Weekly Comment

With monetary policy generating much anticipation in the macroeconomic and financial outlook for this year, it is inevitable that investors will wonder how the presidential election might influence the Federal Open Market Committee (FOMC). Historically, the Federal Reserve (Fed) has not stood on the sidelines during election years but has continued to pursue its dual mandate of price stability and maximum employment, always seeking to maintain its independence from politics. Since 1980, the Fed has adjusted rates in every election year, except in 2012 when rates were at zero due to the recovery from the financial crisis.

The Fed lowered rates in five election years and raised them in five others. In 1980, the Fed raised rates by 1% (the federal funds rate, Fed Funds, had hovered around 17% earlier that year). It then cut back rates by 5.5% between February and July as the economy entered a recession. However, it resumed rate hikes to combat double-digit inflation between August and November (the Fed Funds closed that year around 19%). In 1984, the Fed raised rates by 2.25% in the second quarter as inflation rose and unemployment declined, only to reduce them by 3.5% in the fourth quarter as inflation stabilized. In 1988, the Fed began the year with modest rate cutbacks, then raised rates through August and resumed hikes after the election.

On the other hand, in 1992, it concluded the consecutive rate reductions initiated at the beginning of the 1990-1991 recession and implemented its last reduction in January 1996 after the soft landing that followed the 1994-1995 hiking cycle. Also, the Fed concluded its May 2000 hiking cycle, which began in 1999, noting that the stock market was peaking in March 2000.

In 2016, the Fed waited until after the election to hike once in December and continued with rate hikes in 2017 and 2018. It is also relevant that the Fed entered new monetary policy cycles that required an accelerated reaction, as in the severe recessions of 2008 and 2020, respectively.

In this context, it can be seen that the Fed continued to pursue its dual mandate goal, regardless of the political issue. This year is expected to follow a similar pattern, with a potential decrease in the Fed Funds rate as inflation approaches the 2% target, and the economy experiences a ‘soft landing.’

Note: A soft landing in the economic cycle is the process by which an economy moves from accelerated growth to slow growth, potentially reaching a stagnation phase, although it avoids going into recession.

Changes in monetary policy in an election year.

Net change in the federal funds rate, %.

Source: JP Morgan 

Recently, the renowned investor and Berkshire Hathaway Chairman, Warren Buffett, shared his annual 2023 letter with the company’s shareholders. Similar to previous years, the letter places less emphasis on ‘news’ and more on providing valuable reminders to investors on successful investment strategies, articulated in Buffett’s distinctive style.

Buffett on investing: “Although the stock market is considerably larger than in our early years, today’s active participants are neither more emotionally stable nor better educated than when I was in school. For whatever reasons, the markets now exhibit much more casino-like behavior than when I was young. The casino now resides in many homes and tempts its occupants daily.”

In this context, Buffett’s new letter reiterates some of the principles that have contributed to Berkshire’s success over time, including:

1.  Be clear about the purpose of investing.
2. Focus on quality investments, or as he would say in his own words, “wonderful businesses”.
3. Prefer companies run by good management teams. 
4. Stay for the long term, as patience pays off.

As part of his investment philosophy, Buffett highlighted the holding of two stocks that Berkshire could maintain indefinitely, namely Coca-Cola and American Express. These examples emphasize the importance of “sticking with a truly wonderful business” and how “patience rewards, and a wonderful business can make up for the many mediocre decisions that are inevitable.”

This year, Buffett emphasized two additional long-term investments that he expects Berkshire to hold indefinitely. The first is Occidental Petroleum (OXY), a key player in oil and gas and a leader in carbon capture initiatives. The second involves holdings in five large Japanese financial conglomerates: Itochu, Marubeni, Mitsubishi, Mitsui, and Sumitomo. He highlighted their good management teams, as well as shareholder-friendly policies, including share buybacks when the price is right, reinvestment of profits to develop their businesses, and reasonable compensation for their executives.

Concerning the succession plan for Warren Buffett, Berkshire supporters have long assumed that Greg Abel, responsible for managing Berkshire’s non-insurance operations, could be the successor. Buffett all but confirmed this notion, noting that Abel “in all respects is ready to be Berkshire’s Chief Executive Officer (CEO) tomorrow.” However, investors may learn more on that topic at Berkshire Hathaway’s annual meeting on May 4th in Omaha. 

Finally, on a separate note, Buffett pays tribute to Charlie Munger, who passed away last November, crediting him with guiding Buffett (and subsequently Berkshire) to quality companies. Buffett acknowledges Munger as the “architect” of today’s Berkshire.

Main investments within the Berkshire Hathaway portfolio

Source: CNBC with Berkshire Hathaway data

* Holdings are as of December 31^st, 2023, as reported in Berkshire Hathaway’s 13F filing on February 14^th, 2024, except for: Itochu, Marubeni, Mitsubishi, Mitsui and Sumitomo, which are as of June 12, 2023. Also, Occidental Petroleum, which is as of February 5, 2024. At December 31 Berkshire held a cash and cash equivalents position of US$168bn. 

Note: The companies cited in the image do not necessarily constitute an active Axxets/Activest recommendation and are for informational purposes only.

With the launch of ChatGPT a little over a year ago, as well as other artificial intelligence (AI) tools, the exponential growth of these new technologies continues to arouse particular interest due to their contribution to generate important advances in productivity, benefiting various industries, reducing costs and generating efficiencies for both companies and consumers. 

