Markets in the last couple of years have been very much macro driven. We believe 2024 may be different.
To understand why, it might be useful to summarise what has happened in the last two years. 2022 saw the Russian invasion of Ukraine, which set off an oil price hike sending inflation to levels not seen in Europe in decades. Central banks were behind the curve in raising interest rates but when they did the moves were steep, and H1 of 2022 saw the biggest drop in bonds and equities since the Global Financial Crisis. Growth equities were particularly penalised. H2 2022 and H1 2023 saw a recovery in share prices despite the fact interest rates were still rising. That was entirely to be expected according to the theory of bond convexity. As the interest rate cycle turns upwards it is always the initial rises that are most damaging. In H2 2023, markets were starting to anticipate that central banks had finished raising rates, but a further 25bp hike from the Fed at the end of July and talk of rates staying “higher for longer” sent markets into a downdraft again. Growth equities, again, were impacted. August through October saw further declines and then, in November and December, there was a sharp reversal, and our stocks recovered most of their losses.
So where are we now? Still anticipating the first rate cut in H1 2024. If you look at the weakness in European economies, the first cut could reasonably come in Q1. However, the risk is that central banks will be too focussed on the rear-view mirror. Also, there is enough going on geopolitically, i.e. the Red Sea, to make them pause. Thus far the impact on the oil price has been limited, as the world is well supplied with oil and tankers have diverted around Africa. The Ukraine/Russia, Israel/Hamas wars fester on but, as of yet, have not proven to be majorly damaging to stock markets. As to the China/Taiwan issue, following muted reaction from the former following the recent election, we are inclined to believe the Chinese Communist Party will stay its hand, at least until the outcome of the US election in November is known. This will be critical for markets. We saw back at the end of 2016 a blow out in bond yields on the Trump election, and banks rallied hard. The conventional wisdom is that Trump in the White House would be good for the dollar, bad for the euro, yuan and other currencies. It could also have profound implications for global geopolitics.
Economic growth in Europe is currently anaemic at best. German GDP fell 0.3% in 2023. The month-on-month growth rates in the main European economies have been negative, there is no good reason, in our view, for interest rates to be as high as they are. There must be scope to bring them down a couple of percentage points this year if economic growth continues to hover around zero. Inflation is coming down and we can expect a deflationary wave as China tries to export its way to better economic growth.
Such an environment should be a good one for growth stock pickers. Firstly, with a lack of economic growth, companies that can deliver earnings growth of 15% or more should trade at a premium. Secondly, downward interest rate momentum should lead to PE multiple expansion, reversing the compression we saw as the interest rate cycle turned up in 2022 and 2023. And lastly stocks look good value, particularly following a healthy correction this month after the year-end rally. Markets are obsessed as to timing of cuts, and disappointed by Fed prevarication. Christine Lagarde, President of the ECB, has recently said that Eurozone rates should come down by the summer. With all the uncertainty there will doubtless be opportunities over the next few months to ‘buy the dips’. But the general direction of interest rates is down, and we are constructive for the year as a whole. The investment challenge will be to remain close to our companies, anticipate any potential economically driven earnings slowdown, and take any necessary corrective action. However, all told, we believe this is a good entry level point for the Aubrey European growth stock strategy, especially for investors with a medium-term investment horizon.