Weekly Investment Update (01/05/2024)

QIP 2024 Outlook: Uncertainty Persists Despite a Significant Market Rebound in 2023

Despite a significant rebound in markets and above-average returns in 2023, uncertainty persists as this highly unusual economic cycle continues to unfold. In 2024, above-trend growth is set to slow alongside lower inflation, allowing the Federal Reserve to ease sooner rather than later. We continue to expect that a severe recession will be avoided, and non-recessionary rate cuts can be supportive for both equities and bonds. Still, there are likely to be bumps in the road, especially as consensus has turned more positive in the past year, which may result in volatility in the event of unwelcome surprises.

Challenges remain greater outside of the U.S., with geopolitical tensions and challenges in Europe and emerging markets likely to persist. Geopolitics remain top of mind given two major wars, the ongoing shift to a multipolar world order, and a year ahead poised to see elections impacting roughly half of the world’s population, including the U.S. It is important to note that while geopolitics and policy can loom large in the short run, the stock market has proven resilient over the long term, often moving higher regardless of perceived turmoil. In Europe, headwinds are set to continue as the European economy grapples with the effects of higher interest rates, a softening labor market, changing trade patterns, geopolitical tensions, and elevated energy prices. Meanwhile, emerging markets continue to face headwinds with China, the largest component of the emerging markets index, experiencing a combination of slowing economic growth, rising geopolitical tensions, and slumping property markets.

Amid this unusual and complex backdrop, Bessemer portfolios start the year with a modest overweight to equities but with some cautious elements in our positioning. These include a focus on U.S. equities, reduced cyclical exposure, a longer duration in bond portfolios, and higher credit quality allocation. Looking into 2024, we believe that interest rates have peaked for this cycle and inflation can move closer to the Fed’s 2% target even as the economy continues to expand. Please see January’s Quarterly Investment Perspective for more details on our market views and positioning.

Labor Market Remains Resilient, Signs of Future Softening Persist

What is happening: Though labor demand has softened from the elevated levels seen early last year, the labor market remains healthy with nonfarm payrolls rising 216k in December, beating expectations of 175k. The unemployment rate remained unchanged at 3.7%, mostly due to a drop in the participation rate. Moreover, average hourly earnings growth exceeded expectations as it edged higher to 4.1% from 4.0% on a year-over-year basis. While the headline details of the report are strong, the composition reveals weakness under the surface: Employment gains were driven by only a few sectors, two-month payroll net revisions were -71k, and hours worked declined, mitigating aggregate wage gains.

Why it matters: While the headline payroll number was robust, we think the weakness under the surface is notable. Given our view that economic growth will continue to moderate, we expect to see signs of additional softening in the labor market this year. In fact, with downward revisions to prior months, the 3-month moving average of employment gains continues to trend lower, falling from 180k to 164k. Some further labor market softness could be a catalyst to push equities higher, as evidenced by the positive market reaction to the weakness seen in the employment component of the ISM services report, though it is important for the labor market to strike a delicate balance as significant labor market weakness would be interpreted as a recessionary signal. Additionally, wage growth remains in focus given inflation. The quits rate often leads wage growth, and this measure has declined from the 2022 peak of 3.0% to 2.2%, signaling cooling wage pressures going forward. Overall, additional easing of wage pressure should allow the Fed to pivot to interest rate cuts.

Suspended Shipping Operations Through One of The World’s Most Important Trade Corridors Has Implications for the Global Economy

What is happening: Missile strikes on ships travelling through the Red Sea have caused the biggest disruption to global trade since the Suez Canal became blocked in March 2021. The attacks are being carried out by Yemen’s Iran-backed Houthi militants, who are targeting vessels to protest Israel’s military campaign in the Gaza Strip. The indiscriminate targeting of ships has led to four of the world’s largest container-shipping companies (accounting for 53% of global container trade) to stop all traffic through the passage. Although no ships have sunk so far, some have sustained damage, with one Israeli car carrier having been seized by the rebels in November. With one of the world’s largest trade arteries effectively closed, the U.S. and its allies are increasing naval activity in the area, heightening tensions in an already fragile and unstable region.

Why it matters: The Red Sea is the only route to the Suez Canal, one of the world’s most heavily used shipping lanes, linking Europe and Asia. About 12% of global trade passes through the canal, including as much as 30% of container traffic accounting for more than $1 trillion of goods every year. Western sanctions on Russia energy also mean the Red Sea has become a crucial trade artery for crude and gas passing from the Middle East to Europe.

Following the attacks, shipping companies have been able to reroute much of the Red Sea’s normal traffic around the southern tip of Africa, a diversion that can add anywhere between 10 days to a month to shipping times, leading to higher costs, delays, and ultimately higher prices for the end consumer. For example, the spot rate to ship a 40-foot container to northern Europe from Asia has risen more than 150% since mid-December. When the Ever Given container ship became stuck in the Suez canal for a week in 2021, it took months for global supply chains to normalize. While supply chains are not as tight as they were following the end of Covid lockdowns, the extra costs and delays in the delivery of goods and energy could inflate end prices and curtail demand just as inflation is cooling.

These events will be an unwelcome development for the world’s central banks, which already face the difficult job of navigating interest rate cuts amid a slowing global economy. At this stage, we don’t expect this to have a material impact on the future direction of monetary policy, but it is a risk we are watching closely.