To The Moon

In 2023, all kinds of financial products on a global scale have undergone tremendous challenges. We have also seen many unprecedented financial phenomena. This requires us, as a cross-border financial institution, to carefully observe and meditate. It seems like only yesterday that I was writing about the top ten predictions for 2023, but the year has passed quickly.

I remember when I first joined Morgan Stanley to work on Wall Street after graduating with a Ph.D. from the University of Lausanne in Switzerland over two decades ago. Each year-end, we would study the top ten global economic predictions for the coming year by the company's Chief US Economist, Byron Wien. The debates between him and Steven Roach, Morgan Stanley's Chief Economist at the time, on macroeconomic topics were immensely beneficial for young professionals like us. Mr. Byron primarily researched the US economy, and he also served as the Chairman of the Harvard Club in New York, making him a schoolmaster-level figure on Wall Street. On the other hand, Mr. Roach later moved to Hong Kong to become the Chairman of Morgan Stanley Asia, then went to Yale University to dedicatedly study the Chinese economy, finally became a Wall Street expert on China. He subsequently published multiple books on the China and US economies.While Mr. Byron joined Blackstone as Vice Chairman and continued to release his top ten predictions annually. Mr. Byron passed away in early November at the age of 90, leaving behind a legacy of memorable contributions. He worked tirelessly until his last moment, organizing investor exchange events, delivering hundreds of speeches at Blackstone University, the New York Economic Club, the Harvard Club, and many more, serving as a guiding North Star for our growth on Wall Street.

This year marks my eighth time analyzing and providing ten predictions for the global economy in 2024 from a macroeconomic perspective. Through interactions with various financial institutions in Wall Street, the analyses of extensive financial data, and discussions with academic organizations, I have formulated the following viewpoints. (Please note that these viewpoints are not intended as investment advice, but rather as references for market information, and we welcome any feedback or criticism. Of course, I received invaluable assistance and support from my colleagues and partners at Horizon Financial in compiling these predictions.)

Out of the ten predictions made at the end of last year, one was false, six were true, and three were partial true. If we assign a 50% weight to the partial accurate predictions, the overall accuracy rate was 75%. Perhaps the most controversial prediction at that time was my seventh point. Last year, many people were still extremely optimistic about venture capital until the Silicon Valley Bank collapsed in March, leading to numerous discussions and debates with me on this topic.

Of course, as Barton Biggs, another mentor for macro research during my time at Morgan Stanley, once said, "When it comes to predictions, it's not just about the conclusion but more importantly the logic behind it. The logic can be accurate even if the conclusion is wrong." He also advised being cautious of individuals or institutions with consistently incorrect long-term predictions and suggested that their predictions could privately serve as efficient contrary indicators for trading purposes.

Here are my top ten predictions for 2024. In addition to the prediction itself, I also hope to lay out the analytical logic for discussion and research.

 Prediction 1: The Fed will begin cutting interest rates in the second quarter

Fed Chair Jerome Powell has been quite hawkish in recent years, not only in words, but also in actions. The violent rate hikes and balance sheet reductions starting from 2022 have had a significant impact on global financial markets. The challenge is that most economists only see the negative effects of the Fed's rate hikes, such as increased financing costs for businesses, major hits to highly leveraged industries like real estate, and negative cash flow projects in venture capital target companies. However, they overlook the positive effects, which include substantial interest income for middle-aged and elderly Americans with large savings, boosting their spending power and thus benefiting the US economy. Rate hikes have also led to a sharp rise in insurance company revenues, with Warren Buffett commenting that cash income this year has risen 50 times over last year. Additionally, rate hikes have attracted global funds to the US, positively impacting manufacturing relocation and capital investment.

The Treasury yield curve is expected to return to positive value after the Fed cut interest rates in 2024

As Richard H. Clarida, the vice chairman of the Federal Reserve, told us, raising interest rates is like painting a house—you need to wait for it to dry before enjoying the new look. With the Fed's current cycle of 11 rate hikes, many effects still need time to unfold, such as the rise in US personal auto and credit card loan default rates and the uptick in corporate bankruptcies. I believe the negative consequences of these rate hikes will become increasingly evident in Q1 2024. Among the Fed's three key responsibilities, inflation has already dropped rapidly. If unemployment rate continues to climb and financial stability becomes a concern in the first quarter of next year, there's a high likelihood the Fed will start cutting rates in Q2 2024, potentially starting in May.

