Macro Outlook 2024

Our central expectation in 2023, was that inflationary pressures would abate, and bond yields would move to reflect this. We got the former but had to wait a while for the latter! However, when the consensus moved to join us in the ‘lower inflation, soft landing/no recession’ camp, the resulting asset repricing was swift and extensive.

Markets have been waiting for a shift in the US Fed stance on interest rates from tightening to easing, and it finally arrived. The so-called ‘Powell Pivot’ has been drawn from his utterances that “rate cuts” are something that “begins to come into view” and “clearly is a topic for discussion.” This prompted a repricing of fixed income and equity assets with the US 10-year Treasury yield falling from close to 5% to 3.8% and the S&P 500 Index jumping 16% in the space of two months. For investors, Christmas came early.

After such a robust recovery, it is natural to question the persistence of it and, for markets to take a breather and reassess. This is what we believe they will discover.

1.       Main Street versus Wall Street and the challenge of ‘long and variable lags’

The Fed pumped the brakes on the economy pretty hard, but nothing seemed to happen either to inflation (at first) or to growth. Much of this was likely due to the Biden administration’s significant amount of fiscal stimulus.  This stimulus won’t be repeated and while an election year would normally signal fiscal largess from the incumbent, the Republicans are likely to do everything they can to stymie further expenditure.

This leaves consumers in an increasingly squeezed position. Pandemic excess savings have been run down and higher interest rates and tighter lending standards will constrain consumption. The fall in the rate of inflation is helpful, but prices are still rising in absolute terms at a time when wage growth is slowing. Unlike Wall Street, there is far less of a ‘flick a switch’ outcome for Main Street when the Fed moves to a more dovish posture.

So, why do we remain in the ‘soft landing’ camp? Well, the slowdown remains modest and while US unemployment has ticked up, it is not increasing rapidly. In addition, we see significant cash balances on corporate balance sheets. Capex intentions have fallen to new lows, but with lower borrowing costs on the horizon, companies may be encouraged to consider projects which had previously been mothballed because of higher hurdle rates.

We expect the economy to trundle along in low growth mode with the possibility of a recession in 2024 higher than 2023, but not imminent. A marked upswing in unemployment would see us promptly revisit this view.

2.       Markets won’t be quite as fixated on inflation numbers

In the time of Covid, every market punter became an armchair epidemiologist. Of late, we’ve all become armchair inflation experts. While we talk about ‘inflation’ globally in broad terms, the composition of the inflation basket varies from country to country.

The US inflation statistic predominates in discussions because it drives the Treasury curve which in turn drives the yield curves of other countries. In the US inflation basket, ‘Shelter’ accounts for c. 30% of the basket. In New Zealand, food, alcohol and tobacco account for 26% of our basket.

Focusing on the US, and work done by the San Francisco Fed, they anticipate that shelter inflation will slow significantly in the coming months[1]. This would go a long way towards achieving the CPI target of 2% (last inflation print was 3.1%[2]), particularly as we see other components of inflation declining alongside shelter. In New Zealand, the RBNZ is hamstrung in that a large component of domestic inflation is driven by international factors such as commodity prices, food and shipping costs.

Absent a spike in oil prices (see our next topic), we anticipate inflationary pressures will continue to abate and central banks will have room to cut rates.

3.       Geopolitical risks loom but focus on controlling the controllable

These risks abound. The Israel/Hamas conflict alongside the ongoing Russian invasion in Ukraine are both humanitarian disasters and deeply distressing. Recent Red Sea shipping blockages are threatening supply chains. If the conflict in Palestine spreads more broadly drawing in the Middle East, oil prices would spike and a stagflationary environment could well threaten our more sanguine view.

In addition, 2024 sees 40 countries heading to the ballot box or 41% of the world’s population[3]. Taiwan kicks off the political calendar in January, and of course, we have all the noise and histrionics of the US election to look forward to in November.

It would be foolish to attempt to predict the outcomes from these events – we are not geopolitical experts. They will undoubtedly create a more volatile investing environment, but our naturally more risk aware approach with its emphasis on quality companies and consistent earnings growth should be a solid framework from which we navigate 2024.

