Trends for 2024
hedging for a soft landing
Those who have gotten to know me and my investment philosophy understand how I view making recession predictions. Far too many people make too much money, calling the next great financial crisis in the next thirty days. You can buy this to protect yourself. The reality is you can expect around a 10% drawdown every two years or so and a 20% drawdown around every ten, although the numbers range wildly. The point is stocks are biased to the upside, so sitting 40% cash, 40% gold, and 20% stocks with P/E<5 is typically not a recipe for long-term success.
(Note: by drawdown, I mean for any given two-quarter period or longer from the start to the close of the timeframe. It is not uncommon to see inter-year drawdowns exceeding 20%, from the high to the low, where the market finishes within five percent to the positive or negative)
However, we will see a bear market in 2024. The Covid bear market was cut short by the most incredible fiscal stimulus pump that the world has ever seen. I firmly believe in malinvestment, in which perverse incentives create market inefficiencies that correct down the line. The economy is out of wack in English, which means a downturn. but given where we are now, these are my ten themes to watch in 2024.
Deflation: my theory on this is simple: inflation relies on the assumption that the amount of money circulating in an economy times the average amount of times a single dollar gets distributed will be equal to the price times the quantity of the goods. We had inflation because we had more money chasing fewer goods; now, we have less money chasing more goods. As far as I can tell from Federal Reserve Economic Data(FRED), there has never been a period of deflation exceeding 2% of the money supply that was not followed by a recession. The data we have only goes back to the late 50s, but the entirety of the monetarist school rose to prominence, offering the theory that the chief cause of the great depression was the shrinking of the money supply by the fed. As far as I can see, this is the most significant M2 money supply shrinkage period in over 60 years.
Pair this with the fact that prices are already starting to decrease, and you see what I will call a lagging effect. The Fed taking money out of circulation then leads to prices falling. Suppose we couple this with higher rates, so falling prices and lower gross spending will mean a recession. But because markets move so much on data being released and data is typically backward looking, things look rosy because we have been anchored to a high inflation environment.
Convertibles: Convertible bonds are essentially bonds that you own with a guaranteed payout. But, if the same company’s stock appreciates beyond a specified price, you can convert the bond for stock. This hedges against the possibility of a soft landing where the Fed steers us clear of a recession.
Everything is pretty expensive, but Value looks like a much better bet. I know, the Warren Buffett guy saying Value is going to make a comeback gives the same vibes as a Bears fan going, “We’ll get um next year,” but honestly, the spread between growth and value valuations gives some interesting prospects for value factor exposure or long short plays. Using J.P. Morgan Data from their most recent guide to the markets report the value growth spread is wider than it has been since before the tech bubble burst (we touched down on that point a few months ago right before a bounce back now back to this point. The spread places the forward p/e of the S&P500 value stocks over the growth stocks. The long-term ratio is 0.71, and today it is 0.56. Likewise, value stocks almost always outperform in rate environments, with the ten year between 3-4% growth, and value typically has parity returns but above 4%, and value looks better and better. I don’t see the ten-year going below four for more than a quarter or two, and even then, not until the middle of the year. So buy value
It’s still a decent time to buy treasuries. This is a play that I think has low absolute returns but decently high returns relative to risk. I see it as unlikely the federal funds rate is above 6% even a decade from today. Again, according to the median Fed target, rates are going to be on a downward trend to three by 2026. I don’t put too much stake into FED targets given their relatively poor performance. But the risk for treasury holders in going from 5.5 even to 6.5 is way less than the gain for holders at around 5 down to 3. In essence, for relatively conservative investors I think there is a good risk-reward outlook for 2024.