The transition from a hiking cycle to a cutting cycle will undoubtedly bring substantial volatility to the US stock market. As American consumers begin to spend lessly, the financial reports of US-listed companies, especially many small and medium-sized businesses, may not look as rosy as they did this year. For instance, 40% of the stocks in the Russell 200 index are currently in the red, and these companies might see their losses widen next year. I expect a significant pullback in US stocks in the second and third quarters of next year, followed by a new all-time high in the fourth quarter. Investors should prepare for potential buying opportunities during these dips.

The us unemployment rate bottoms out and rises

 Prediction 2: Japan will raise interest rates in Q3

The Bank of Japan (BoJ) stands as a particularly unique presence globally, having maintained a zero-interest rate policy for three decades and implemented Yield Curve Control (YCC) to its fullest extent. It still clinging to a negative 0.1% short-term interest rate and a zero rate for medium to long-term government bonds. Such unsustainable practices, contrary to economic principles, are especially evident now as Japan's inflation becomes increasingly apparent, with Japanese companies beginning to raise wages amidst rapid price hikes across society, from food to housing. In 2024, there's a strong possibility that the BoJ will become the last central bank among developed countries to exit the Zero Interest Rate Policy (ZIRP). Timing-wise, it's highly probable that they will announce a rate hike decision in the latter half of next year, specifically in the third quarter. A substantial yen appreciation and a subsequent decline in Japanese stocks are both anticipated around this period.

Japan's inflation rate in the last five years

 Japan's current inflation rate for Q3 has hit 3.3%, on par with other developed countries. This is partly attributed to imported inflation due to Japan's heavy reliance on imported food and energy. Warren Buffett's large-scale investment in the Japanese stock market, particularly in the country's top five general trading company stocks, starting from 2022, also reflects an expectation for Japan's return to inflationary conditions.

 Prediction 3: Commodity market will be in a bear market

Global terminal demand weakness is expected to be the dominant theme in 2024, driven partly by the winding down of proactive fiscal policies across countries and partly by the increasing impact of monetary policy tightening. While speculation remains evident in financial markets, real economy demand is likely to fall short of expectations. Consequently, there will be a high probability of a commodity market bearish trend in 2024, encompassing industrial metals like copper, iron, lead, and zinc, as well as energy commodities such as oil and natural gas.

The World Bank's forecasts for global commodity markets over the next three years

In reality, the global commodity market has already witnessed oversupply this year, but geopolitical premiums in the energy market have soared due to conflicts like the Russia-Ukraine war and Israel-Palestine tensions. If global situations ease next year, commodity prices are anticipated to gradually decline, returning to supply-demand balance points or even dropping below cost prices.

Prediction 4: Big reshuffle of artificial intelligence sector

The AI sector in 2023 can be described as red-hot, with nearly 100% of the S&P 500 index's return this year coming from seven AI-related stocks, while the other 493 constituents' overall return is close to zero. Warren Buffett's insights on Apple's AI investment at this year's Berkshire Hathaway annual meeting were eye-opening.

 Seven artificial intelligence stocks of the S & P 500 and the remaining 493 stocks

Not only is the secondary market buzzing with AI-related activities, but the primary market for AI is also booming, with over 300 AI startups being established weekly in Silicon Valley, according to a friend of the author. With so many AI businesses entering the fray, intense competition is inevitable. The majority of these AI companies might face closure, making 2024 a year of significant reshuffling in the AI industry. Akin to the dot-com bubble burst in 2000, numerous AI enterprises could emerge stronger next year, but most traditional businesses will invest in their own AI applications.

 Prediction 5: Defaults rise in the high-yield bond market

Although the fixed income market witnessed a sharp decline in US Treasuries this year, credit spreads have remained remarkably stable, surprising many investors. Except for Chinese real estate developers, default rates in the high-yield bond market have been very limited this year. The primary reason is that the energy sector, which has benefited from high energy prices resulting from conflicts like the Russia-Ukraine war and conflicts in the Middle East, is one of the largest issuers of high-yield bonds in the US. However, many high-yield bond issuers will face maturity issues next year, including numerous US real estate developers with significant high-yield bond maturities. The probability of these issuers defaulting is expected to increase significantly.

The default cycle of American companies has begun

At present, the yield of US Treasury bonds is much higher than the historical level, while the spread of high-yield bonds is much lower than the historical level

Prediction 6: The $USD Index(USDindex.FOREX)$ will start a slow decline

Global investors are keeping a close eye on the US dollar exchange rate. I believe that the US Dollar Index has peaked in this cycle and will undergo a slow depreciation process. The primary reason is that the Fed's rate hike cycle has come to an end, and the conditions that prompted investors to funnel funds into the US based on rate hike expectations have changed. In 2024, the direction of the US Dollar Index will primarily be influenced by the trends in the Euro and Japanese Yen. If Europe regains peace and capital flows back into the region, it could potentially lead to Euro appreciation. There's also a possibility of Yen appreciation due to the Bank of Japan's exit from quantitative easing.

 Overall volatility of monetary indices in emerging market countries

Apart from countries facing extreme inflation, like Turkey, I believe that most emerging market currencies should appreciate against the US dollar in 2024. Especially after the Fed begins to cut interest rates, there's a high probability of capital flowing back into other countries, including capital markets in emerging nations.

Prediction 7: The Russia-Ukraine ceasefire will draw huge sums of money into European reconstruction

Undoubtedly, the Russia-Ukraine war has lasted much longer than anticipated. In a recent interview, Musk called for an immediate ceasefire in the Russia-Ukraine war and maintaining the status quo at the current border. He stated, "If the leaders of Russia and Ukraine continue to sacrifice their countries' flowers, young soldiers, and send them to the front lines to die in trenches like in World War I, history will treat them very harshly." 2024 will mark the third year of the Russia-Ukraine war, and considering various factors, there's a significant possibility of a ceasefire. Post-ceasefire, Europe will require reconstruction, which will have an immense impact on the global economy. From a supply perspective, Russia and Ukraine can resume large-scale exports of energy and food, which is very positive for global supply. In terms of demand, reconstruction will necessitate importing large quantities of machinery and consumer goods, which will also significantly boost exports for various countries.

Ukraine's economy has gradually returned to normal since the war

As Ukraine gradually transitions from a wartime economy to normalcy, on October 26th this year, the Central Bank of Ukraine announced a 400-basis-point cut in interest rates, lowering the benchmark rate from 20% to 16%, due to gradual economic recovery and declining inflation. Subsequently, on October 27th, the Central Bank of Russia announced a 200-basis-point increase in interest rates, marking the fourth rate hike this year to combat inflation, raising Russia's benchmark rate to 15%. It's evident from financial markets that the financing costs of both Russia and Ukraine are now very close. If the two countries achieve a ceasefire, arbitrage opportunities based on interest rate differentials can largely be avoided.

Prediction 8: New energy investment will accelerate

Much of the stronger-than-expected growth in the U.S. economy this year comes from the Inflation Reduction Act (IRA) passed by Congress in November 2022. Last year, I attended the IRA convention in West Virginia and witnessed the massive investment in new energy. Of course, new energy investment does not happen overnight. From solar and wind power generation to electric vehicle promotion, this year is just the beginning. Based on my observations, these new energy investments in the US, especially in power generation and charging stations, should accelerate in 2024. While Musk's statement about increasing US power generation by 100% next year might be somewhat exaggerated, the direction he's pointing towards is very accurate. Currently, one-third of US energy demand comes from transportation, one-third from cooling and heating, and one-third from computing needs. Transportation and cooling/heating are still primarily reliant on gasoline, diesel, and natural gas, which are rapidly being replaced by electricity. Thus, a significant increase in power generation next year, especially from new energy sources, is inevitable.

Buffett's Berkshire Hathaway is constructing a new energy hub in West Virginia

One major requirement of the US Inflation Reduction Act is local production, which necessitates building power plants near factories. Currently, these power plants largely rely on wind, solar, and hydrogen energy sources. Investments in this area will only continue to scale up in 2024.