4.       Fixed income assets offer asymmetric returns

We know term deposits have drawn a lot of investment interest and understandably so. 6% (gross) yields are undeniably juicy after an extended period in the yield wilderness. However, we would be remiss if we didn’t give a shout out to bonds which are now offering great asymmetry and real yields.

The yield to maturity on the fixed income component of our Diversified portfolios (at the time of writing) was 5.8% and a duration of 4.6 years. What this means is that for a 1% decline across the yield curve, we get a 4.6% uplift in price which comes on top of that attractive yield. Even if rates rise from here, the magnitude of the loss is small because of that compensating yield.

We are optimistic that our Diversified funds will provide strong returns after a trying period for multi-asset investing. Our Diversified Funds are well positioned to capture a decline in yields and has already started to benefit with a strong showing in November and December.

5.       The composition of equity markets is occluding valuations

We wrote recently about the ‘Magnificent Seven’ and their outsized contribution to index returns in 2023.  The degree of index concentration is concerning. Over the last 35 years, the average weight of the top 10 stocks in the S&P 500 index was 20%. During the dot-com bubble, it peaked at 25%, today, it stands at 31[4]%.

For investors who access markets via indices, they are no longer doing so in a well- diversified manner. This concentration also skews headline valuation metrics. Currently, the S&P 500 is above its 15 year forward price-to-earnings ratio but not by much and most of that has been driven by technology stocks.

We believe this provides an opportunity for active stock selection. Within our Diversified Growth Fund, we hold c. 60 international stocks. Some of these are the larger technology names, but we also own non-tech stocks underpinned by strong earnings growth and solid balance sheets. Our weightings to these stocks are determined by the opportunity set, not merely the market capitalisation.

Over the long term, we see this as a source of material outperformance for our investors. In addition, we hedge all non-NZD exposure back to NZD. Currency calls are notoriously challenging to get right, but with the US Dollar looking particularly stretched on a purchasing power parity basis, we see the potential for our domestic clients to capture the full gains in international equity markets without suffering currency related losses should the US Dollar weaken.

While the Australasian market has far more limited technology related investment opportunities. We have though identified opportunities within this sector in the form of Serko and Vista, and have recently introduced Megaport as a new technology allocation to our Australasian Fund.

This position is reflective of our inclusion of growth-oriented names which we believe can generate long term returns for our clients.

6.       Here at home

The domestic macroeconomic picture is bleaker than our global outlook. The recent negative GDP print of -0.3% does not tell the full story of domestic economic pain as it is somewhat buoyed by record levels of immigration.  In addition, the likelihood is that the new government will be looking to cut spending. We expect the RBNZ to cut rates quickly as the economy falters, particularly as inflationary pressures, many of which are externally driven, abate.

As we often remind investors however, the NZ GDP composition and the stock market composition are fairly unrelated with many of the core constituents of the NZX 50 deriving revenues from international sources.

Where we have incorporated a more negative domestic view, is within our NZ SRI Equity Fund and Australasian Equity Fund. We have maintained our underweight position in real estate securities as we remain concerned that a number of these names will be required to reduce their dividend or raise capital in the coming year.

In addition, under the guidance of Rachel Tinkler, Head of Responsible Investment, we have enhanced our engagement activities with respect to our core holdings and look forward to progressing these interactions in 2024. Our Quarterly Sustainability Report documents our efforts more fully. As stewards of your capital, we have an obligation to deploy it in a manner which achieves great returns but also seeks to improve outcomes for all of the stakeholders in the businesses in which we invest.

Thank you for your ongoing trust in the Mint Investment Team. We look forward to another year of doing what we do best – implementing a disciplined, repeatable approach which generates great long term investment outcomes for our clients.

[1] Federal Reserve Bank of San Francisco, Where is Shelter Inflation Headed?, Where Is Shelter Inflation Headed? | San Francisco Fed (frbsf.org)
[2] US Consumer Price Index for All Urban Consumers Nov ’22 to Nov’23; US Bureau of Labor Statistics
[3] Bloomberg Businessweek Economics
[4] Goldman Sachs Asset Management Insights, Equity Index Concentration and Portfolio Implications and iShares Core S&P 500 ETF holdings data as at 19 Dec 2023