2024 has been a year marked by uncertainties and surprises. From financial markets to geopolitical developments, and from fluctuating interest rates to persistent inflation, events that once seemed unlikely gradually turned plausible and ultimately became reality. Whether it's Trump sweeping the elections by capitalizing on the perceived inefficiencies of the Biden administration or the Modi government falling short of a majority to form the next government, one thing stands out: aggregate economic data doesn't resonate with voters. Voters base their decisions on personal experiences, making it essential to analyze segmented and granular data to predict electoral behavior.
From the Fed delivering a "jumbo" rate cut to the unfolding yen trade fiasco and Israel's retaliatory actions, markets have seen it all this year. What's interesting is how markets reacted or didn't react. In some cases, markets shrugged off pessimism, while in others, they experienced significant turbulence. These jitters often occur when outlier events, which markets fail to price in, take everyone by surprise. And yes, "surprise" is the term that rattles portfolios across the globe. Volatility and surprises share a strong positive correlation.
As we navigate this landscape, it's critical to track every possible event and sentiment in the public domain. While these events may cause minor disruptions, the real challenge lies in understanding their second-order effects. By anticipating these ripple effects and aligning strategies accordingly, one can challenge the efficient market hypothesis.
In the past, debates on generating alpha focused on efficient asset allocation. However, the definition of asset allocation is evolving. It's no longer confined to mid-caps or small-caps. Today, beating the benchmark requires decisions about which country to gain exposure to and which assets to hold—be it crypto, gold, silver, real estate, or stocks.
Looking ahead, five key trends will shape the markets. Remember, it's never just about the events themselves; it's always about the surprises they bring and their cascading impacts on portfolios.
- Chinese Stimulus
- US Tariffs
- Regulation on Crypto
- Inflation
- Interest Rates
Chinese Stimulus
The 2024 Chinese stimulus package, announced in September, is one of the country's most significant efforts to address its slowing economy. The Chinese stimulus package had an immediate positive impact on the Chinese stock market, particularly in the short term. After the announcement of the measures, the CSI 300 Index, which tracks the top companies on the Shanghai and Shenzhen stock exchanges, surged by 4.3%, almost erasing its year-to-date losses. This rebound was largely attributed to investor confidence in the government's commitment to supporting the economy and stabilizing financial markets. Post the stimulus efforts, public fatigue began to build, which was clearly evident from the sell-off and outflows the market experienced. It was evident that markets were screaming for more stimulus measures, and groundwork to boost consumption was far from what this stimulus was supposed to achieve. So why is China shielding itself given the scale and size of its economy, comfortable public debt to GDP, and running a 100 billion dollar surplus a month?
So, Post CEWC. The current policy approach of the Chinese government appears to be more reactive than proactive, especially regarding tariffs that are set to take effect following the Trump administration's policies. Boosting domestic consumption is on the agenda, but it seems Beijing is taking a conservative stance with the stimulus measures announced so far, likely waiting for clarity on the tariffs before responding with policies they consider necessary. Depending on the severity of the tariffs, China may respond with substantial monetary and fiscal support to counteract their impact.The ultimate goal for China is to ensure that its policies—both monetary and fiscal—offset the effects of the tariffs, particularly by supporting its manufacturing sector. China aims to maintain its global leadership in manufacturing, including high-tech manufacturing. This intent is evident from China's rising share in global automobile production, which has grown from just 1% to 30% over the past decade.China is likely to go all-in to support its industries, which raises a key question: Will this response negate the intended purpose of the tariffs, which were implemented to address trade imbalances? Alternatively, could we see companies collaborating, investing in new economies, and creating jobs as a result?It's worth noting that Trump was elected to prioritize growth over inflation, but tariffs may also hurt the U.S. economy by making it difficult to find alternative markets, thereby reducing manufacturing competitiveness. This, in turn, could undermine the very goals the tariffs were meant to achieve.
