Note May 18 2024: Ephemeral Rate Cuts And Expectation Mismatch Challenges

Note May 18 2024: Ephemeral Rate Cuts And Expectation Mismatch Challenges- The central thesis of pricing in the capital market of today appears to complacently hinge around policies of central banks being either to be positioned or being otherwise forced into providing ease on demand. Yet, the several rate cuts widely expected at the start of 2024 have instead proven ephemeral. Other challenges revolve on internal market valuations including those dependent on fiscal budgeting; operating and financial margin management. Prolonged real or proxy outright war l cauldrons appear close to vital trade routes of various types.

Generally latent during the great quantitative ease, currency turbulence is a likely challenge underway for trade, for government finances and indeed for corporate operating as well as financial statement management. The aspects of impact would include currency translation volatility that was last of investment concern decades ago. Rather than the yesteryear euphoria of momentum and of short term gratification of early rate cut anticipation, greater selectivity is likely at the individual security level. Within markets and the performance mix therein so far in 2024, rather than a value versus growth or geographical selection matrix, quality of operational and financial statement management will likely be paramount. It would include that within equity sectors and that within fixed income credit tranches. At the asset level, we would include precious metals as a core consideration.

We would submit as looming, several foreign exchange issues of forty years ago. They have likely become rusty in current experience and hence will likely be of greater impact than the consensus of today appears to globally recognize. Since the ballooning of credit and quality mismatch of a decade and a half ago and through into most of the great monetary/fiscal ease, currencies have been relatively stable, Only some exceptions were experienced even among emerging market currencies. It has continued despite gaping fiscal pressures and despite massive interest differentials even among advanced economies. Saliently, currency markets appear now to be giving signals of turbulence. Beyond some indications of a tougher Federal Reserve being in policy bifurcation with others, specific reasons for this currency turbulence appear obscure. However, the flaring of risk that can emerge from currency turbulence are clear when going back to the cracks of 1985 into 1987. The impact of currency turbulence can be insidious  in its impact on governmental costs and global trade tensions. Currency turbulence affects corporate operational costs and margins simply because human and physical assets are not as nubile as can be currency level change. It affects financial statement accounting for foreign exchange translation, transitory or not.

Seemingly without  adverse consequence In the last decade and a half has been an unusual confluence of massive monetary quantitative ease and of equally massive fiscal deficits. With such a gush, capital markets have appeared to be momentum dominated, even within historically challenged credit entities such as low quality emerging and junk corporate deb, albeit with some extreme exceptions. It has fostered capital market complacency, especially as related to risk, While markets appear focused on expecting a slowdown in the rate of change in inflation cause an early ease in central bank rate strategies, the Federal Reserve has not been reticent in emphasizing that beyond slowing of inflation, the core need is to achieve inflation down to 2% and stable in toto. One does not have to go much beyond memory to recall the country and company challenges that can and did emerge in myriad past cycles as conditions changed, when compared to the conventional assumptions of the time.

The winds of trade and geopolitical rivalries seem less than suppressed. Both concurrently, elections in democracies and elsewhere, the reasserting of authoritarian principles have emerged. Since the great credit crisis, they have for several years now been ratcheting up markedly. The summit in Beijing of the leaders of China and Russia were salient in comraderies and substance and especially so when compared to the muted visit by the U.S. Secretary of State just before. Tariff and trade tensions for instance in electric vehicles and elsewhere have bloomed between Europe and China, high level visits to Europe notwithstanding. Global GDP growth of 3% annually as opined by many transnational organizations contains half such for Europe and potentially such a year or so out in the United States. Growth in China seems stuck at half of its pre-2008 levels. Japan has recently reported a decline  in quarterly GDP. Ever sensitive to trade winds, south east Asian economic growth appears comparatively anemic to its past. Among the major economies, India appears singular with a good growth rate but seems not yet to be at the stage of being a global trade locomotive. Meanwhile several explosive wars continue in several cauldrons right on the peripheries of vital trade routes. We believe that both the revenue potential and cost structures will be more volatile than capital markets appear to count upon currently in mid-2024.

Within global GDP annual growth of 3% are advanced country growth of 2% or less including Japan recently contracting and China at a sedate 5%. There appears to be currency turbulence overhang. We see as being optimistic, the consensus expectations such as of S&P operating earnings growth of 10% for each of 2024 and 2025. So far in 2024, geographic and sector succor has appeared above all else to have again reverted to those of momentum and of expectations of an early U.S. Federal Reserve interest rate cut. Below the surface momentum however, sector rotation has appeared to be far more mixed than a cursory look would suggest when considering recent sequential consensus euphoria such as over climate change, social media and artificial intelligence. Lower relative valuation has failed to charge up Japan and Europe in major country equities while emerging markets also have lagged alongside small and mid-cap aggregates. Equity valuation such that as for the S&P 500 is elevated enough to engender volatility even with modest changes upwards in risk premiums.

Rather than the yesteryear euphoria of momentum and of short term gratification of early rate cut anticipation, greater selectivity is likely at the individual security level. Within markets and the performance mix therein so far in 2024, rather than a value versus growth or geographical selection matrix, quality of operational and financial statement management will likely be paramount. It would include that within equity sectors and that within fixed income credit tranches. At the asset level, we would include precious metals as a core consideration. E.o.e.