Positioning for the next cycle

Initial US dollar weakness reversed as the resilience of the US economy became clear. Continued strong consumer demand and looser fiscal policy more than offset manufacturing sector weakness. As a consequence, corporate earnings held up and equities rebounded, led by the so-called magnificent seven¹. At one point, commentators were making the case for a new bull market. At the time of writing, bond markets are on track to record a third year of negative returns, adding up to one of the most severe bear markets on record.

Geopolitics remained fraught. The Ukraine conflict showed no signs of ending. China continued to flex its muscles over Taiwan and in the South China Sea, and America tightened restrictions on trade in key technologies. In a tragic turn of events, hopes for a more stable Middle East were dashed.

The big macro question

The key macro debate revolves around the degree to which the dramatic reset in borrowing costs will impact the US, Europe and associated economies. The consensus appears to be for benign growth and inflation outcomes, rapid earnings growth and mild-to-no credit issues, leading to a modest US interest-rate cutting cycle. We agree inflation will continue to slow in the near term. But we think the price to be paid for the shift into a new interest-rate regime is higher, particularly in terms of growth, and that the macroeconomic risks are to the downside.

In the coming year, inflation could fall quite quickly, close to central-bank targets. In some cases, as in Europe, it may even undershoot. Consequently, interest rates are probably at or near their cyclical peaks. However, barring an event of some kind, official rates are likely to remain elevated until economic stress becomes more evident.

Monetary tightening typically works with a lag of 12-18 months, which means the impact of the July 2023 rate hike will still be playing out in July 2024. The economic strength seen thus far has been the result of excess savings built up during the pandemic and the subsequent resilient income growth and fiscal expansion that have elongated this process. Policy tightening will continue to push against this. Europe has probably already overtightened. We therefore think the probability of a soft landing is overstated.

China to stabilise

The other major macro issue concerns China. Deliberate policy tightening to address the imbalances of China’s growth model of the past three decades, and its residential property sector in particular, have had a material impact on the economy.

China remains in a multi-year transition to a more domestically driven, higher value-add economy. The leadership is highly incentivised to ensure this transition proceeds apace, which requires adequate nominal growth. Recent supportive measures to achieve this include fiscal and monetary loosening, as well as steps to improve business confidence. On balance, we think domestic consumption growth will stabilise, in turn supporting global growth. The result could tail previous recoveries. In a way, that is the point – a transition to a new, more stable, lower equilibrium level of growth.

A stronger China would support developing economies. They are already benefitting from having tightened policy to counter inflation before their developed-world counterparts. Their central banks have emerged with more credibility from the last few years, and in many cases their macroeconomic fundamentals are in the best shape in years. Brazil is a good example. Its trade account is extremely healthy and inflation is falling, providing ample scope for real interest rates to decline from the current high levels.

Still buying

Chinese commodity import volumes for oil, iron ore and copper ore, rebased to 100

Source: Ninety One, Bloomberg, as at 31 October 2023.

Pivoting to the Global South

Chinese exports to the Global South vs. to the US, Europe and Japan

Source: Ninety One, Bloomberg. Please note that this chart has been redrawn by Ninety One.

1. Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla.