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Dan Alderson

When a war breaks out, people say: “It’s too stupid; it can’t last long.” But though a war may well be 'too stupid', that doesn’t prevent its lasting. Stupidity has a knack of getting its way; as we should see if we were not always so much wrapped up in ourselves.

I had planned to start 2024 Macro Propheting with a more upbeat message than that given by Albert Camus in 'The Plague', but geopolitical risk has a knack of wrecking optimism at this time of the year.

Conflict again, unfortunately, looks likely to move markets more than other factors at the get go, even if primary pipelines and central bank dot plots were what investors had front and centre even a few days ago.

Some of this year’s opening credit market weakness could be attributable to expectations the January pipeline for high yield bonds and leveraged loans will be strong. Various deals are already earmarked, as my colleague Laura Thompson detailed here for Europe, and there is often overspill after a busy December. Thus investors might be selling out of existing paper to make room for new.

Likewise, going long CDS in the absence of primary market opportunities was a notable theme of 2023, with the volume share of single name CDS rising versus cash credit instruments, along with increased index and option trading. 

Therefore some synthetic credit spread widening could be preparation for new bonds and loans, and the sell off in indices like iTraxx Crossover and CDX HY would be more pronounced given these liquid contracts are the first things investors would look at to de-risk long positions, or add hedges.

Another understandable component would be that investors are looking to rebalance in credit after the prolonged bull-run. This explanation would similarly address the correction in equity markets, after the S&P 500 enjoyed an incredible nine straight weeks of improvement — its longest winning streak in 20 years.

S&P 500 — past six-months’ performance

One also has to factor in dwindling rate cut hopes for Q1. The latest Fed minutes made no mention of plans to hike or cut, while German inflation rising to 3.8% in December (from 2.3% in November) won’t help soften the ECB’s hawkish stance. US and Eurozone PMI Services numbers rose more than expected in December — the former from 50.8 in November to 51.4, the latter edging up from 48.7 to 48.8. Although arguably a positive, this won’t enthuse policy committees to pivot. And still there is conspicuously little discussion about the sort of bad market conditions that would need to be in place for the Fed to start cutting. History suggests optimistic sentiment around risk asset outperformance may not necessarily last long when that happens.

But with Crossover 33bps wider in the year’s first two sessions, to 343bps (although recovering slightly to 340bps Thursday), and the Russell 2000 dropping nearly 2.7% Wednesday, there is clearly more afoot than all these considerations. It looks like financial markets are finally waking up — rudely — to something that has been right in front of everyone’s eyes as headline news for three months. Though geopolitical volatility has been on the menu it is only now translating into a quick uptick in credit volatility (admittedly from very low levels), as evidenced in the Credit Vix.

iTraxx/CBOE Europe Crossover one-month volatility — via S&P

In the final quarter of 2023, surging asset markets largely disregarded Israel’s escalating assault on Gaza following the 7 October Hamas attacks. But as the death toll there reaches ever more horrific levels, Israel is extending its campaign into Lebanon and Syria. Without any firm request to desist from western governments, the pursuit of Hamas is in danger of becoming all-encompassing and without limitation in the way the “War on Terror” did in the early 2000s.

Various other neighbouring countries could easily get drawn in or destabilised, presenting an array of deeply unpredictable outcomes. Think Iran intervening (and having experienced its own, IS-claimed, bombing attacks); think Iraq’s fragile government in a balancing act between the US and Iran (from whom it imports 40% of electricity and gas); think Egypt facing mounting pressure to accept Gaza refugees into North Sinai with no prospect that they will ever be able to return.

Think the Suez Canal route for commercial ships becoming blocked by Houthi attacks, or the conflagration that will ignite if a US ship (which have grown in number in the Red Sea lately, as commercial disruption rises) were to be sunk. The attempted hijack of a Maersk ship over the weekend has prompted it and other carriers to rethink passage through the Red Sea.

This assumes ships don’t have to change plans mid-route

Being forced to reroute via the Cape greatly adds to cargo travel time and shipping costs, while cutting capacity. In a televised interview with Fox Business on Wednesday, freight booking platform Freightos’ CEO Zvi Schreiber said 50% of ships are diverting and the FBX 11 index, which tracks the Suez route cost from China to Europe, is up around 30% since November.

Newswire reports (BBG and Reuters) citing Freightos data suggested overall Asia-to-north Europe rates have more than doubled to exceed $4,000 for a 40-foot container, with Asia-to-Mediterranean prices hitting $5,175. Here’s what the Drewry World Container Index shows:

This on its own may not entail the level of supply chain disaster that has been witnessed in recent years. And for now the pressure on oil remains more to the downside than towards the $150 a barrel levels forewarned by some economists should the Middle East conflict spiral. WTI crude slumped 2% on Thursday, to $71.37 a barrel — a far cry from the $90+ pricing of September.