Note: Battling deflation and property market concerns, Beijing faces pressure to implement massive stimulus to avoid the 'Japanification' trap of the 1990s. Both China and Europe (struggling to maintain positive growth amid rising debt servicing costs, competition from China in major industries, and demographic headwinds) should be on one's watchlist. But why?"
Remember: pessimism, when propagated, serves its purpose all too well.
The Tariff's
Before we begin, let us question. Why did Mr. Trump succeed and defeat his rival Joe Biden? Just think about it once!!
What did Biden do? Nothing wrong? And what went wrong? Almost everything he did?"
From launching full-scale stimulus measures, adding $12 trillion to the Fed's balance sheet in the last four years—mind you, that's as much as the U.S. government added in its entire 244-year history, from George Washington to James Buchanan and from George Bush to Obama"—in debt, and Mr. Biden and his administration went all in. Liquidity was out in the market, and the supply (production) did not catch up. Remember, the government doesn't produce anything, and someone's debt is someone else's income. Therefore, unlimited liquidity chasing a limited supply—what would it result in? Yes, inflation
It built up in such a way, casting doubts and questioning FED quantum machines and brains. The Fed's actions followed then, raising interest rates at a pace never seen, which not only flipped money out of the pockets of consumers but also flipped the government. Thereby, Trump solely won the election due to Biden's administration's inefficiency in controlling inflation, which hurt the US consumer, and Trump's aggressive policy stance, ranging from MAGA (Make America Great Again) focus on nominal GDP growth, immigration, tax subsidies, prudent fiscal policies, and, importantly, letting the economy run hot with moderate inflation and low interest rates, which won public confidence.
Now think again: are tariffs really a factor to be worried about? Tariffs induce inflation and are inflationary in every possible way. Tariffs are largely a propaganda tool and part of election promises (such as the proposed strong dollar policy and a 60% tariff on China). However, implementing such measures is far more complex than it seems. Trump has primarily won the election by capitalizing on the Biden administration's inefficiency in controlling inflation. This raises the question: Will tariffs really be implemented? It reminds me of a popular Hindi saying, "Sleep early, or Gabbar will come," and in here it is being used to calm markets by creating a bit of panic and restoring sanity.
The second-order effect. The U.S. will definitely compensate for the lost output it imports (as it will be costly for the U.S. to produce domestically) from China by sourcing from countries like Vietnam, Mexico, India, and Brazil, where China has already formed, or is in the process of forming, joint ventures with local companies. Re-export markets will gain momentum, and regional hubs will emerge, or another way that may surprise the markets is Chinese FDI seeping into the economies, where they set up the base in the Americas/others and start production and share limited technical know-how, and thereby a win/win for both the economies and global supply chains.
Also note: Another debt ceiling showdown looms while federal debt continues its relentless climb beyond $34 trillion, hence the need to refinance this more affordably. The shale revolution, pro-growth policy, and the AI revolution are major reasons for the extended US rally, the latter playing an important role.
Crypto's
Well, we all know the evolution of crypto—from an asset class once dismissed as insignificant to one that has gained widespread acceptance, culminating most recently in the launch of ETFs that further legitimize its role in mainstream financial markets.
What makes crypto an asset class so hard to avoid?
Gold investing gained widespread popularity with the launch of the first Gold ETF in 2004, triggering a dramatic rise in prices as substantial retail investments flowed into GLD. Similarly, in January 2024, Bitcoin investing became mainstream with the debut of the first Bitcoin ETF.
The crypto market, currently at ~$3.5T, could potentially expand to $8-11T by cycle end. Why?
- Institutional capital seeking non-correlated assets.