Prediction 9: The global industrial chain restructuring will be completed

A significant change in the global economy this year is the restructuring of supply chains, driven by both supply and demand factors. From the supply side, many companies are establishing new production bases in Mexico, Southeast Asia, and India. From the demand side, the post-pandemic consumption boom in the US and Europe has quickly cooled down, leading to many retail businesses focusing on reducing inventory in 2023. The result is a rapid decline in global logistics demand, with prices for shipping, air transport, railways, and roads all dropping sharply. Shipping prices have returned to 2019 levels, and many US trucking companies are facing bankruptcy and closure. The abnormal phenomena during the pandemic, such as port congestion and dock worker strikes, have gradually disappeared. 2024 will be the first year for the global supply chain to return to normal, with excess transportation capacity and newly established production bases expected to normalize.

The largest yellow truck company in the United States declared bankruptcy

Prediction 10: Latin America's economies will change dramatically

 The recent presidential election results in Argentina have left many people surprised, with the new president, Mire, bringing a unique background as an economist, football player, and pop musician. His right-wing economic ideology may seem extreme but is also understandable given Argentina's long-standing economic challenges. With Argentina's sovereign debt in default for two decades, high inflation rates, and a greatly devalued currency, young people in the country are eager to try new economic policies. Dollarization, a controversial option, could be seen as a last resort when other measures have failed. Ecuador, one of Argentina's neighbors in South America, adopted dollarization in 2000, replacing its domestic currency with the US dollar as the only legal tender. Since then, Ecuador has achieved three major economic goals: stabilizing the domestic economy, gaining confidence from foreign investors, and restoring faith in the local financial system. Over the past two decades, Ecuador has maintained a trade surplus, reduced government debt, and achieved stable economic growth.

 Economic growth in Ecuador

While Argentina's adoption of dollarization aims for similar outcomes, it faces an uphill battle with potentially many setbacks. Latin American countries have long oscillated between liberal and conservative economic policies, learning costly lessons over the years. However, these countries possess valuable resources, including minerals and agricultural products, and are also home to some of the world's most ecologically diverse regions. The current global demand for electric vehicle batteries, energy, and food commodities plays to Latin America's strengths. Notably, Argentina's new president has enlisted a prominent American macroeconomics expert as his economic advisor, which could lead to economic policies yielding better-than-expected results. Despite potential challenges, the overall upward trajectory of Latin America's economy in 2024 appears promising.

Prediction 11: Additional discussion of real estate

Given that global investors, particularly high-net-worth individuals and large institutions, have significant investments in real estate, we offer our views on this market as an additional topic outside our top ten predictions.

Firstly, real estate is a highly fragmented market varying by location and sector. Our focus on healthcare real estate investments in the southeastern United States due to healthcare being a relatively counter-cyclical industry and the region experiencing consistent population growth. We advise against investing in real estate in areas with stagnant or declining populations.

Secondly, post-pandemic trends indicate that remote work will persist, leading to long-term structural challenges for large office buildings in major cities due to increased vacancies. We recommend avoiding significant investments in large-scale office properties.

Lastly, regarding residential properties, a generation of investors has become accustomed to leveraged real estate investments, especially in residential properties, due to two decades of zero or ultra-low interest rates. With central banks from the Federal Reserve to the European Central Bank and those in emerging markets maintaining a stance of  Higher for Longer, the cost of capital remains high. This makes most real estate investments unsuitable for long-term investments. Coupled with aging populations, the structural risks in the residential real estate market will continue to rise. The principle of "housing is for living, not for speculation" should guide the market in the coming years. Even in the US, where the average home price nationwide hit a new high at the end of the year, investors may see minimal positive returns on residential properties due to soaring financing costs, a significant drop in new home sales, and a surplus of vacant properties.

Sales of new homes in the United States have fallen to the level of the 1960s

In summary, 2024 should be a year of recuperation. The stock market, bond market, commodities, real estate, and foreign exchange market should all be developing in a direction towards normalization. The era of zero interest rates is unlikely to return, and the Federal Reserve's aggressive rate hikes have come to an end. In 2024, there is a trend of mean reversion in the risk premium of major asset classes. We believe that investors need to consider diversifying risks and focusing on stable allocations. Of course, like Mr. Buffett, keeping some cash on hand to deal with unexpected needs and to enter the market at the bottom when market risks are mismatched should be our core strategy.