Half the cat is dead!
In popular culture the thought experiment of Schrödinger’s cat has gained some level of popularity, mainly owing to some references in various movies on concepts in quantum mechanics.
The concept involves an experiment with a cat and an equal-weighted probability of it having been either poisoned or fed normal food. The cat is unobservable for a period, and during this time it is assumed to be both dead and alive until the outcome is known. Though physicist Erwin Schrödinger is said to have devised the thought experiment to highlight some problematic concepts in quantum mechanics, it has since been widely used to explain these very concepts.
This is probably where we find ourselves in the geopolitical landscape and global economy
— half the world appears to be in crisis, and the other half is worried about how this affects it. The biggest question for any investment management professional in 2024 is whether we will find ourselves in a global recession or a soft landing. Schrödinger’s cat would put it to us that the economy is both thriving and in recession.
Though the likelihood of a recession is less, as we appear to have reached the peak of the rate hiking cycle and inflation continues to trend lower, it is still elevated relative to history. Over the past 35 years, of the five aggressive monetary tightening regimes, in the US, a recession has been avoided only once. Therefore, if history is anything to go by, the probability of recession should be around 80%. However, most economists currently have it closer to 50% from a peak of about 65% in 2023.
Of course, these events are not linear and should not be looked at in isolation, and, as every good statistician knows, the past is not necessarily a good indicator of the future. One major difference is the easy monetary policy over the past 15 years, which has resulted in excess money in the economy coupled with structural breaks due to the Covid-19 pandemic, and which resulted in excess savings in the developed economies as consumer spending propensities decreased.
Notwithstanding these factors, some aspects continue to point towards elevated risks of a recession. For starters, the economic implications of monetary policy can lag by a couple of quarters, which means we are still going to experience the effects of 2023’s rate hikes throughout 2024.
Furthermore, even once the respective central banks begin cutting rates, the lag effect could well mean that the rate cuts only begin affecting economic activity in 2025 — especially if they wait too long to start cutting.
Increasingly, it does appear that the US Federal Reserve (Fed) and the Reserve Bank’s monetary policy committee (MPC) are likely to start cutting rates only in the latter part of the year. At the moment most reserve banks are not under a lot of pressure to begin cutting. Though inflation has shown signs of easing in the developed economies, including the US, the UK and eurozone, it remains above target. While locally it is within range, it remains uncomfortably close to the 6% upperbound target versus the 4.5% midpoint target where the MPC would prefer it.
Furthermore, the Fed changed its target from a point to an average target. This means that not only does inflation need to be under 2%, but it also needs to be under 2% for a sustained period before the Fed considers cutting rates according to its average targeting. This was instituted while inflation was rising, which allowed the Fed to keep rates lower for longer. With the inverse now true, there may not be an appetite for this kind of monetary policy.
An unintended consequence is that it renders it slow to react
— waiting too long to hike rates while inflation is rising, hiking too aggressively once it has risen, and then waiting too long to cut once it has stabilised.
In addition, geopolitical tensions continue to induce supplyside disruptions, rendering inflation stubbornly elevated.
Meanwhile, unemployment numbers remain low in the US, putting little pressure on the Fed to start cutting rates as the economy appears resilient, despite the unemployment rate being a poor indicator of economic recession, and often only starting to rise once in that recession. This means the very catalyst for rate cuts could be what markets are hoping to avoid: an economic recession.
Locally, despite our economic challenges, the MPC is likely to want to maintain real-rate differentials with the US, which means it is unlikely to start cutting before the Fed.
In the field of statistics, we would probably say half the cat is dead! There are certainly prospects of a soft landing, but we do think market participants are underestimating the chances of a recession.
While we continue to find value in various counters such as luxury goods brand Richemont as Asian markets continue to recover, as well as various healthcare stocks with innovations and medical advancements, we are concerned about valuations in the tech sector as markets continue to rally.
We foresee a potential pullback with some profit-taking as part of the normal market cycle, but we still like counters such as Netflix, which continues to report subscriber growth, that are close to a steady state of capital expenditure and increasing free cash flow that it can either reinvest or pass back to investors.