- Growing recognition of crypto
- Increased regulatory clarity driving adoption, especially in Trump's US
- Technical cycle alignment with macro debt dynamics
Earlier, the roaring U.S. economy fueled growth in other markets, but now it seems to be drawing capital away from them. A surprising historical anecdote lies in the period post-1970, after the Bretton Woods system collapsed and the dollar was decoupled from gold. This shift ushered in market-driven currency dynamics, yet the dollar needed a mechanism to sustain its demand. This led to the emergence of the petrodollar system. Drawing a parallel to the present, could it be possible that crypto, as an emerging asset class, might play a role in supporting the dollar today in a way akin to how gold once did or the emergence of the petrodollar? So in that sense, crypto could create a parallel dynamic to the petrodollar system by sustaining or even increasing global dollar demand.
Note: Keep a watch on it; maybe a certain % of your portfolio returns should be driven by it.
Inflation & Interest Rates
What induces what?
Lower interest rates induce inflation, or high inflation induces high interest rates; it's a chicken-and-egg analogy, isn't it? With some turbulence and a few jolts, central bankers navigated their way to a conclusion in 2024. The dire forecasts suggesting that only severe recessions could bring runaway inflation under control turned out to be wrong. Instead, a significant rise in interest rates, improvements on the supply side, and the mere passage of time were sufficient to achieve the desired outcome.
Gone are the days when economic challenges were solely driven by monetary policies and when problems were mostly addressed through policy measures. Today, monetary policy alone is neither the cause nor the solution to economic issues. The world is so interconnected that an increase in interest rates in one region can trigger a selloff in other markets unless addressed or commented on (think of the yen trade debacle).
An intriguing fact: the RBI has spent $200 billion since 2022 managing its currency, as it couldn't afford to engage in policy maneuvers due to inflation concerns. This clearly demonstrates that monetary policies are no longer a micro-level agenda; global policy dynamics now play a critical role in economic movements. Recall the recent Fed meeting, where the 2025 outlook and terminal rates, once projected to be around 3%, are now expected to rise to 3.5%.
However, with rising debt servicing costs, it's likely that more quantitative easing and continued monetary expansion may be on the horizon. It's essential to understand the second-order effects of these developments. Consider 2020, when markets had crashed and bottomed out, followed by a strong one-way rally that seemed unstoppable. The crash was expected, but few anticipated the second-order effects of government stimulus (which were in line with second-order thinking). Those who saw this coming made substantial gains during the rally.
Liquidity and stimulus will likely fuel the bubble even further. Remember, liquidity is the primary driver of bubbles, while fundamentals take time to catch up. The current bubble may slow down and even consolidate due to global uncertainties, but it's still likely to persist for the long term. Bonds might be a decent short-term option given the easing on cards, but…
- Traditional safe havens, such as bonds, are losing appeal as sovereign debt risks rise.
- Hard assets and inflation hedges are becoming more attractive as currencies face mounting pressure.
- Riskier assets, particularly cryptocurrencies, could attract significant investment as investors look for alternatives to conventional financial systems.
The Indian Markets in a Nutshell
Believe the markets are heading for a period of price and time correction, where valuations will cool down. The next bull phase will begin when the markets shake out weak hands. The decadal themes will emerge, and the winners of tomorrow aren't yet reflected in today's indices (a hint). The days of multi-bagger growth driven by stocks like Asian Paints or HDFC Bank are behind us. Pay attention to where liquidity is flowing and what the government is focusing on, and plan your allocations accordingly. The government holds the power to shape the winners and losers in this market. Bonds are likely to outperform equities, and deeper cuts are on the horizon. The pain is real.
Gold and silver offer diversification in a market where most other assets are priced to perfection.
Indian equities remain expensive. The Nifty 50 Index continues to trade at 23x trailing earnings, with earnings growth slowing to single digits. The broader mid- and small-cap space is also trading at high multiples. The Nifty Midcap 150 Index is at 40x trailing earnings, and the Nifty Smallcap 250 Index is at 32x trailing earnings. Large-cap stocks offer relative advantages over SMIDs, although their absolute valuations are above average. Markets are never truly expensive; it's our emotions that drive up costs, influencing our choices and decisions.
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