Risky Business: VanEck’s 2024 Q4 Summary 

Please Note: This report was created and provided by VanEck.

“The job of the Central Bank is to worry.” – Alice Rivlin, 16th Vice Chair of the Federal ReserveIf central banks worry, what is an investor to do? In its last monetary policy decision statement, the Reserve Bank of Australia (RBA) stated, “Sustainably returning inflation to target within a reasonable timeframe remains the Board’s highest priority.” The RBA is worried about inflation. Earlier in the month the Federal Reserve (Fed) issued its policy statement, noting “The economic outlook is uncertain”, before proclaiming, “In light of the progress on inflation and the balance of risks, the Committee decided to lower the target range for the federal funds rate by 1/2 percentage point”.

So while the RBA frets about inflation risks, the Fed now frets about the slowing economy, a different risk of their dual mandate. The result is a divergence of policy. The European Central Bank (ECB) appears to have shifted to the Fed’s thinking too. The manoeuvrings of Central Banks are driving markets. Irrespective of their focus, all central bankers will be doing all they can to pilot a ‘soft landing’, and we think for the most part they will.

In the meantime, rather than react to data releases, markets overreact as they tend to do. Volatility spiked and slowed as quickly as ever during the quarter. China started the last week of September among the worst performing equity markets, then rallied to finish the quarter as the best performing asset class, following an unexpected easing onslaught by authorities. Gold also bucked the trend as investors sought a hiding place from uncertainty and economic weakness, it surpassed US$2,600 per ounce. As rates fell globally, long-duration assets such as infrastructure did well. Likewise, REITs were the best-performing equity sector.

Central banks’ actions, and inactions, are driving markets.

No one knows which direction inflation will move next, no one knows what the next employment print will show. Each geography has unique issues. Central bank divergence is happening and could continue well into 2025.

The other show in town is the US Presidential Election, again, difficult to predict. The result will have implications for markets, but it seems no matter who wins, US debt will rise and there will be tariffs on China. It’s just the scale that differs between the two parties.

We are optimistic for investors and think opportunities exist into the next cycle. Investors should continue to approach risk assets selectively. Now is not the time to be brave for over-owned risk assets. While Australia may appear cheap relative to global equities, its composition skews to ‘cheaper’ sectors. We would caution to be mindful of concentration risks. Small companies, locally and globally, also present an opportunity, again selectivity is paramount. Emerging markets, both debt and equity complexes, offer a greater risk premia and past structural reforms have resulted in strong relative fundamentals coming to the fore now. We could still see the US dollar come off and gold climbing to new heights. Gold miners are still undervalued relative to the price of gold, and we think with strong cash flows they could outperform the yellow metal into the backend of 2024.

Investors must navigate more risks than central bankers, who choose to either focus on inflation or growth. It’s a risky business. As a noted former hedge fund manager once observed:

“The single greatest edge an investor can have is a long-term orientation.” – Seth Klarman

A tale of two central banks

As COVID supply and demand shocks unravel, alongside global growth that could be best described as modest-to-anaemic, central banks find themselves on different timetables. In one notable case, Japan, is moving in a different direction.

Most central banks have either commenced easing or are edging towards it. The three biggest economic blocs, China, Europe and the US are cutting.

Monetary policy is a trade-off between different goals, made in the face of uncertainty.

Policymakers don’t have up-to-the-minute data. As we have seen, as recently as the last quarter, the past (data) is also subject to revisions. As Niels Bohr, the father of quantum physics, said: “prediction is very difficult, especially if it’s about the future.”

Some of the variation between central banks noted above is due to differing current and expected macro performance.

There are also other factors at play. For example, the gap in the policy setting between the Fed and the RBA is looking more like a chasm. With its 50 basis point cut (bps), the Fed has gone full ‘dove’, with the RBA appearing to out ‘hawk’ the long-time title holders at the ECB.

For the jargon illiterate, doves seek an expansionary monetary policy, lowering interest rates while pursuing a policy of quantitative easing. On the other hand, hawks seek a contractionary monetary policy, hiking rates, or keeping them high and avoiding quantitative easing.

Crisis? What crisis?

For the umpteenth time since the US economy escaped the clutches of COVID, we’ve been through another round of “oh no, here comes the recession”. A lot of survey data has, once again, turned ‘softish’. And yet, the hard data suggests the US is about to deliver another above-trend growth quarter.
The difference this time is the Fed has joined in, delivering a jumbo 50 bps cut at its most recent meeting, and forecasting another 50 bps by year-end.

It’s difficult to say what changed the Fed’s mind. Not a lot appears to have changed in its economic forecasts since its June projections, with the notable exception of the interest rate projections, which have been slashed.

One explanation could simply be a change in the risk they’re now most focused on, growth. Since the commencement of its hiking cycle the Fed has been steadfast in its commitment to fighting inflation. Now it seems the Fed has declared victory on inflation, after data flipflops through the last quarter of 2023 and the start of 2024. The rate cut signals that the Fed has decided inflation is now on the path back to target.

That has allowed them to swing their focus back to unemployment, now a whisker above their estimates of non-accelerating inflation rate of unemployment (NAIRU).
A bit of Sahm rule hysteria mid-quarter and a downward benchmark revision (see, the past is subject to revisions) to payrolls may have unnecessarily added to angst.
Both have question marks over them.

We should all be sceptics

The Sahm rule, when the 3 month average unemployment rate increases by 0.5 percentage points from the prior 12 month low, signals a US recession. It has correctly marked the previous 12 recessions. This time might be different.

Fed-trained economist, Claudia Sahm, inventor of the Sahm rule, doubts it is correct this time, thanks to COVID distortions. Consumer expenditure is higher than in previous recessions. And there are reasons to be sceptical over the scale of re-benchmarking downward revisions of non-farm payrolls – most notably due to employers under-reporting the hiring of illegal immigrants to avoid legal problems.

Even with the revisions, payrolls seem to be running at levels that should, more or less, soak up labour market growth. Another, broader issue is what interest rate the economy needs to keep cruising around trend. This is a variant on model instability questioned above.

Through its projections, the Fed appears to think the neutral Fed Funds rate is just under 3 per cent, with inflation at 2 per cent, so a real neutral rate around 1 per cent. This is higher than in the post-GFC, pre-COVID era but sceptics should wonder if it is the appropriate, but unobservable, rate now.
There are reasons the neutral rate should be higher than the Fed thinks it is now: resurgent military spending, deglobalisation, decarbonisation, the return of fiscal spending. None of these appear to be going away.

Indeed, the fiscal outlook continues to darken.

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