On the 14th of November the latest CPI figures were released in the USA, resulting in equity prices shooting through the roof. Bond yields also dropped, resulting in capital gains for their holders.
In the 12 months through October, the CPI climbed 3.2% after rising 3.7% in September. Economists polled by Reuters had forecast the CPI would increase 3.3% on a year-on-year basis. So why was the reaction so positive for a mere 0.1% positive surprise?
The answer lies in what we have been saying all along: lower inflation will result in lower interest rates, which will boost asset prices.
Back there at the beginning of 2023, we were rather positive about the potential for markets to bounce back from a very bad 2022. We have seen a steady outperformance by the large technology companies listed on the Nasdaq (up 35% ytd), relative to the smaller companies, represented by the Russell 2000 index (up only 3% ytd) in the USA. What we might see in 2024 is a further improvement by the broader market as interest rates come down and a recession is avoided. Lower interest rates will also benefit the larger tech companies, but after a 35% up year, further increases might be a bit more muted.
The risk-adjusted star performer, however, might be US bonds. Remember that the holder of a bond gets capital appreciation when interest rates go down. The US Central Bank has raised interest rates to the highest level in 22 years. If they start to unwind these increases, the value will fall through to bonds. US bonds remain the risk-free asset class in the world and geopolitical problems will only enhance its attractiveness.
Another benefit of lower interest rates in the US will be a weaker dollar. This will benefit multinational companies with their exports, as well as emerging markets, especially commodity-driven ones like SA. We have already seen the dramatic increase in our commodity companies after the weaker than expected CPI figures came out. Anglo American went up 5.5% on the day, Anglo Plats up 8.2%, Kumba 5.6% and Glencore 4.4%. The JSE Resources index was up 4.3% on that day.
So, looking at 2024, we might see a weaker dollar; stronger rand; strong rebound in commodity shares on the JSE; stronger equities worldwide but favouring emerging markets; and the return of the 60:40 portfolio where the positive bond prices will contribute to those balanced fund returns. The loser, however, will be cash.
You might wonder what would spoil this party?
Well, we have the old geopolitical uncertainties, with two ongoing wars and the ever-present threat of a Chinese invasion of Taiwan. We also have two elections coming up; one in the USA where Donald Trump might win again, as well as our own election where the ANC might lose their outright majority. The impact of these events are uncertain. They might be positive or negative for investors. As with everything in life there is always a positive for every negative and vice versa. If the rand strengthens against the dollar, your dollar investments converted back to rand will be lower, but your dollar growth might be bigger than your currency fall. If the interest rates come down, your cash investments will give you less interest but your bonds will pick up the slack.
All in all, we can say that 2023 delivered what we hoped for and we expect 2024 to continue the upward trend. We can, however, not plan for those unforeseen negatives, so always build a margin of safety into your portfolio.