Rudi's View | Apr 24 2024
In this week's Weekly Insights:
-A Market Narrative Delayed
-Conviction Calls & Best Buys
-Rudi Unplugged - The Video
By Rudi Filapek-Vandyck, Editor
A Market Narrative Delayed
Four months ago, the outlook for equities and bond markets looked as straight as an arrow: inflation was decelerating and the Federal Reserve and other central banks were preparing for rate cuts later in the year.
That's all investors needed, and wanted, to know.
Suddenly, and noticeably, the narrative has changed in April. And share markets the world around have given up most, if not all of their gains year-to-date in three weeks of trading. On Friday, the main indices in Australia dipped into the negative, ex-dividends, for the running calendar year thus far. The Nasdaq, can you believe it, has only 1.80% left from January 1st.
While the downsloping trajectory for inflation was never going to be a straight line, equity markets only paid attention when the US bond market forced them to. It is easy to blame Mr Bond for the removal of most share market gains from the prior three months, though the risk of an all-out war in the Middle East has made market participants more risk-averse too.
Rising bond yields in response to higher-than-predicted inflation readings in the US have equally swung market momentum in equities back in favour of resources and other more cheaply-priced cyclicals, while the same combination is not favourable for smaller-cap companies generally.
The latter is an important observation at a time when all and sundry seem to be focused on finding the next ten bagger among cheaply priced, lagging, small cap stocks both in Australia and in the US.
As also highlighted during a presentation by JP Morgan strategists in Sydney last week, smaller cap companies in general suffer more when the cost of capital remains high. And while economic forecasts are being upgraded for key economies following on from the latest statistics -a positive both for cyclicals and small caps- history suggests what really puts a rocket under share prices for small caps are interest rate cuts and falling bond yields.
According to the latest switch in market narrative, inspired by moves in government bonds, there's no longer any prospect for imminent rate cuts. There may not even be one single cut in 2024.
While we can never be 100% certain about what might be revealed in the next set of economic statistics, history equally shows it is dangerous to extrapolate first quarter data and trends into the rest of the year, and beyond. For what it's worth: I personally still believe the most likely scenario remains for lower inflation ahead, but also for slower growth, and the longer bond yields remain high, and central bankers on hold, the more likely this scenario will play out.
It's the timing of things that is much more difficult to predict.
So, with the major indices in Australia down more than -4% so far in April, and indices in the US down by between -4.5%-6.7%, should investors be fearfull of something more sinister brewing for financial markets this year?
The big unknown remains the situation in the Middle East, which understandably has made investors more cautious. Once upon a time, all it took was the assassination of Archduke Franz Ferdinand in Sarajevo to start a global war that predominantly debilitated countries in Europe. Let's hope the current conflict is not our era's trigger point for something similar. At least both Iran and Israel seem to be messaging they're happy to show off their hairy chests, with little desire for substantially more.
As far as the script for the remainder of 2024 goes, more delays in seeing inflation in the US fall have certainly the capacity to unsettle markets, in particular if US bonds would give up on the prospect of Fed rate cuts. Add sluggish economic growth and the worst of all scenarios could play on investors' mind: stagflation.
In the same breath, all it takes is one favourable inflation reading and the general market mood could well switch to positive yet again.
Modeling US equities
Probably fair to say, general uncertainty and volatility in market moves are but par for the course for the time being. And while debates among investors will continue unabated, strategists at RBC Capital have tried to model a variety in outcomes this year, and what they could mean for the S&P500 index.
In case of one lonely Fed rate cut, delivered late in the year at the December meeting, the RBC Capital modeling shows -all else remaining equal- the S&P500 could well finish the year between 5050 and 5200, also depending on what exactly happens to corporate earnings.
The index closed a little below 5000 on Friday.
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