litigation at the end of 2024 related to education/student loans. Earlier in 2023, a short report on Grand Canyon Education said that the company was artificially lowering costs and juicing earnings by ascribing all the good stuff to the for-profit wing and all the bad things on the not-for-profit university Grand Canyon University. The FTC has also sued Grand Canyon for deceptive advertising. I believe that once student loans begin to get repaid, all of the data we have on the supposedly healthy consumer balance sheet will start to falter. The increase in delinquencies will lead to a round of litigation on all companies in the for-profit education sector, precisely what that means, I don’t know, but there will be fireworks. The fact student loans only began to get repaid in October suggests that data on delinquencies is incomplete. And with average delinquencies at 10% historically that have been depressed at 0, I see an opportunity for certain realms of asset-backed credit, especially with the potential for household debt service as a percentage of disposable income to rise as high as 11%, which is late-90s early 200s levels. The debt service will bring down consumer spending, which accounts for approximately 2/3rds of the GDP
A good time for active high-yield credit: over the past decade, a Worst spread below 4% (the spread between high-yield credit and treasury bonds of similar durations) has signified a rebound in the spread, or in other words, either high yield would become more attractive or treasury bills would get worse. Now bear in mind there is an inverse relationship between price and yield, but with a high spread, that means there is more opportunity for active managers to make good returns, especially since I am also predicting a default cycle in Asset Backed Credit,
Japan and Europe look interesting: With the US being relatively expensive (but Value being fair), it might be a good idea to consider international investing. Looking at relative valuations but I also stay away from investing in China or Russia out of political/moral fears. Japan is trading near the bottom of its 25-year p/e range, and I believe Japan is a stock pickers market where some businesses are going to be lousy, but there will also be abundant opportunity. I think a lot of the same is true of Europe but I think there will be less dispersion. A stock picker will find more opportunities in Japan but will be better off buying European indexes. Interestingly these markets tend to underperform US markets in high-rate environments but the same value-growth paradigm relates internationally, meaning aligning the portfolio to value stocks in Japan and Europe should offset interest rate effects
Tech as a growth beacon, real estate in play. There are two particular sectoral dynamics in the US I want to look at. The first is that tech might actually perform all right as a growth sector. It is a huge problem that indexes are more overweight than ever in the top ten indexed stocks; meanwhile, so much capital has flown there that almost all of them look to underperform the index, although modestly. The sector as a whole is still cash-rich and cheap relative to tech in Europe. So, as a growth exposure, I would look to tech in the 10-100B range. Real estate is going to have a lot of interesting dynamics in 2024. The spread between cap-rates and 10-year treasuries is at its lowest point since 2008. Office looks to keep sucking, Industrial still seems stable and return dispersion among core real-estate managers is really tight. But I think the real fireworks are going to be in the apartment and retail space. I think the trend of distressed and deep value plays in office is going to continue for several years but I think there is going to be a real diversity of returns in strategies focused on retail and multifamily strategies that will start to take hold in 2024.
Intrigue in Latin America. While EMs as a whole are not interesting to me Brazil and Argentina in particular are. Brazil is a really cheap, stabilizing market, while Argentina is going through some major economic reforms that I believe will turn the country around. Hence, investors have the opportunity to invest in some pretty large businesses like Petrobras, Mercado Libre, JBS, or either of the country's major banks as they try to make the countries more stable and open to foreign investment.
Political Instability is a determinant of market directionality. I’m not trying to get into politics in this article. But stability is essential for markets. High tax, low tax, high spending, low spending, socially conservative, socially liberal, it really does not matter all that much to the markets as a whole. The absolute worst thing we could have is a gridlocked political system with a deeply polarized electorate and an unclear path forward (oh…wait) in general; if this election gets incredibly nasty and we maintain a situation of being obsessed with deeply political litigation all while having ineffective policy than the markets will be unable to break out of a volatile band as the best case scenario.
These are all pretty broad predictions. I find that sometimes that is just the way things are. Last year I could have told you about how I thought coal was going to rip before that oil, but it looks a lot to me like even if there is still outperformance in those areas, the juice has been squeezed to the point that calling the whole sector isn’t really worth it. The same is somewhat true of biotech. I can see companies like Novo Nordisk, Lilly, or more minor cancer therapy and gene therapy companies getting expanded multiples from investor sentiment, but that theme is already in play right now. All this stuff is relatively Macro but so much of this is charting a course. I would like to say that your upside is in micro, and your downside protection is in macro.