We are starting a new year and it is important to highlight the big risks for the year 2024 which could impact the financial markets. Obviously, there are several but we will focus on 8 of them. There are risks that cannot be anticipated, such as a blackswan for example. But there are also risks that we can know in advance and which we can underestimate. This is why we are going to look at these risks together.
1. A wave of optimism about the rate cut for 2024
Throughout 2023, we juggled between the probabilities of rising and falling rates. Consequently, financial markets have ridden the wave of these expectations. We can support the fact that the end of 2023 was mainly marked by expectations of a rate cut for 2024. Obviously, this wave of optimism generated a good part of the entire end-of-year performance. based on anticipations and not actual facts. For example, we can see in the table below that the forecasts give 7 rate cuts until the end of 2024.
But what if inflation is more resilient than expected and we don’t have all these rate cuts? This becomes a risk for financial markets. They may not like this since the rise was largely driven by this. We can see in the graph below that the FED’s decisions remain a driver for the markets for 2024.
2. Inflation more resilient than expected
Despite major efforts to reduce inflation since 2022, it may be more resilient than expected. On another note, we could say that the 3% level could be the new 2%. There are several factors that can keep inflation above 3%. We will list a few of them below:
- Shipping costs, see Shanghai index
- The fiscal deficit which can lead to fiscal dominance and maintain high rates
- Maintaining a support level on raw materials
- Service inflation still resilient
Regarding shipping costs, you can see the rise of the Shanghai index below:
Regarding commodities, as there is a correlation with inflation, we can see that the support level remains quite resilient. Unless this level breaks, this will not help inflation.
Generally speaking, if we don’t have an accelerating economic slowdown that could lead to higher unemployment, it will probably be difficult (but not impossible) to bring inflation down below 3%.
3. Political risks for the presidential election
We are entering a presidential year for the USA, which means bringing to the fore the conflicts between the two parties, Republican and Democratic. A return of Donald Trump could be possible and at the same time generate volatility on the markets. Conflicts between the two parties very often concern state spending, immigration, the fiscal deficit and the debt ceiling. For example, there are conflicts over the debt ceiling limit but also over spending. This is why we have heard a lot about shutdowns during 2023.
4. The risk of recession
The risk of recession is once again postponed until later. To talk about recession, we need to have leading indicators that give signals. This is particularly the case with the inverted yield curve gap. That said, there is a delay between the bottom of the inversion and the recession:
That said, the difference between 2022 and 2023 is that in 2022, the majority envisaged a recession and in 2023 a soft landing. We can see this in the data that is taken from Google search. And generally, that kind of optimism or pessimism over time is not necessarily what’s going to happen.
From an economic point of view, we are still in stable growth with a resilient job market. The most important variables to watch for 2024 remain unemployment and inflation. For the moment, we still have no acceleration in the level of unemployment.
Therefore, we are not in the hard landing theory and it is still early to talk about the soft landing theory as long as the FED has still not reached its inflation targets of 2%. Therefore, we are still in transition.
5. The concentration of risk in the MAGNIFICENT 7
It is true that the performance of the index for 2023 is impressive, but we must highlight the fact that it was fueled by the Magnificent 7. When we talk about the magnificent 7, we are talking about: nvdia, microsoft, apple, facebook, amazon, google, tesla.
Here is an illustration of the performance of the Magnificent 7 compared to the rest of the S&P500 index:
This concentration may pose a risk to financial markets if we experience rotation and rebalancing within the index. Moreover, we can even see that hedge funds are fully invested.
In the past, a concentration of risk has not really been positive for the performance of a futures index. It becomes less and less efficient.
There are several reasons why these 7 assets have outperformed. Firstly, these are companies which initially have more liquidity than other companies. As a result, they found it easier to cope with inflation. They had become the “new defenses”. Thanks to this availability of liquidity, these companies were able to place their money on the money market and benefit from high rates of return. Moreover, during the covid period when rates were very low, these companies took advantage of issuing corporate bonds at low rates. They were thus able to use this liquidity generated by corporate bonds to place it at higher money market rates.
6. Artificial intelligence and the risk of bubbles
The other element that marked the Magnificent 7 is obviously the emergence and development of artificial intelligence. As they have more money, they have been able to invest in the development of artificial intelligence. For example, we can highlight the performance of NVDA which has become a leader in the industry. Particularly with the release of its new GPU graphics card which can cope with artificial intelligence models.
From a technical point of view, all this euphoria focused on AI can create a stock market bubble just like in the 2000s with the internet. And just like in 2000, we have a concentration of major stocks within the stock index. Therefore, this may represent a risk of a bubble in the financial markets. However, AI can address several problems that we will face in the future, particularly in terms of labor shortages. As debt is high and population growth in developed countries is increasingly weak, productivity needs will have to be met in another way. This is where artificial intelligence can take place and increase the productivity we need. However, like any emerging industry, we risk being confronted with certain situations that will overwhelm us, which would result in the emergence of new regulations.
7. Country debts too high
We know that since covid and the liquidity injections, we have had exponential growth in debt. This type of situation can become counterproductive in the long term. The greater the debt, the lower the growth. The upside here is that artificial intelligence could increase productivity in some way. Here is an illustration of the overall debt:
However, having high debt increases a country’s risk of default. Therefore, a higher yield premium is required to attract buyers. It is in this vein that we risk having structurally high rates for a certain period of time. And this can represent a risk on financial markets in the sense that high rates can become unbearable for large holders of government bonds (institutions). Yes because their bond portfolio is made up of unrealized losses. This may affect the liquidity available to banks with lower assets. This was the case for regional banks in March 2023. Consequently, a certain balance will have to be adjusted in the long term.
8. Geopolitical risks
News which concerns geopolitical phenomena already present for several months/years has less and less impact on the markets. We are talking here about cases like Ukraine, Russia or the conflicts in Israel. As these are cases already priced in the markets, there is less risk of repercussions on the markets if further news on this subject arises. However, other events that are not yet concrete may have an impact. This is particularly the case with Taiwan and China or other cases that are still unknown today.
Conclusion
In all cases, we cannot control or predict the events that will happen, but we can have an idea of the major elements that can disrupt the environment. It is from this information that we can have an idea for the year 2024.
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