This year seems abundant with opportunities for smart investors

-Considering the market action over the last couple months, investors should be extra careful. Why? Because while neither the future state of the economy nor the interest rate decisions by central banks of developed countries are known, the equity markets are betting that global recession may be avoided while inflation is curbed, and that this will lead to lower central bank rates in the first half of 2024.

–As of February 23^rd, the US equity index S&P 500 and European stock index Euro Stoxx 50 were up by +5% and+ 3% respectively on the month.It wasn’t just the developed world, but also the emerging markets that benefitted from this euphoria. Over the same period, global emerging market equity index MSCI EM was up by +5.6%. The global equity market returns reflected this optimistic outlook as well with global equity indicator MSCI All Country World Index (ACWI) up by +4.6% in February.

–As of February 23^rd,Bloomberg Global Aggregate Bond Index, the benchmark for global investment grade bonds, dropped by -0.75% on the month. Bloomberg Global Corporate Bond was also down in February losing -0.95%. The High Yield Bond Index however was up by +0.8% as investor confidence went up and therefore credit spreads between government and high yield bonds tightened.

–As inflation fears abated, the price of gold continued to soften up in February. Investors turn to gold as a store of value and a hedge against uncertainty and inflation and the reverse happens as uncertainty and expected inflation subside like in the more recent period. Case in point, as of February 23^rd, the first month futures contract for gold was down by -0.9% on the month.

–Crude oil had another positive month although it wasn’t as strong as January where it had closed the month up with a +5.9% gain. Crude oil prices are driven by both demand and supply dynamics. The improving macroeconomic fundamentals supported the expected demand while the ongoing conflict in the Middle East, a major oil-producing area, cast a shadow on the future of crude oil supply. As of February 23^rd,the first month futures contract for US crude oil WTI was up by +0.8% on the month, bringing its year-to-date return to +6.7%.

–Crypto markets had a mix and eventually a flat month in January on the back of speculation that the US Securities Exchange Commission (SEC) would finally approve the new Bitcoin ETFs which opened up the crypto market up to more mainstream investors. Contrary to January, February turned out to be a very strong month for both Bitcoin and Ethereum. Bitcoin hit $51,000 for the first time over two years. As of February 23^rd,both Bitcoin and Ethereum were up on the month by a whopping +20% and +29% respectively.

–Similar to January, the Turkish stock market benefitted from the positive market sentiment and continued its strong start to the year. As of February 23^rd, Turkish stock market index BIST100 gained +10.3% in local currency terms (+8.3% in US dollar basis). The monthly performance of BIST100 in US dollar was lower than its return in local terms due to the appreciation in the greenback against Turkish Lira by +1.9% in February.

–Should equity indices continue their strong upward trend, as more non-positive macroeconomic data become available, a correction, or a normalization could be in the cards. Investors can exploit it by a careful underweight in their equity allocations, possibly with a slight overweight tilt to their bond portfolios. This year seems to be abundant with opportunities for the smart investors who stay well informed and keep an open mind across all investments globally.

2024 has started out as a very different year for financial markets than 2023 or 2022, both of which were full of ups and downs driven by unexpected geopolitical tensions intertwined with ambiguity surrounding inflation, and direction as well as resilience of macroeconomic fundamentals. 2024 on the other hand so far seems to pose less ambiguity for market players, particularly for equities which have been shooting up in nothing less than a straight line. In fact, some of the major equity market indices such as US Dow Jones, SP 500 and even Japan’s Nikkei hit record highs in February. This was welcomed by investors who had seen their net equity returns fluctuate around flat since the end of 2021. For further discussion on investment returns over the preceding two years, please see our recap of 2023 published in our January 2024 issue.

EQUITY MARKETS ARE CONSIDERED A LEADING INDICATOR

What exactly triggered this recent so-called “melt up” in equity markets globally?

To better understand this market action, we should first discuss the drivers of equity markets. Stock markets are generally considered as “leading” as opposed to “lagging” indicators. In other words, stocks tend to first move on the basis of “expected” data and then they course correct based on actual data. Of course, it is not as discrete and orderly in real life, but at the end of the day equities don’t simply wait for the actual macroeconomic data or central bank rate decisions to be released. This in no way means equity markets don’t care about the actual data. They do, but only to a certain extent. That is why stock markets could have major moves even when there is no actual data that is being released. Markets love playing the guessing game.

BONDS HAVE DEVIATED FROM EQUITIES ONCE AGAIN

This nuance is also crucial in understanding the more recent response of equities vs. bonds which we have discussed in our previous issues in detail. While equities look at both economic fundamentals and interest rate markets, the latter are more focused on the short, medium and long term real and nominal interest rate expectations. This difference in perspective has created the recent incongruence between equity and bond market returns that we have explored in our previous issues as our readers may remember.

The reason for this strong upward swing in equities have been really due to the expectation that economies will be resilient against central bank rate hikes. Equity markets believe this due to recently published resilient macroeconomic data and strong consumer demand not just in the US but in most of the developed world accompanied by inflation that seems somewhat under control.

However, investors should be extra careful. Why? Because while neither the future state of the economy nor the interest rate decisions by central banks of developed countries are known, the equity markets are betting that global recession may be avoided while inflation is curbed, and that this will lead to lower central bank rates in the first half of 2024.

Let’s now look at the returns across the global markets.

