Crispin Murray: Five key questions for 2024 (and how we’re going so far)

Here are the main factors driving the ASX this week, according to Pendal’s head of equities CRISPIN MURRAY. Reported by investment specialist Chris Adams

• Find out about Pendal Focus Australian Share fund
• Pendal’s Crispin Murray reviews the lessons from 2023 and outlook for 2024

MARKETS kicked off the year with a small sell-off, catching their breath from the November-December rally, before staging positive returns last week.

The S&P/ASX 300 rose 0.14% and the S&P 500 1.79%.

To recap 2023:

• The ASX rose 12%, with tech (+28%) and consumer discretionary (+21%) the lead sectors. Consumer staples (+1%), utilities (+3%), healthcare (+4%) and energy (+5%) all lagged
• Globally, the US rose 26%, Europe lifted 26% and Japan gained 29%
• US 10-yr Treasury yields ended up flat for the year at 3.88%, having peaked at 5.02% in October
• The AUD was flat and the DXY (a trade-weighted measure of the USD) fell 2%
• Iron ore rose 22%, gold increased 13% and copper lifted 2%, while oil fell 10% and lithium dropped around 80%

Markets start 2024 with a positive view that disinflation is proceeding faster than previously expected, growth will hold up, and the Fed has reinstated the “Fed put”.

Investors are positioned for this with a systematic strategies limit long in equities.

However, there is still a lot of cash on the sidelines, which may be squeezed into equities.

The breadth of the market is improving, which is usually a positive signal.

The liquidity environment is constructive in the near term, with reverse repurchase agreements (or repos) continuing to be drawn down and a limit on Treasury issuance. Both these factors are likely to reverse after Q1, however.

On the data front last week, we saw slightly negative US Consumer Price Index (CPI) data brushed off by the market.

The Producer Price Index (or PPI) was more positive, while jobless claims data indicated that the economy is holding up fine.

In Australia, inflation data was marginally positive.

We also saw conflicting signals from Fed speakers on the potential for quantitative tightening to be re-evaluated, but there is a growing suspicion this will occur to offset a tightening of liquidity in H2.

Middle East tensions escalated, with the US and UK both launching attacks on the Houthis in Yemen.

This had no sustained effect on oil prices, but freight rates have risen on the need to redirect shipping, which represents a risk to the disinflationary growth narrative.

The market continues to price for six-and-a-half interest rate cuts in the US, starting in March.

Current implied expectations are that the ECB and Bank of England will both start cutting in April and May, respectively.

The market is only pricing two cuts for Australia in 2024, the first occurring between June and August.

Five key questions for 2024

In our last note of 2023 we highlighted some key questions for markets in 2024. We can now assess these in light of recent data and developments:

1. Will disinflation continue to surprise to the upside?

Recent data has been mixed but is supportive of the market’s belief that disinflation will facilitate rate cuts.

US December CPI came in a bit stronger than expected, with the headline index up 0.3% month-on-month – driven, in part, by electricity prices.

However, there was sufficient ambiguity for markets to largely brush off the reading.

Looking forward, the continued drop in fuel prices and rents should help the headline CPI continue to fall.

Core CPI rose 0.31% month-on-month.

The Goods component was flat month-on-month following six months of decline.

The question is whether this signals an end to goods deflation, which has played an important role in positive inflation surprises.

New and used car prices rose, which may not be sustainable.

The recent weakening of the USD and the issues in the Red Sea may also be factors which could lead to an end of goods price deflation, so this remains an issue to watch.

Core Services ex-rents rose 0.4% month-on-month.

This, too, was higher than expected – driven by recreation services, airfares and medical services.

Airfare increases has been seen by a number of inflation bulls as unsustainable, partly due to fuel costs coming down.

These categories are also measured differently in the core Personal Consumption Expenditure (PCE) measure that the Fed prefers.

As a result, the market has not changed its expectations for the December PCE reading, which is that the three-month annualised Core reading could drop to 2.0%.

US PPI came in below expectations at -0.1% month-on-month and 1.0% year-on-year, making this three negative readings in a row.

Some inflation bulls have also cited the potential for more competition to drive corporate profits margins lower.

These rose substantially though the pandemic, and while they are no longer rising, they have not yet normalised.

While this is good for the rate outlook, it would be negative for corporate profitability.

One countersignal is wages data, which is proving to be more stubborn; the Atlanta Fed twelve-month wage tracker held at 5.2% in early January.

The market has priced a 65% probability of a March rate cut in the US, with 165bps of easing expected for the year.

European inflation was in line with the ECB forecast, but higher than consensus expectations (headline 2.9% and core 3.4%).

This may delay the first rate cut in Europe until May or June.

We note that Europe has experienced another warmer winter so far and gas prices have come in well below the assumptions made by the ECB. 

