Interest rates
The last meeting of the year of the US Federal Reserve (Fed) and the European Central Bank (ECB) revealed notable differences in their decisions. Even though both central banks left their policy rates unchanged, they expressed very different appetites in terms of rate cuts for 2024.
The biggest surprise was the Fed’s pivot. The Fed acknowledged that inflation is easing faster than expected and an early discussion about rate cuts has begun. In contrast, the ECB decisively rejected speculation about interest rate cuts. This is surprising, as the economic backdrop of stagnating growth and a surprisingly sharp drop in inflation suggests that monetary policy in the eurozone is too restrictive, while the US economy has so far been better positioned to deal with the high level of the key interest rates.
As a result, money market pricing suggests the ECB might start cutting rates only in May 2024, although April is also seen as a likely outcome. In the US, the first rate cut is now expected in May 2024 (from July 2024 before).
Equities
The set-up of accelerating earnings per share (EPS) growth and decelerating gross domestic product (GDP) growth presents an interesting scenario for equities that does not occur very often. This provided a great backdrop for equity returns, with the S&P 500 index rising 14% on average.
Although these growth rates usually enjoy a positive correlation, the opposite set-up also coincides with our 2024 outlook. Indeed, we forecast a slowdown in the US economy and a stronger expansion of profits for the first half of next year. Companies need to adapt to the weaker demand environment and cost-cutting plans have already been extensively undertaken.
Earnings usually recover stronger than they fall, with consensus now expecting double-digit earnings growth for 2024 (we expect high-single digits). Furthermore, the shift from goods to services post-Covid-19 has now normalised, and the economy is going back to an equilibrium, which is a tailwind for EPS growth vs GDP given that 50% of S&P 500 earnings are goods-related, although these weigh less than 20% in the economy.
China
Most economic activity indicators have picked up in November compared to the previous year when China was under tight Covid-19 restrictions. However, the underlying growth momentum points to a continued divergence between an improving supply side (industrial production, manufacturing investment) and a weak demand side (retail sales and home sales). Property remains a weak spot, with home sales and property prices declining further in November. Subdued loan flows to businesses and households and the broad-based decline in inflation underscore the ongoing weakness on the demand side.
We expect the sequential growth momentum to stabilise at subdued levels over the course of 2024 and annual growth to slow to 4.4% in 2024 from 5.2% in 2023. As the reopening effects fade, the property sector remains a drag, and government policies focus on containing downside risks rather than providing a major growth boost.
Cloud Computing and AI
2023 will no doubt be remembered as the year when artificial intelligence (AI) caught public attention and became the most important topic within capital markets as well as the economy. In 2023, Cloud Computing and AI was one of our best-performing investment themes. We remain confident that demand will continue to grow and outstrip supply for the next quarters, as we are still at the inception of a multi-year race that will turn generative AI into a ubiquitous technology.
What does this mean for investors?
Apart from these short-term musings, the overarching theme remains to look out for companies that provide solid growth while not trading at mind-boggling levels, i.e. ‘growth at a reasonable price’ in our jargon (the Warren Buffett/Charlie Munger approach to investing).
As a result, we recommend sticking with quality growth and defensive stocks going into 2024. At some point in the first half of 2024, we expect to see an opportunity to rotate into more cyclical parts of the markets, as investors should start anticipating the new cycle once the economy reaches its trough around the middle of the year.