The chart reveals performance for both the full year and up to 27th October. The contrast is quite stark and just demonstrates and just shows what a difference a quarter makes. The drivers behind this are clear enough: (1) endless talk of rate cuts; (2) falling headline inflation (aided strongly by energy price declines and, to a lesser extent, by food price declines) and (3) a perceived decline in geopolitical risk (aided by hostage negotiations/release and the idea that Israel’s ground offensive might proceed faster than expected).
So, what can we expect in 2024? The first thing to note is how quickly the rally has fizzled out! Scepticism and pessimism have developed very quickly around the idea rate cuts will be extensive. There has been some considerable back-tracking by certain Central Banks (CBs). I am not just referring to the US. There have been cautious comments from Australia and NZ where caution and concern has been expressed at how sticky core inflation remains! Last year, there were projections of 3 (as hinted by the Fed itself) to 6 (other market players) rate cuts. The debate now has shifted to whether there will be as many as first thought.
2024 will be characterised by the following factors:
1. What will be the next evolution in the Israeli-Gaza conflict and its impact on wider geopolitical tensions?
2. What will happen to inflation?
3. How will the election calendar playout with a lineup of over 60 national elections up for grabs.
Israel-Gaza: some 3 months after fighting began, civilians have borne the brunt of deaths (over 22,000 Palestinians and 1,200 Israelis). There are 130 Israeli hostages still held captive. Hamas continues, via its tunnel network, to fire rockets (albeit fewer at 27 since the start of the year vs 3,000 in just the first few hours of the conflict on 7th Oct). A deputy Hamas leader (Saleh al-Arouri) was killed in Beirut on 2nd January though Israel has not formally claimed responsibility. Its two, key targets – political leader, Yahya Sinwar and military leader, Mohammed Deif – still remain elusive and at large! Newsflow has been controlled by the IDF. However, Israeli deaths and wounded have been high – a leading, daily publication (Yedioth Ahronoth) published information obtained from the Defence Ministry’s rehabilitation department stating over 2,000 IDF soldiers had been registered as disabled. The Times of Israel has reported the number of injured IDF soldiers, Israel Police and other security forces as 6,125! Israel’s stance and tone remains bizarre and unaccommodating (just recently two Cabinet Ministers called for a solution to encourage Palestinians to emigrate from Gaza while Israeli settlers return to the strip). Israel claims to have killed/captured up to 10,000 (considered to be an exaggeration) Hamas fighters out of a total of up to 45,000 – but Hamas is still standing & fighting. Support for Hamas has risen from 12% to 44% in the West Bank and from 38% to 42% in Gaza. The US is becoming increasingly frustrated at Israel as the latter refuses to heed US warnings. Meanwhile, the Houthi rebels are giving warships and global cargo shipping absolute hell – so much so that we saw US/UK strikes on Houthi positions in Yemen. This is the first, clear sign the war has spread to the wider Middle East. The Houthis have pledged retaliation – and most likely they will. Meanwhile, what will Hezbollah do next? As a military force they are far stronger than Hamas. Last – and most critically – what about Iran? Hamas, Houthis and Hezbollah all take their orders from Iran who backs them financially. Even the US wants to avoid a conflict with Iran. It is unclear whether Iran wants to get involved - especially following the bombings at the tomb of the former Quds Force commander, Qassem Soleimani resulting in the deaths of some 100 Iranians.
The stakes have clearly risen and the conflict is no longer isolated – it has spread. At the very least, it’s hard to see Hezbollah standing by and doing nothing if Hamas starts crumbling (and it has a way to go before that happens). If Hezbollah intervenes, how does Israel cope on both fronts (North and South)? The US warned non-Hamas forces (it was a warning to Hezbollah and Iran) to stay out of the conflict or else its warships would launch attacks. If it does, it leaves the door open for Iran to get involved. Risk premium will soar, markets will take a dive and sentiment will be hit hard. This is the sort of thing recessions are made of. Until now, recession talk was overblown.
Inflation: early days but we have seen a pickup as per the latest US inflation print. Worryingly, headline inflation rose at a higher rate than energy and food inflation. Even more worrying is core inflation which saw services rise strongly (+0.50% m/m) driven by shelter and healthcare costs. Insurance costs are rising too and the events in the Middle East and the impact of Houthi attacks on cargo ships is resulting in rising insurance costs. Ships are starting to take longer routes to evade the conflict zone – which is more costly. The path of inflation from here really depends on the outcome in the Middle East. If the supply side is severely hit, oil prices will escalate and oil dynamics will change. Rising oil prices is a boon for OPEC+ members. Prior to this, people wondered (and still do) whether the combined leverage of OPEC was losing its “Mojo”. OPEC+ has slashed oil output at least four times last year with little impact on prices. Oil and Brent prices are today less than at the time of the disruptions in the Red Sea when oil prices shot up. US shale output is surging again. Basically, at the margin, US producers are powerful enough to make quite a difference helped by technological advances in drilling and falling costs. The combined OPEC+ cuts have resulted in some 6mn barrels per day of idle production capacity. Saudi Arabia – who is already pumping the least amount of crude in more than a decade – needs a fiscal break-even oil price of $88 per barrel (GS estimate) to fund its development plans. Higher oil prices are a function of rising global demand (which is lacking right now) or geopolitical risk. The latter looks more likely than the former at the moment. Oil only has to settle in the $85 to $90 per barrel range and that relaunches inflation. Currently, it is around $73 per barrel. It’s not a million miles away!
Election calendar: 2024 is full of elections, some minor (like Palau in Oceania) and some major (the US in November!). Those in the global limelight are Russia (pretty much a given who will win there), UK, US. We kicked off this month with the elections in Taiwan. India is another big election in Asia – though Modi is expected to win. South Africa’s election is key – it sets the scene for democracy in the rainbow nation and will quickly affect risk pricing in the country. Elections in countries like Austria, Belgium and Portugal will be closely watched seeing as the far-right has made substantial gains there. Russia has defied its critics that it would fold given all the sanctions placed upon it. State spending is at a record and much of it is driven by defence spending on Ukraine. Putin has to keep spending on his people to maintain their living standards while maintaining macroeconomic stability. There’s really only one asset he has to enable him to get remotely close to doing this without incurring the full wrath of inflation – higher energy prices (Russia’s main export)! It’s very much in his interests too to help “fuel” the conflict in the Middle East. Last, but not least, the US. If Trump is cleared to run, it totally changes the picture in the Middle East.
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