Pushing Back Against Market Expectations

Week Ending, 19th January, 2024

Main points this week:

Middle East: The Israel/Gaza conflict is spreading. Following the Houthi attacks on military and cargo vessels which were then followed by retaliatory air strikes by the US and UK, the Houthis struck again. This time their target was a US-owned commercial vessel. Even President Biden conceded the air strikes from the weeks before have not halted Houthi attacks in the Red Sea. Following that, Iran launched rocket & drone strikes first into Iraq’s semi-autonomous Kurdish region (allegedly a Mossad facility) and Syria (ISIS targets) and then into Pakistan (the separatist group Jaish al-Adl). Pakistan retaliated by striking separatist militants inside Iran just days later. For now, the escalation between Iran and Pakistan seems to be limited and constrained.

The only glimmer of hope to emerge is an initiative led by Saudi Arabia to secure a ceasefire and release of hostages as part of a broader plan that could offer Israel a path to normalisation of relations. It would however require “irreversible” steps towards the creation of a Palestinian state. The plan has been discussed with the US and Europe. It would formally require the latter to recognise a Palestinian state. Even Blinken acknowledged such a state was needed and would have to be one which can work with Israel to be effective. It’s a very big – but not an impossible - ask. The pressure for a two-state solution – which is not new – is growing. It presents a real challenge for Israel with its far-right wing government.

Fixed Income: Economic data, especially out of the US, has given investors, Central bankers, and economists quite a headache. Bond yields have risen hard (i.e., bond prices have fallen) as the previously held belief that rate cuts would be quick and extensive were overdone. US December retail sales were strong and weekly jobless claims data shows a still strong labour force. Rate cut expectations for 2024 have dropped from 1.65% to 1.40%. Odds for a first cut in March have dropped to 54% (from an almost 90% late last week). Meanwhile, we have seen increases in inflation in Canada, Germany, and the UK.

China: announced 2023 GDP growth of 5.2% driven largely by consumer spending of 4.29%. Fixed Asset Investment contributed 1.50% and Net exports detracted -0.59%. The announcement was proudly made by Premier Li Qiang at Davos one day before its official release. It has been met, by many, with the usual cynicism and doubt. The cynicism centres around the property market, perceived insufficient action from Beijing in terms of stimulus, an underwhelming consumption recovery and a poor showing on trade (mostly because of a drag effect in Western economies).

It might be easier to look at things in China a different way as opposed to the conventional, Western playbook. In the past Fixed Asset Investment and Trade were always the main drivers of its GDP. Private (or household) consumption is only about 40% while Government consumption contributes another 15%. Contrast that with the US where private and government consumption totals close to 80%. So despite the doom and gloom reported, last year’s GDP at 5.2% showed the bulk of it coming from private consumption while fixed asset investment was considerably less. Trade was negative! I am not suggesting it’s all rosy in China – just that the nation has reached an important crossroad. Its reticence in using a bazooka style stimulus package (despite having plenty of resources to draw upon) actually indicates it can afford to be careful in its next steps. It’s not about whether Beijing will use stimulus – it’s about how. It doesn’t want to end up in the same credit mess following 2007/8. Consumption continues to rise – albeit below the pre-pandemic trend. Considering the slowdown in the West, the impact of Covid and the property saga, the fact that it still continues to rise is impressive! The key is to ensure the property sector doesn’t get worse.

MARKET SUMMARY
For w/e 17th January, global equity funds saw big outflows of $8.68bn. This was the third, straight week in a row as CBs in the US and Europe pushed back against market expectations of an early interest rate cut. US and European funds saw net outflows of $9.23bn and $1.48bn respectively. Asian funds attracted flows of $1.48bn. Bond funds saw huge net inflows of $14.33bn while investors withdrew $28.51bn from MM funds.