2. Will the US economy continue to grow?

This question, alongside the first, is likely to drive the outlook for rates and corporate earnings.

US jobless claims have remained very benign, with initial applications near historic low levels and continuing to hold flat.

This reiterates constructive employment data from the week before and helps underpin the economy.

Anecdotes from retailers indicate there was a late surge in Christmas spending, which held up well overall as a result.

Early January sales are on the soft side, although this may be weather-related. 

The consensus expectation is 0.7% GDP growth in 2024, but the upside risk comes from higher consumer demand – benefiting from real disposable income growth combined with the support from an easing of financial conditions.

If the Fed is comfortable with inflation, then it does not need to force the economy into sub-trend growth levels.

Some estimates suggest the potential impact of easier financial conditions could go from a GDP headwind to potentially adding 0.5% to growth.

3. The impact of geopolitics and elections

Threats to shipping via the Red Sea have seen a dramatic decline in traffic, with companies opting for the longer path around Africa.

This effectively reduces supply and impacts freight rates and has raised some concerns about the flow-on effect to the price of goods and the risk of slowing the rate of disinflation.

That said, the trade between Europe and Asia is most heavily affected, with a more limited impact on US routes.

There has also been a material increase in shipping capacity post-pandemic, so the impact will be far more muted than what we saw during Covid.

In Taiwan, the Democratic Progressive Party candidate Lai Ching-te won the party’s third consecutive Presidential term, as expected.

However, the party won 51 of 113 parliamentary seats and lost its majority for the first time since 2012 (again, expected, and unlikely to move the status quo in terms of the level of tensions).

4. China’s ability to sustain moderate growth

Real-time indicators suggest the Chinese economy has started the year softer.

Consumers continue to lack confidence, with the gap between retail sales growth and the pre-Covid trend continuing to widen.

This is tied to weak property market.

Inflation data also remains weak, which leaves scope for continued policy stimulus driven by a supportive fiscal situation.

5. Australia’s ability to engineer its own soft landing

Australian monthly CPI for November was lower than market expectations, up 0.33% month-on-month and 4.3% year-on-year (down from 4.85%).

Core inflation was also lower, up 0.25% month-on-month and 4.77% year-on-year (down from 5.05%).

Housing was the main contributor to inflation for the month, along with rents and new dwellings.

Electricity prices rose to a lesser degree, helped by new Victorian government subsidies.

Services inflation rose 0.7% month-on-month to 4.71%, after a similar fall the previous month.

The three-month trend is now 3.6%. 

Goods rose 0.16% to 3.95%, held down by lower fuel, clothing and recreational equipment, with food higher.

December data should see another step down as the base effects fall out, fuel prices are lower, and Western Australian power subsidies kick in.

Last week, the December Politburo meeting and the Central Economic Work Conference took place, where key economic targets are set (but not announced until March).

Signals were for policy support focused on fiscal policy, though there were no major initiatives which was seen as slightly disappointing.

Australia

Employment data was much stronger than expected (up 61,500) despite a marginal rise in unemployment (to 3.9%) given the continued rise in labour supply.

Total hours worked were flat, which implies average hours worked was lower.

This indicates that businesses are looking to save costs by lowering hours rather than layoffs – possibly due to the difficulty of rehiring in the past.

Forward indicators on unemployment still indicate it should be set to rise further, though these signals have so far not been validated.

Markets

The Fed cutting rates is not necessarily a green light for equity markets, as in the end, the economy gets the final say.

If a recession were to occur, the de-rating of earnings would overwhelm the benefits that the lower rates would bring.

This is why GDP growth next year is key.

We are also seeing some interesting shifts in market internals on the back of this. Notably, mega-caps have done their dash and market breadth is rising.

This can be tracked in the relative performance of the Russell 2000 vs the S&P 500.

For small-caps, this is a particularly positive signal for them to outperform.

Another interesting disconnect is that the market has a very different perspective on the economy than some of the traditional leading indicators of growth, shown by the rotation away from defensives to cyclicals. 

This makes early 2024 interesting, as the cyclicals would be sensitive to any weak growth.

In Australia, the ASX saw a broad-based rally with only utilities underperforming.

Rate-sensitive sectors such as REITs and tech led the market.

Energy was supported by the bounce in oil and the continued fallout of the potential STO-WDS merger.

Lithium stocks also had a strong bounce back given how oversold they have become.

Lastly, this environment looks to be positive for the AUD, which continues to look good technically.

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About Crispin Murray and Pendal Focus Australian Share Fund

Crispin Murray is Pendal’s Head of Equities. He has more than 27 years of investment experience and leads one of the largest equities teams in Australia. Crispin’s Pendal Focus Australian Share Fund has beaten the benchmark in 12 years of its 16-year history (after fees), across a range of market conditions.

Pendal is a global investment management business focused on delivering superior investment returns for our clients through active management. 

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