The United States economy, the world’s growth engine and by extension the leading indicator for global growth, remains on course for a soft landing. Because of its size and interconnectedness, developments in the US economy are bound to have important effects around the world. The US has the world’s single largest economy, accounting for almost a quarter of global GDP, one-fifth of global FDI, and more than a third of stock market capitalisation. It is the most important export destination for one-fifth of countries around the world. The US dollar is the most widely used currency in global trade and financial transactions, and changes in US monetary policy and investor sentiment play a major role in driving global financing conditions.

There has been lots of change over the past few months. A warm, windy, and wet start to winter has averted the energy crisis in Europe, while in the US the consumer has brushed off bad news and continued spending its ‘Covid piggybank’. Governments have helped avert the energy crisis in Europe and ended lockdowns in China. While falling energy costs will cut headline inflation back from record levels, underlying inflation is still 4.90% in the EU and 3.70% in the US, whilst the 2% rate for central banks is still the target. The head of the IMF Kristalina Georgieva, in October, has said the “remarkable resilience” of the global economy this year has cut the chances of a painful recession in the coming quarters, even as she warned of weak growth over the next five years.

Global  fiscal policy and particularly the US has been the primary growth driver and has been incredibly supportive in recent years to households and businesses in response to the pandemic. Its effects continue to reverberate both domestically and internationally. Whilst Global price inflation has declined, we know that monetary policy operates with long and variable lags. So, it won’t be until next year until we find out whether Central Banks raised interest rates enough. Indeed, in recent days, the US Federal Reserve has commented on the uncertainty of future Interest Rate increases and the potential for more.

Ultimately, many Managers believe the Federal Reserve will keep rates higher for longer until there is verifiable evidence that inflation is back under control (or unless something breaks in the meantime), and U.S. consumer spending trends have moderated. A successful outcome will depend on energy price volatility and on the outcome of the unfolding crisis in the Middle East. So far, energy markets have looked through the geopolitical chaos.

However, it would be folly to underestimate the risk of recession over the next twelve to eighteen months, as certain challenges continue to percolate below the surface.

Outside the United States, growth trends are a little less encouraging. In the Eurozone, many of the economic indicators  suggest the region is flirting with recession, particularly in the manufacturing sector. Inflation rates also remain elevated. While the view exists that the ECB has finished raising interest rates, similar to the U.S., a reversal of course is not on the horizon. Turning to China, policymakers had been following a conservative fiscal policy, despite growth momentum slowing sharply in recent months. This policy changed in October and the Chinese government has become more willing to use its balance sheet to support its slowing economy. China’s National People’s Congress recently approved the issuance of an additional RMB 1 trillion of treasury bonds in 2023. This will increase China’s budget deficit for the year from 3% to closer to 4% of GDP. The proceeds will support growth by increasing infrastructure investment across the country. While this will be welcomed by local governments, it will not move the growth needle in a meaningful way. China continues to deal with the ramifications of a property bubble that is deflating, which will take years to run its course.

How will markets adjust to slowing GDP growth and falling inflation?

The combination of positive but declining economic growth and inflation in 2024, quarter-on-quarter will be a challenging environment for equities to navigate. The heavy lifting will have to be done by corporate earnings next year for a broad return from equities. Multiple expansion will be difficult with interest rates remaining higher for longer. Jerome Powell may land the plane in 2024, but not without some turbulence along the way.

For the remaining months of 2023, we have witnessed, and many expect a continuation of a ‘Santa Claus’ rally to look forward to as active fund managers and individual investors, underweight the stock market for much of the year, chase equities higher into year end. Performance anxiety will likely become a dominant theme. Take a look at the AAII Investor Sentiment survey for example. The latest reading shows bears outnumbering bulls by a factor of two to one. Only 24.3% of those surveyed had a bullish outlook for equities over the next six months, while 50.3% held a bearish view. The difference is reported in the chart below. Investor sentiment is usually quite a useful contrarian tool when analysing market trends.

November 2023 Insights | Insight Private Clients

Despite a negative performance in October where stock markets fell over -2% on average, year-to-date, global equities remains on a solid footing. November is also off to a strong start. Meanwhile, Eurozone government bonds continue to struggle as yield curves steepen across development markets. Cash is becoming an attractive alternative for conservative investors with ECB deposit rates now at 4%pa. Let’s turn our attention next to equities to discuss what may lie ahead next year for this important asset class.