Endowus Q1 2024 Market Update & Outlook—Geopolitical risks and markets

Escalation in the Middle East

The conflict in the Middle East, which originated between Israel and Hamas in late 2023, further intensified with Iran’s air attack on Israel on 13 April. The attack was allegedly in retaliation to an earlier airstrike in Syria, which targeted a building and resulted in the deaths of seven Iranians, including individuals affiliated with  Iran's Islamic Revolutionary Guard Corps. 

Oil prices had previously climbed in anticipation of Iran's actions, with Brent crude approaching a six-month peak last week. After Iran’s attack, prices started to come down again.

The ripple effects of the ongoing Middle East conflict extended to other markets, triggering a decline in equities. The CBOE Volatility Index (VIX) also registered its highest level since November. The US dollar, traditionally considered a safe haven during times of crisis, also rose.

The markets remain on edge as they closely monitor Israel’s anticipated response to Iran’s attack.

Aside from the Middle East crisis, the past week saw significant developments from the central banks. The European Central Bank (ECB) left its rate at 4% but left the possibility of a June rate cut open. The Japanese yen weakened against the US dollar, but the Bank of Japan dismissed the possibility of bolstering the yen with a rate hike.

Red hot inflation

The US March CPI report released last week indicated that the inflation rate had ticked up to 3.5% in March from one year ago, compared to 3.2% in February. The March figure was above the 3.4% forecast and came as a surprise to many. This marked the third monthly year-on-year increase for the CPI. January's year-on-year percentage change was 3.1%.

The US economy continues to defy expectations 

Economists have once again revised their forecasts on the US economy, with updated reports on employment and productivity. The Atlanta Fed GDPNow model is now estimating a 2.8% GDP growth for the first quarter  which is much higher than the consensus estimate.

Meanwhile, a survey of economists conducted by the Wall Street Journal indicated that there has been a strong revision upwards for the US GDP growth forecasts.

With such persistent inflation and strong economic indicators, some economists are starting to believe that the US economy may be able to handle the higher interest rates with strong growth, especially with increased worker productivity. 

In line with this, economists anticipate that the Labor Department's productivity measurement will grow at an annual rate of 1.9% over the next decade. This projection aligns with the average annual productivity growth observed over the past 40 years. However, it exceeds the 1.2% growth rate experienced during the 2010s, a period when the 10-year Treasury yield generally hovered between 1.5% and 2.5%.

Higher, for much longer

‍However optimistic the scenario looks, there is still a large degree of uncertainty. The persistently high inflation rate coupled with a robust U.S. economy complicates the Federal Reserve's ability to implement the long-anticipated interest rate cuts. It is now expected that the Fed will delay the initial reduction in interest rates.

According to the CME FedWatch Tool, as of 10 April, traders have adjusted their expectations, with the probability of the first interest rate cut occurring in June dropping to 19% from 56% just a day earlier on 9 April.

The first rate cut is now predicted to come only in September. Expectations for the number of rate cuts in 2024 have also shifted quite significantly. Initially, investors were expecting five cuts beginning in March. However, this outlook has been adjusted to now slightly favour just two cuts, with a projected year-end target range of 4.75-5.00%. To compare, the latest dot plot from the March FOMC meeting indicated that the Fed members were largely expecting three rate cuts in 2024. This is a decrease from the 5 to 6 rate cuts suggested in earlier dot plots.

Wars, geopolitical events and monetary policies

Amid the ongoing geopolitical tensions and the constant chatter about global events, it is crucial for investors to maintain a composed and steady head. The world can often seem fraught with uncertainty, which can make the markets jittery and unpredictable.

However, the best way forward is not to react hastily to each headline but to remain calm and committed to a well-thought-out investment plan. History tells us that markets have the capacity to recover and grow over time, despite short-term fluctuations driven by news and events.

A comprehensive study by LPL Research, examining 21 geopolitical incidents since 1941—from events like the Pearl Harbor attack to various Middle Eastern conflicts and the 9/11 attacks—illustrates this trend.

On average, following these events, the market typically dropped by about 1.2% in a single day and declined around 5% to reach a low, which usually occurred 22 days after the event. Remarkably, it then took an average of 47 days to recover these losses.

The bottom line is that historically, many wars, both minor and major, have had little effect on the core fundamentals or the ongoing trends of the markets.

By staying invested and focusing on your long-term financial goals, you can avoid knee-jerk reactions that might adversely affect your investment results. In essence, patience and perseverance are key to navigating through the noisy global landscape and achieving your investment objectives.

Q1 2024 market update

In the first quarter of 2024, global financial markets presented a mixed but generally positive landscape, reflecting diverse economic conditions and investor sentiments across different regions and asset classes.

‍Global equity market 

Equity markets generally showed strong gains, with the S&P 500 and MSCI Japan indices standing out as the top performers, posting double-digit increases. 

The US economy continued to charge ahead in the first quarter as it continued to show signs of resilience. Corporate earnings were also generally strong across multiple sectors. With the US economy not showing signs of slowing down, a still-strong job market and persistently high inflation, the markets have resigned themselves to a slower pace of monetary easing by the Fed. 

The Japanese equity market experienced a strong run during the first quarter, helped by positive investor sentiment over Japan’s mild inflation, wage growth and positive economic cycle. Corporate earnings from Japanese companies also contributed to the continued interest in the stock market.

In general, developed markets, as proxied by the MSCI World Index, outperformed the MSCI EM Index representing the emerging markets by a significant margin in the first quarter of the year. The MSCI China index continued its downward trajectory, affected by regulatory uncertainties and slower economic growth, highlighting regional disparities in market performance.

In terms of factors, growth was once again, the flavour of the quarter even though value companies outperformed growth companies in the last month of the quarter (March). This trend was consistent in both the developed and emerging markets. As for the size factor, small companies continued to remain out of favour, relative to large companies. This was seen in both the developed and emerging markets.

Global fixed income market

The first quarter of 2024 marked a notable shift in the dynamics of inflation and interest rate expectations. Initially, there was an anticipation of quicker moves by central banks to reduce interest rates. However, as the quarter unfolded, these expectations were moderated. A significant development was the Bank of Japan (BoJ), which raised interest rates from -0.1% to 0.1%, marking its first increase in 17 years and signalling an end to its negative interest rate policy. 

Throughout the quarter, yields on government bonds adjusted in response to evolving market sentiments and economic data. For instance, the yield on the US 10-year Treasury increased from 3.87% at the close of Q4 2023 to 4.21% by the end of Q1 2024. =

Investment grade corporate bonds generally outperformed government bonds. High yield continued to generate positive returns (as represented by the Bloomberg Global High Yield Index) even as default rates saw a modest increase.

Commodities and gold

The commodities market (S&P GSCI) saw substantial growth in the first quarter, with all its components finishing the period on a positive note. Energy was the top performer, with livestock posting strong returns as well. Gold also generated positive returns, with the S&P GSCI Gold returning more than 7% during the quarter.

Agriculture as a segment was one of the worst performers during the quarter, posting a meagre 0.9% return. Within the agriculture segment, cocoa prices surged due to robust demand and supply shortages in West Africa, which is responsible for producing over half of the world’s cocoa beans. Wheat and corn declined substantially with wheat posting double-digit negative returns.

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For details on how the Endowus portfolios performed in the quarter, click here. Watch our webinar on Q3 performance and market insights here.