Historically high US job openings and reluctance of US businesses to let workers go after having been in short supply in recent years, might mean worker layoffs are not as common this economic cycle versus past cycles.
US household purchasing power is growing as wage growth outpaces inflation, thereby supporting household spending. Household finances are in reasonable shape with relatively low debt burdens relative to incomes.
Because of expected US consumer resilience, investors see moderately higher company revenues over the next 12 months. Outside the US, labour markets are also in reasonably good shape, which should help support moderate consumer spending and company revenues.
Alongside higher revenues, we expect company earnings growth will be supported by moderating wage growth, easing commodity prices and declining interest rates. Lower interest rates should also support higher company valuation multiples as future earnings are discounted at lower interest rates.
2. Will inflation slow sufficiently to allow central banks to cut interest rates to the extent currently expected by financial markets?
Consumer price inflation has eased in the major economies, although it remains significantly above pre-pandemic rates.
In the US, the main influence preventing faster disinflation has been residential rent inflation. There are clear signs US rent inflation is on the way down, which will dampen inflation ahead.
In Europe, inflation has decelerated markedly in the past few months, suggesting mounting disinflation forces caused by struggling European manufacturing.
There is concern in many developed countries that easy disinflation gains are near an end and progress towards central bank inflation targets will be harder to achieve from here. The fear is services inflation could be held up by high wage growth caused by tight labour markets.
On this score, there are encouraging signs. US job openings and the rate at which workers are quitting their jobs (an indication of worker confidence in their ability to obtain a new job) have been trending down, with the quits rate now below its pre-pandemic level. The US labour force has continued to grow steadily.
Importantly, wage growth has eased from previously high rates. In the US, high productivity growth is negating the inflationary impact of robust wage growth.
US Federal Reserve chairman Jerome Powell, has indicated the Fed could cut its policy interest rate if the downward trend in inflation continues, even if inflation is not yet at its 2 per cent target. Based on our expectation that disinflation progress will continue over this year, we expect the Fed will be in a position to begin cutting its main policy interest rate by the middle of this year.
The European Central Bank also sees policy interest rate cuts as likely this year. While the Reserve Bank of New Zealand is not yet prepared to concede the possibility of Official Cash Rate cuts this year, it has hinted interest rate hikes are a low probability from here.
3. Are current elevated equity valuations likely to be a drag on investment returns?
With the rally in equity markets over 2023 and so far this year, aggregate valuation multiples have risen to elevated levels relative to the past 10 years. This particularly applies to US equities, which appear significantly overvalued compared to their history. This largely reflects the high concentration of high-earnings growth technology companies in that market.
Outside the US equity market, valuation multiples are around or slightly lower than their longer-term medians. While high equity valuations can be a signal of lower average equity returns over longer horizons, they have by themselves generally proven to be poor predictors of equity performance over shorter periods of a year or less. This is particularly true when recent return momentum and investor mood are positive, as they are currently.
4. What geopolitical developments could disrupt financial markets?
While several geopolitical issues flared in 2023, geopolitics didn’t cause widespread disruption to the global economy and financial markets. This year we are keeping an eye out for any geopolitical developments that could disrupt financial markets in 2024.
One example of a political event impacting markets is the upcoming US election. It looks likely the US presidential election race in November will be between Donald Trump and Joe Biden.
A potentially rancorous contest could cause angst in financial markets due to proposed policy shifts on global trade, support for Ukraine, reduction in the US Federal Reserve’s political independence, US tax changes or other matters.
5. How should investment portfolios be positioned in 2024 given the balance of risks?
We expect cooling economic momentum and inflation to lead to further interest rate declines over the next 12 months. This will be supportive for New Zealand debt securities investment returns as securities are revalued.
The key questions for the direction of global equities are whether recession emerges in 2024, which would hit company earnings, and whether central banks start to ease monetary policy from mid-2024, thus potentially supporting equity valuation multiples. On these questions, we consider the risks are tilted to further upside for global equities.
Nevertheless, the current cycle appears to be especially different from past cycles, which makes predicting future outcomes even more difficult. As always, portfolio diversification is the best defence against uncertainty, with a broad mix of securities across multiple industries and countries within asset classes that best meet investors’ individual circumstances.
- John Carran is a director, Wealth Research.
Jarden Securities Limited is an NZX firm. A financial advice disclosure statement is available free of charge at https://www.jarden.co.nz/our-services/wealth-management/financial-advice-provider-disclosure-statement/.
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