Will energy and raw material prices increase further?
Because, while waiting for the Christmas rally, the risks of rising inflation remain. Analysis by Ritu Vohora, Investment Specialist, Capital markets, T. Rowe Price
With the holidays upon us, can we expect a Santa Claus rally? Global markets surged in mid-November as falling inflation data in the United States and United Kingdom boosted hopes that major central banks are done raising borrowing costs.
End of the rate hike cycle
US CPI data delivered a downside surprise: headline CPI posted 3.2%, down from 3.7% in September, below forecasts of 3.3%. This resulted in a sharp decline in US Treasury yields across the curve and a rally in most asset classes. It was a big event for stock bulls. The report perhaps confirmed the market's view that the Fed has ended its rate hike cycle. We believe the Fed has reached the terminal rate for this cycle. However, it will be important to listen to his communications on inflation versus the labor market. The latest payroll data indicates that labor demand is cooling, but we see no signs of significant weakness yet.
After the surge in yields in recent months, which crushed some parts of the market, the view that real rates need not be so restrictive has provided some relief and bolstered hopes that the Fed will be able to rein in high inflation without causing a painful recession.
The Fed has already raised interest rates to the highest level since 2001, with the last hike in July. Investors are wondering whether 2024 will be the year of rate cuts, with two cuts priced in by July next year. This is despite Fed officials reiterating that they will likely keep interest rates high for some time to ensure a sustainable decline in inflation. So while the timing and size of any cuts remain uncertain, we are in a new regime of higher rates for longer. This means greater competition for capital and real portfolio returns are likely to be lower than over the past decade.
The investment environment will remain tricky to decipher as the world navigates through post-pandemic disruptions. The fragile balance that has supported risk assets to date could persist through the end of the year and drive a holiday rally, but we remain concerned about the risks to upside inflation and downside growth, especially given the lagged effects of the worsening and weakening of the factors that favored consumer resilience.
While we expect greater volatility, we are likely to see more diversified sources of return for those focused on fundamentals and valuations. It might be a good time to diversify your stocks.
We expect earnings growth to extend across all sectors and regions with a wave of disruptive innovation in key sectors and an improving structural outlook for commodities broadening the opportunity set for global equities in 2024.
Game changer: generative AI
The massive outperformance of the “Magnificent 7,” mega-cap technology stocks, driven by the prospects of generative artificial intelligence, has been a hallmark of the stock market in 2023, and has driven the strongest concentration of returns since the 1960s. While valuations appear high among this small cohort, they may be somewhat justified by the high return on equity offered by these companies (33% versus 18% for the S&P 500).
Looking ahead to 2024, earnings growth will be a key determinant of winners and losers. We believe many companies will benefit from AI applications across technology, broader industries and complex businesses with the ability to improve productivity. Opportunities include those who support the chip ecosystem, across a range of software, semiconductor, internet and data center stocks. Winning companies are likely to be those that are developing the 'pivotal' technology to enable the next innovation cycle and that have a compelling path to monetization.
Outside of the dominant tech stocks, the other 493 stocks in the S&P are trading at about 15.6x forward earnings. This is a value in line with the fair value both on an absolute historical basis and with respect to interest rates.
Energy: costs and investments on the rise
Commodity cycles tend to last 10-15 years, driven by long waves of productivity that drive prices. Since 2011 we have been in a bear market. However, we may now be at a turning point. Energy productivity fell towards the end of 2022 and is now recovering. This is fueling rising cost curves, as producers need higher incentive prices to start new projects and increase supply. This will likely lead to a structural increase in energy prices.
Furthermore, as the world pursues decarbonization ambitions, the need for green infrastructure will likely fuel an increase in demand for metals and materials and a new investment boom. As global suppliers, this could work in emerging markets' favor. Finally, geopolitical volatility also has implications for energy security and should contribute to structurally higher oil and gas prices.
This is a machine translation from Italian language of a post published on Start Magazine at the URL https://www.startmag.it/economia/i-prezzi-di-energia-e-materie-prime-aumenteranno-ancora/ on Sun, 10 Dec 2023 06:36:32 +0000.