2023 started with low expectations for global growth and elevated fears of recession but resilience in the broader economy, in the face of significant rate rises, counteracted this pessimism. Various themes also sparked optimism such as artificial intelligence, weight-loss drugs, and latterly expectations of US Federal Reserve interest rate cuts and an economic ‘soft landing’. This resulted in markets delivering a broadly positive performance in 2023, where markets have gone from pricing in a ‘hard landing’ (a more severe economic slowdown after a period of rapid growth, to a soft landing (i.e., a moderate economic slowdown after a period of growth), and now the so-called “Goldilocks scenario” of falling inflation alongside resilient economic growth is gaining traction. Further developments in the final quarter of the year were equally positive, with consumers still showing surprising resilience. Energy prices continued to fall, with the price of oil passing below US$80 a barrel according to the Brent Crude benchmark, in part thanks to an increase in US supply and OPEC+ members’ failure to adhere to production quotas. Despite the well-documented and increasing geopolitical risk in the year, there were elements of positivity as US-China diplomatic hostilities cooled, softening the harsh rhetoric that has been present over the past year.
UK inflation expectations for 2024
Whilst inflation appears to have taken a first leg down, in order to get it down back under the Bank of England’s 2% inflation target, demand needs to slow. Even at this point, the risk remains that many of the structural drivers of inflation like energy costs and supply chain issues, such as those witnessed in 2023, will be ready to re-emerge thereafter. This is especially true for real-world resources that are labour or energy intensive. With economic growth remaining relatively solid and unemployment close to historic lows, it feels an odd time for central banks to embark on a path of monetary easing. History would suggest that inflation comes in waves and whilst the journey from the crest of this first wave down may feel like normalisation, the danger is for further waves to emerge. We are conscious that markets are sensitive to the current rate cut enthusiasm and increased optimism that inflation is on a declining path, but we would not be surprised to see above target and variable inflation over the next few years. A combination of realigning geopolitics, reshoring of supply chains, higher labour costs and the green energy transition point to higher and more volatile inflation for some time to come, as these events disrupt supply more than they diminish demand.
The impact of China and global geopolitical tensions on the world economy
Sentiment surrounding the global economy and markets has been overly optimistic before and the uncertainty surrounding monetary policy also points more towards the potential fragility of the latest rally. Monetary policy is constrained. With inflation above target, central bankers are unable to smooth shocks to the real economy or financial market ructions. The era of the US Federal Reserve safety net may be over. At the same time, two favourable structural forces in the global economy are ending. Firstly, China's economy appears to be decelerating and its priorities evolving. Going forward, China will target state-led growth, common prosperity and national security. After powering global growth for decades, Chinese economic growth is slowing and, as a result, fewer of its financial reserves will be invested into international markets. China’s contribution to reducing global inflation in recent decades is also likely to diminish, as reshoring and diversifying supply chains reduce reliance on the massive Chinese workforce.
Secondly, the previously benign geopolitical landscape is increasingly dangerous. In recent years, fronts have emerged in the growing conflict between the US-led liberal West and the axis of China/Russia/Iran. Whether in Ukraine, Israel, the Balkans or the Taiwan Strait, this tension will be increasingly impactful in the foreseeable future. A new landscape of greater geopolitical risk will mean higher inflation and bigger budget deficits. With an election this year in the US likely to meaningfully influence this outlook, it would be foolish to ignore this heightened risk within client portfolios.
Market outlook for the year ahead
Companies need to have the ability to grow, by virtue of the growing markets in which they operate or because of their technology, innovation and product development, the power to raise prices to offset inflation, the scale to absorb cost increases and the balance sheet strength to reinvest in their businesses. These criteria take us into companies that are involved in digital transformation, artificial intelligence, renewable energy, quality consumer products and healthcare. Excitement remains about the growing opportunities in these areas. The defence sector should continue to grow as a function of higher government spending. Precious metals form an essential part of a diversified portfolio to preserve capital in real terms. They provide a hedge against geopolitical risk and further monetary devaluation over time.
Overall, there is more optimism heading into 2024 on the state of global economies than when we were entering 2023, but that alone does not remove our caution on the performance of markets and the broader macro outlook over the next 12 months, due to building monetary headwinds, geopolitical risks and expensive valuations in some areas. Although the earnings season for the final quarter of the year was encouraging, it was the changing macro view and associated rerating of company valuations, rather than an increase in revenue and profits, that drove the market higher.
Please note that the value of investments and the income from them may go down as well as up and you may not receive back all the money you invest. Past performance is not a reliable indicator of future results. The views expressed are those of the author and should not be considered a recommendation or solicitation to buy or sell any securities.