EQUITIES HAD A STRONG MONTH

As a result of this overly optimistic sentiment, as of February 23^rd, the US equity index S&P 500 and European stock index Euro Stoxx 50 were up by +5% and+ 3% respectively on the month. It wasn’t just the developed world, but also the emerging markets that benefitted from this euphoria. Over the same period, global emerging market equity index MSCI EM was up by +5.6%. The global equity market returns reflected this optimistic outlook as well with global equity indicator MSCI All Country World Index (ACWI) up by +4.6% in February.

While US equities were focused on the resilient US macroeconomic data, US bond yields continued to price in expected higher nominal rates in February. This was particularly apparent in the long end of the US yield curve as illustrated in the graph below (see the blue line).

Source: Bloomberg

US YIELDS ROSE DUE TO DEBT BURDEN AND EXPECTED DELAY IN FED RATE CUTS

There are couple factors that played into this rise in the long-term yields depicted in the graph. The first is the debt issuance by larger treasuries that are starting to weigh on bond prices, which we discussed last month as follows:

“This year-end euphoria in bonds started to wear off in the first days of 2024 as market players began to face the stark reality of increasing debt burden in developed markets. Starting in January, treasuries of large players like the US, UK, Eurozone and even Japan will sell over a $2 trillion of new bonds to finance their spending. According to Bloomberg Intelligence estimates, this is roughly a 7% increase from last year. 

With quantitative easing becoming a remote memory, central banks are no longer gobbling up the debt which flooded the markets with cheap money. Instead, they are looking to flood the markets with more debt gradually sucking up liquidity, hence pushing the interest rates up once again. 

What does that mean for investors?

This will likely translate into higher nominal interest rates similar to those we have seen in 2023, at least in the near term. The supply/demand dynamics in bonds we described above may in fact delay the rate cuts longer than many expect.”

The other driver of higher yields has been the fact that even though inflation hasn’t retreated back to the 2% target set by the FED and other leading central banks, macroeconomic data has remained unexpectedly resilient. This continued to increase the expectation that the FED may maintain the rates at its current level of 5.5% longer than anticipated. As a result, in February a broad set of financial institutions started to pare back their bets that central banks would start cutting rates sooner than later… and many revised their economic forecasts for 2024 expecting only a mild slowdown as opposed to a recession. This naturally helped raise the nominal rates on the long end of the US yield curve.

In line with this increase in rates, bond indices continued to give back some of their gains running up to the end of 2023. As of February 23^rd, Bloomberg Global Aggregate Bond Index, the benchmark for global investment grade bonds, dropped by -0.75% on the month. Bloomberg Global Corporate Bond was also down in February losing -0.95%. The High Yield Bond Index however was up by +0.8% as investor confidence went up and therefore credit spreads between government and high yield bonds tightened.

GOLD GAVE BACK SOME OF ITS GAINS FROM 2023

As inflation fears abated, the price of gold continued to soften up in February. Investors turn to gold as a store of value and a hedge against uncertainty and inflation and the reverse happens as uncertainty and expected inflation subside like in the more recent period. Case in point, as of February 23^rd, the first month futures contract for gold was down by -0.9% on the month.

CRUDE OIL PARED MOST OF ITS LOSSES IN 2023

Crude oil had another positive month although it wasn’t as strong as January where it had closed the month up with a +5.9% gain. Crude oil prices are driven by both demand and supply dynamics. The improving macroeconomic fundamentals supported the expected demand while the ongoing conflict in the Middle East, a major oil-producing area, cast a shadow on the future of crude oil supply. As of February 23^rd, the first month futures contract for US crude oil WTI was up by +0.8% on the month, bringing its year-to-date return to +6.7%.

CRYPTO HAD A VERY STRONG FEBRUARY

Crypto markets had a mix and eventually a flat month in January on the back of speculation that the US Securities Exchange Commission (SEC) would finally approve the new Bitcoin ETFs which opened up the crypto market up to more mainstream investors. Contrary to January, February turned out to be a very strong month for both Bitcoin and Ethereum. Bitcoin hit $51,000 for the first time over two years. As of February 23^rd, both Bitcoin and Ethereum were up on the month by a whopping +20% and +29% respectively. Bitcoin and Ethereum had a phenomenal 2023 with +157% and +90% gains respectively.

TURKISH STOCKS STARTED THE YEAR STRONG

Similar to January, the Turkish stock market benefitted from the positive market sentiment and continued its strong start to the year. As of February 23^rd, Turkish stock market index BIST100 gained +10.3% in local currency terms (+8.3% in US dollar basis). The monthly performance of BIST100 in US dollar was lower than its return in local terms due to the appreciation in the greenback against Turkish Lira by +1.9% in February.

MARKET DISLOCATIONS CONTINUE TO PRESENT GREAT RETURN OPPORTUNITIES

As discussed in our previous issues, extended moves and/or dislocations in financial markets present great opportunities for investors. One such disconnect has been between equity and bond markets since 2023, and one way to exploit this dislocation is by adding more credit and rates related products to a well-balanced investment portfolio, particularly those with shorter duration that can benefit from a lower but upward trending yield curve.

This month seems to point to another potential opportunity, thanks to the melt-up in equity markets we discussed earlier. Should equity indices continue their strong upward trend, as more non-positive macroeconomic data become available, a correction, or a normalization could be in the cards. Investors can exploit it by a careful underweight in their equity allocations, possibly with a slight overweight tilt to their bond portfolios.

Most importantly, this year seems to be abundant with opportunities for the smart investors who stay well informed and keep an open mind across all investments globally.

ELA KARAHASANOGLU, MBA, CFA, CAIA

International Finance Expert

karahasanoglu@turcomoney.com

ela.karahasanoglu@ekrportfolioadvisory.com

https://www.linkedin.com/in/elakarahasanoglu/