Oil performance finished 2023 rather dismally, unlike the bulk of financial assets, as this chart from Deutsche Bank shows. Spiking oil prices in 2022, driven by Russia’s invasion of Ukraine, were a big part of the inflation problem central banks have grappled with since. But the subsequent slump suggests a converse challenge around world economic growth outlook (rather than, say, allowing a positive ESG spin).

Perhaps the softer markets this week also simply reflect that investors view 2024 as another year that is inherently unpredictable. Certainly 2023 took the majority of market participants by surprise, on multiple fronts.

Many economists had expected the US to enter recession, yet it printed 5% growth in the third quarter. China was tipped for a post-covid boost, but instead added to macroeconomic concerns with a slump into deflation and a deepening property crisis.

The negative correlation between US government bonds and stocks in 2022 did not reverse as anticipated, largely due to an AI-driven rally. In fact the Nasdaq 100 had its best year since 1999 as Nvidia posted 350% stock price gains (doubling the performance even of Bitcoin) and the Magnificent Seven (the other six being Amazon, Apple, Google, Meta, Microsoft and Tesla) accounted for almost all of Nasdaq 100/S&P 500 gains. 

Some rebalancing is due, but a lot of us thought that in Q3. I doubt many would bet on the premise with conviction after what happened in Q4.

The US Treasury curve not dis-inverting in 2023 was probably the biggest surprise for me. But on reflection, I think that has to go hand in hand with the Fed actually pivoting on rates, rather than just agreeing to a pause. Markets have had this priced in as 85% likely by March, which suggests Q1 will be a real testing ground for investors’ strategies, and that a lot could change by Q2. 

For a large swathe of 2023 it looked like being another very bad year for passive 60:40 and ‘all-weather’ risk parity strategies, still nursing their wounds from 2022, as Markov Processes analysis detailed here. Only the strong year-end rally (December in particular) made amends for the earlier poor performance.

S&P Risky Parity Index — 10% target volatility 

It’s probably not incredibly insightful to suggest at this point that bad economic data will continue to help government bonds, but hurt stocks. Although, based on this chart, maybe even the time honoured flight-to-safety mantra is misguided.

I’ve seen a few people try to canvas opinion on public forums such as LinkedIn about what will be 2024’s biggest outperformers. I won’t spoil anyone’s fun by quoting results, but from some quite widely voted exercises I’d say it’s looking like anyone’s guess between gold, Bitcoin, the Magnificent Seven and 30-year Treasuries.

A big relative value question hangs over CLOs versus underlying bonds and loans after 2023’s performance, as revealed by JP Morgan’s $-CLOIE index. I suppose if 2024 is a repeat you may not lose too much sleep though on +10-20% gains across most of the cap stack. The major question not addressed by these aggregate numbers though is dispersion — both in CLO performance and the credit spectrum of the underlying assets. We didn’t see much of the promised dispersion in 2023, but it looks like a bet in the post that will crop up in 2024. If so this will widen the gap between different manager tiers and make it harder for B3 credits to find a home in CLO portfolios (given concerns of downgrade to triple-C).

To end on a more fun note — having begun with an angsty existentialist — I’d posit that picking this year’s top movie box office smash will be an even harder exercise than it was in 2023. I’m not sure how many people saw Barbenheimer coming, but it gave a massive boost to the ailing cinema industry. 

Barbie alone took over $1.4bn from audiences globally, with simultaneously released Oppenheimer reaching almost $1bn. Looking ahead, I’m struggling to find an obvious cultural event of that order in the pipeline Rotten Tomatoes has put together — but some of the list are indeed anticipated to surpass $1bn. Can you pick those winners?

Actually let’s sign off with an optimistic message from Camus himself, taken from one of his letters. Setting aside financial market fortunes for a second, this is a message for improved humanity, which is what I hope we will see a lot more of in 2024. Either way, if it gives you added personal resolve to deal with the challenges ahead — whatever they may be for you — then so much the better:

In the midst of hate, I found there was, within me, an invincible love.

In the midst of tears, I found there was, within me, an invincible smile. 

In the midst of chaos, I found there was, within me, an invincible calm. 

In the midst of winter, I found there was, within me, an invincible summer. 

And that makes me happy. For it says that no matter how hard the world pushes me, within me, there’s something stronger — something better, pushing right back.

Is it better to stand on a ledge for eternity, or take the family to watch Despicable Me 4? (photo source IMDB)

Macro Prophet — Barbenheimer II

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