 6.5%; but the current trajectory is indicating that India’s GDP may record 7% growth in the current year. The growth momentum also indicates that the present rates may not be restrictive for growth.

Tuesday, December 19, 2023

2023: The year that was

2023 was a watershed year in many respects. The global economy, politics, geopolitics, climate, and technology witnessed some material changes that would have critical long-term impacts on human life.

Global economy

The global economy resumed the process of normalization after two years of disruptions caused by the pandemic and the Ukraine war. Supply chains were mostly restored. Fiscal and monetary stimulus unleashed to mitigate the impact of Covid-19 started to wind up. The prices of most commodities that had witnessed a sharp surge in the previous couple of years retraced back to their pre-covid trajectories. The interest rate cycle, which witnessed one of the sharpest hikes in policy rates in decades to rein the runaway inflation, also appears to have peaked.

The developed economies have been mostly successful in avoiding a meaningful recession, despite material monetary tightening, higher rates, and fiscal restraints. Most notably, Japan, which has been struggling with deflationary pressures for over a decade, managed to return to the path of growth with moderate inflation.

Geopolitics and politics

The Ukraine war in 2022 opened multiple fault lines in global geopolitics. The post-Cold War thaw in US-Russia relations evaporated completely. The US-Sino trade conflict that started to worsen in 2017 transformed into a major geopolitical standpoint. In 2023, the conditions seem to have worsened materially.

The latest episode of hostilities in the Gaza Strip has further widened the abyss. There were some indications of the Arab world mending its way with Israel. However, the Hamas attack on Israel in October changed everything. Middle East Asia is now a major flashpoint for a wider escalation of the conflict as groups of larger forces have pledged support to Israel and Palestine. The regrouping of Arabs with Russia and China alliance against the interest of the Western world is a clear pointer to the potential shape global order may be taking in the next couple of decades.

Hyper-nationalist right-aligned leaders/parties won elections in Italy, Argentina, and the Netherlands; while hardline leftists won elections (re-elections) in many jurisdictions, e.g., Germany, France, Australia, Chile, Mexico, Bolivia, Brazil, Peru, Honduras, and Columbia, etc. Both the Chinese Premier Xi Jinping and Russian Premier Vladimir Putin are firmly entrenched in their respective offices for as long as they wish, and actively working to polarize the world.

The commodity-producing and most populated emerging economies which felt that they had been at the mercy of the financialized Western world due to the overwhelming dominance of USD on global trade, regrouped (expansion of BRICS) to be in a position to command terms of trade.

Climate change

As the emerging economies and the developed economies made some progress in finalizing a workable deal to set effective emission targets at COP28 (Dubai), the weather conditions in the world worsened materially. Countries across the world witnessed dramatic changes in weather patterns, affecting crops, livestock, and human life. The global temperature continued to rise as many countries in Europe, North America, and Latin America witnessed episodes of extreme heat, rain, and snow. Floods were seen in many countries. The incidences of earthquakes, cloudbursts, cyclones, etc. also increased in many countries.

Technology

Artificial intelligence and blockchain technologies entered the mainstream in 2023. Cryptocurrencies and digital currencies gained much wider acceptance both as a store of value and a medium of exchange. Generative artificial intelligence entered the common man’s sphere, impacting the lives of households. Significant advances were made in the fields of biotechnology, green energy, astronomy, and space science.

Some of the key events of 2023 could be listed as follows:

· Croatia adopts the euro and joins the Schengen Area, becoming the 20th member state of the Eurozone and the 27th member of the Schengen Area.

· A deadly cold snap in Afghanistan kills 166 people and nearly 80,000 livestock.

· A massive earthquake strikes southern and central Turkey and northern and western Syria causing widespread damage and at more than 59,000 fatalities and 121,000 injured.

· The European Parliament approves a ban on the sale of new petrol and diesel vehicles in the European Union from 2035.

· Lawmakers in the Russian State Duma vote to withdraw Russia from 21 conventions of the Council of Europe.

· Vladimir Putin announces that Russia is suspending its participation in New START, a nuclear arms reduction treaty with the US.

· The 2023 Chinese presidential election is held with the National People's Congress unanimously re-electing Xi Jinping as the President of the People's Republic of China to an unprecedented third term.

· Iran and Saudi Arabia agree to resume diplomatic relations which were severed in 2016, at talks mediated by China.

· OpenAI launches GPT-4, a large language model for ChatGPT, which can respond to images and can process up to 25,000 words.

· Brazil and China sign an agreement to trade in their own currencies, ceasing the usage of the United States dollar as an intermediary.

· San Francisco-based First Republic Bank fails and is auctioned off by the US FDIC to JPMorgan Chase for $10.7 billion. The collapse surpasses March's collapse of Silicon Valley Bank to become the second largest in US history.

· Russia and Belarus sign an agreement in Minsk allowing the stationing of Russian tactical nuclear weapons on Belarusian territory.

· Indian oil refiners started payments for Russian oil imports in Chinese yuan as an alternative to the US dollar due to increasing sanctions against Russia.

· The world's oceans reach a new record high temperature of 20.96 °C (69.73 °F), exceeding the previous record in 2016. July is also the hottest month on record for globally averaged surface air temperatures by a considerable margin (0.3 °C (32.5 °F).

· The global average temperature temporarily exceeds 2°C above the pre-industrial average for the first time in recorded history.

· At the COP28 climate summit in Dubai, a consensus is reached for countries to "transition away" from fossil fuels, the first such agreement in the conference's 30-year history

· India's Chandrayaan-3 becomes the first spacecraft to land near the south pole of the Moon.

· The European Central Bank (ECB) raises eurozone interest rates to an all-time high of 4%, amid ongoing inflationary pressures across the continent.

· Hamas launches an incursion into southern Israel from the Gaza Strip, prompting a military response from the Israel Defense Forces. Israel launched numerous air strikes on Lebanon after rockets are fired by Hezbollah and further attempts are made to penetrate Israel.

· A series of earthquakes occur in Herat Province in Afghanistan, killing over 1,000 people and injuring nearly 2,000, with tremors felt in Iran and Turkmenistan. The earthquakes are the deadliest in the country since 1998.

· The first AI Safety Summit takes place in the United Kingdom, with 28 countries signing a "world first agreement" on how to manage the riskiest forms of artificial intelligence.