2024-01-02 What Is Lars Thinking ("WILT")

Submitted by Lars.Toomre on Tue, 01/02/2024 - 08:00
Warning sign labeled "Uncertainty Ahead"

As we start the year of the 2024 American federal elections, there is significant uncertainty. One thing though is virtually certain: the year will be much more volatile than what is currently being priced into the Capital Markets.

There are considerable geopolitical issues, at least one of which is likely to shift economic outlooks. Wars are currently raging in Ukraine and Gaza with other tensions in the areas around the Red and South China Seas. These conflicts will require economic and political resources, both of which seem to be in more limited supply today than earlier.

The funding of the American deficit is likely to be a key topic during the coming year. The rise in interest rates since mid-year 2022 will cause the 2024 deficit interest expense to be approximately double that incurred in 2023. Foreign buyers appear to have stepped away from the American Treasury markets and questions no doubt will arise again who will buy the debt if retail investors step away like they did in the summer of 2023.

The American capital markets rallied into the 2023 year-end, pricing in at least six 25 bp cuts in the Federal Funds rate during the 2024 calendar year. Many suspect that markets have gotten ahead of themselves. Surely, either the equity markets or fixed-income are wrong since it is so difficult to envision a scenario where both are accurate. Correct?

How one hedges or weighs the capital markets risks this year likely will be key to relative performance. A key consideration should be whether one will do better than the 4.25% risk-free rate on the 2-year Treasury note (e.g., "do nothing").