The world will finally return to economic and financial normality this year, but the “high stakes” US presidential election taking place in November may threaten to uproot that, according to Swiss private banking group Lombard Odier.
Speaking at the bank’s 2024 global outlook media conference on Jan 25, Lombard Odier’s chief economist Samy Chaar says that the global economy over the last three years has been characterised by commodity price shocks, and upset in the global supply chain system.
Chaar was joined by the bank’s new global chief investment officer, Michael Strobaek, who held the same role at Credit Suisse prior to joining Lombard Odier last November.
“And our view is that 2024 is the process of getting back to something more normal,” says Chaar. “Normality when it comes to macro, has never really been defined, it doesn’t mean that we’ll be in a perfect environment without risk and [that we’ll be] in a booming economy. But it does mean that some of the key economic variables will get back to levels that are more consistent with historical patterns.”
Most crucially, the sectors that are the most sensitive to interest rate increases are not getting any worse, such as housing and manufacturing, among others. Leading indicators in these sectors are bottoming out, and are improving but at weak levels, a positive sign that things are not getting worse, he notes.
Likewise, global growth is going through a bottoming process. The economist notes that there has been an outperformance of the US economy due to an increase in government spending and consumer spending. In contrast, Europe has lagged behind due to a more conservative sentiment towards spending.
See also: Franklin Templeton sees opportunities in Asia following US elections
“Europeans did and are doing what they do best, which is [getting] retrenched [and] being fearful and have therefore saved, while Americans are also doing what they do best, which is to spend like there is no tomorrow,” says Chaar.
This environment of modest growth has also led to a readjustment of the labour market, from being in an overheated territory to “something more normal”, according to Chaar. Unemployment trade is stable at low levels in which companies are rebalancing their labour force but no longer seeking to reduce it.
In addition, wage growth has grown more in line with inflation, while productivity levels are returning to its historical patterns. All of these factors combined have therefore led to inflation numbers moving closer to historical norms on the daily.
See also: Patient angel investors provide climate tech start-ups much-needed capital
These are all important signs that will influence the decision that the world has been waiting on — interest rate cuts. “We don’t believe that the US inflation will significantly breach the 2% level, but inflation between 2% and 3%, let’s say around 2.5% seems like an acceptable level for central banks to be cutting rates,” says Chaar.
Macro narrative favours policy rate cuts by major central banks. Charts: Lombard Odier, Bloomberg
Lombard Odier is “very clear” that rate cuts are coming, but it has taken a more conservative view than the market’s on their rate cut expectations. While market expectations are predicting five to six cuts, the private bank forecasts four cuts that will start anytime from March to May.
More important than the timing however, is to what extent the central banks will cut, according to Chaar. The chief economist anticipates “north of 2%, around 3.5%” for the US, and “south of 2%” for Europe.
He says that it is “legitimate” for central banks to begin their cuts now, particularly in Europe where growth is “particularly weak”.
“Christine Lagarde is in the position to cut rates, but she would like to wait more,” he says. The jury would be to see inflation levels in the coming two to three months, and should it move “in the right direction”, Chaar believes a cut should happen before summer.
For more stories about where money flows, click here for Capital Section
“Why would you risk more damage to the economy and labour market if inflation is where it should be?” he explains.
Safer assets not to be overlooked
The private bank’s new global chief investment officer, Strobaek, says that one of his “key convictions” is that markets this year will unlikely be anywhere near as strong as the year of 2023.
“A lot is already priced in the markets, which have gotten the message from the Fed, at least here and now that rates have peaked and that they may be going the other way, sometime soon,” he says.
Major asset class returns in 2022 vs 2023. Charts: Lombard Odier, Bloomberg
Strobaek says that the world has already gotten a material rally in risk assets, particularly in stocks in the last quarter of 2023 — a key assumption he has is that quite a bit of returns were already taken out of the market last year.
Strobaek says it is therefore prudent not to stray too far away from strategic allocations into equities and not to “chase the rally”. “Equities are not the only game in town”, he says.
Instead, safer asset yields have “come materially up” as interest rates have increased over the last two years. Now, credit and bonds present as serious alternatives to equities, Strobaek adds.
Even though bond yields have declined in 4Q2023, Strobaek is of the view that should investors be able to get up to 5% in high quality bonds, it presents as a very good cushion for total return inside a multi-asset portfolio. “I would not simply leave on the table for the ride of running after equity markets,” he adds.
Strobaek names credit as one of his “highest convictions”, as credit quality and spreads are holding up well, and the US dollar as an anchor currency to hedge portfolios against, in case of a slowdown due to geopolitical risk. Investors should not depart with the US dollar, he says.
His investment thesis, therefore, is to keep equities at current levels of 45%, increase allocations to cash and high quality bonds at 40%–45%, and put a small amount into alternatives of about 10%–15%.
Fixed income is becoming increasingly competitive. Charts: Lombard Odier, Bloomberg
Finally, on private equity, Strobaek says that he believes that whether private assets belong in a portfolio depends on the language profile of an investor. A growth-oriented investor for example, should have about 20% of private assets.
While the yield environment has experienced a slowdown as rates remain high, it is not impossible for investors to generate a 13%–15% return on their portfolio, which may prove better than a diversified one.
Geopolitical conflict, US elections
Meanwhile, geopolitics, revived over the past couple of years as a key market-moving element, figures too in Lombard Odier’s prognosis of the markets. The global supply chain pressure index (GSCPI) by the Federal Reserve Bank of New York has been keeping at “relatively normal” indicator levels, a sign that the ongoing Red Sea crisis has not yet affected the world’s return to normal, according to Chaar.
However, the chief economist warns that should the conflict last a whole year, there will be a material impact on the inflation of goods.
Meanwhile, the Baltic Dry Index (BDI), which is an index of average prices paid for the transport of dry bulk materials across more than 20 routes, has picked up increased costs of longer trade routes from China to Europe or the other parts of the world, Chaar notes.
This is a sign that these supply chain disruptions are having an impact, but it is of a “totally different nature” than the one experienced in 2022 when China shut its economy down, he adds.
Another indicator of how the geopolitical conflict may impact global economic activities can be measured through oil prices. The chief economist notes that oil prices are “relatively well behaved” for now, due to the supply coming from the US.
Instead, what is more important in these localised conflicts is how nations have been able to de-risk their supply chains from these impacted zones.
Finally, Chaar describes possible outcomes should a second Donald Trump administration occur. First, he expects an “American first” mantra to ensue, which would be a challenge for Europe and Asia, as tariffs will return and commitment to fund Ukraine or the North Atlantic Treaty Organization will come under question.
Second, tax cuts “might be back on the table”, as well as restrictive migration policies. This means that from 2025 onwards, the US might face labour market scarcities, potential worker shortages, which would cause higher wage growth and inflation problems.
