Our view for 2024 🦈
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[This is the third and final text in the 2024 market overview series. We presented the bull case and the bear case, and now we present our view 🦈. The emoji is an orca, obviously!]
We will talk about the probability of a soft landing in a historical context, the danger of easing financial conditions, and our own view of what to expect from the Fed and the Treasury coming into 2024.
Before we jump in, let’s once again recapitulate the bull and the bear view for 2024.
The bulls 🐂 say:
The Fed hiking cycle is done (cuts are getting priced in), disinflation is the clear trend.
The economy is strong, resilient, growth is high, recession risk is low. Soft landing is upon us.
Fiscal policy will be accomodative (2024 is an election year in the US), the deficit itself carries a stimulus effect.
The bears 🐻 say:
Growth is expected to slow down, recession is still on the table.
Wage inflation is still too high, the Fed could have made a big mistake announcing cuts too soon.
Mediocre earnings despite strong nominal growth.
Contrarian sentiment; too many people are bullish, greed is high.
Geopolitical risks that could bring inflation back.
Which side do you think will prevail? Leave a comment below, happy to hear your thoughts.
For us, the first step is to revisit our macro playbook.
The general logic was this (comments in italic):
Fed keeps interest rates higher for longer
=> no longer the base case, rate cuts are getting priced in.
Bond yields keep rising, despite inflation easing, fully aligned with the FOMC rates
=> this too has been reversed since November 1st. Bond yields are going down, as a consequence of a lower supply of long-term bonds, but also in expectation of FOMC cuts.
A supply catalyst on the bond market pushes long duration bond yields up to new highs, triggering an equity sell-off - the dominant scenario of Q3
=> this has completely reversed after the QRA on Oct 31st. We went long after that and are still long.
Equity earnings go down - hasn’t happened yet. This is when the wealth effect and tightening finally start to hurt demand. When this happens, we will get that big second leg sell-off. The yield curve disinverts.
=> still hasn’t happened. The prevailing bias on markets right now is that it won’t happen, as demand will not contract, and will thus not hit earnings.
Then, and only then, do we get a recession. Fed cuts rates, as unemployment keeps rising. Probably not before Q1/Q2 next year. These are the probabilities we continue to update.
=> yes, the Fed will cut, but not due to poor earnings and weakening demand. Without a demand slowdown we never get to a scenario of rising unemployment.
The main question we need to answer is how realistic is all this? How realistic do we think that the soft landing scenario occurs and we completely avoid the negative impact of a standard Fed hiking cycle. This one:
If it does indeed happen, I’m gonna have to unlearn what I have known so far about macroeconomics :)
But the probability is there, certainly. Let’s entertain it.