In this sense, it is common to overestimate the effect of technology in the short term and, conversely, to underestimate its impact in the long term. Therefore, it is key to distinguish between what could be considered speculation and trendy, and what could be a real and lasting opportunity over time. As examples, the use of AI in the following sectors stands out:

• Healthcare

• Diagnosis and treatment planning: AI is used to analyze medical images, such as X-rays and MRI scans, for faster and more accurate diagnosis.
• Drug discovery: AI algorithms help to identify potential drug candidates and predict their efficacy.

• Finance:
  • Algorithm-based securities trading: AI is used to analyze financial markets and execute trades at optimal times.
  • Fraud detection: AI algorithms can detect unusual patterns in transactions to identify and prevent fraudulent activities.
• Retail:
  • Customized recommendations: AI analyzes customer behavior to provide customized product recommendations.
  • Inventory management: AI optimizes inventory levels and predicts demand, reducing overstocking or shortages.
• Manufacturing:
  • Predictive maintenance: AI analyzes sensor data to predict equipment failures and schedule maintenance before problems arise.
  • Quality control: AI-driven systems inspect products for defects on production lines.

As seen, the further development of these trends in technology and other areas appears to have the capacity to transform everyday life in the coming years, potentially generating opportunities for companies and investors who possess the virtue of adaptation and patience. 

A wide range of companies are harnessing the potential of AI

Source: Capital Group.  

The Consumer Price Index (CPI) for January recorded an acceleration of 0.3%, surpassing expectations of 0.2%. This elevated the annual inflation rate to 3.1%, compared to the estimated 2.9% and the 3.4% recorded in December. On the other hand, core CPI inflation, which excludes food and energy, increased by 0.4%, exceeding the forecast of 0.3% and the December figure of 0.3%. In its twelve-month variation, it reached a rate of 3.9% (versus the expected 3.7% and the 3.9% in January).

In the report, the monthly performance of the food component advanced 0.4% (+2.6% annually), highlighted by a 0.5% monthly (+5.1% annually) rebound in food away from home. On the other hand, the energy index declined 0.9% on the month (-4.6% annually), mainly due to a decline in the gasoline component.

Surprisingly, after several months of moderation, the shelter index rebounded in January, registering an increase of 0.6% monthly (+6% annually). It is worth noting that this category contributed more than two-thirds of the monthly increase in the entire CPI. In detail, the rental index increased 0.4% on the month (+6.1% annually), while rent equivalent to owning a home rose 0.6% on the month (+6.2% annually). 

Considering the latest employment and inflation data, it could be thought that the Federal Reserve (FED) will not rush changes in monetary policy, as there is still room for improvement in terms of Core CPI. In this context and after Jerome Powell’s reaffirmation that there will be no cuts in March, conditions and consensus expectations suggest that the first adjustment to the reference rate could take place until the June 12 meeting. As we have previously expressed, with this combination of factors prevailing, it is anticipated that the talk of higher rates will remain until a more pronounced cooling in the economy and/or an improvement especially in the shelter index, which carries specific weight in the cost of living for Americans – is observed.

Change (%) in the last twelve months in CPI and Core CPI

Source: U.S. Bureau of Labor Statistics

CPI monthly change (%)

Source: U.S. Bureau of Labor Statistics

January is now history, leaving a positive impact on the markets. The S&P 500 closed the month with a 1.6% increase, while the Nasdaq registered a 1% advance. The first month of the year is always full of discussions about how the remaining months might evolve. That said, certain key themes will be on almost every investor’s mind throughout 2024. Here are some perspectives on these.

Can the Economy Continue to Grow at the Same Rate? 2023 was billed as the year of the recession that never came. So far, some signs suggest continued economic resilience. This has generated the possibility of thinking about a very optimistic “Goldilocks” scenario, implying solid growth and declining inflation. Fourth-quarter 2023 GDP data showed a 3.3% year-over-year increase, with the labor market remaining solid, as indicated by the most recent nonfarm payroll report. Looking ahead, it is not out of the question that the economy will experience a deceleration, allowing for a soft landing, meaning healthy employment generation and inflation slowing to the target range. This environment could allow the Federal Reserve (FED) to begin adjusting rates before the end of the first half of the year (the market is discounting a total cut of 100 basis points for the full year), after Jerome Powell made it clear that there would be no adjustment in March.

Will the Dominance of the Magnificent 7 Persist? While there is optimism around the tech sector and the “growth” style, it is unrealistic to assume that these tech giants will perpetually rise together. A high standard implies a small margin for error, as evidenced by the fall of Google and Tesla after reporting lower-than-expected numbers, while Meta and Microsoft presented solid reports. Now, these companies will have to excel in all aspects to please the markets. A key theme this year could be differentiation among the Magnificent 7, with some winners and some losers. It is easy to forget that these are seven very different companies. Therefore, the ability of each to monetize new revenue streams, such as artificial intelligence, could make the difference in staying on top or not.

Should Markets Be Concerned about Geopolitical Tensions? As unfortunate as it is that, in recent years, humanity has entered a new era of rising geopolitical tensions in various regions of the world, as a general rule, geopolitics is not a major driver of long-term returns. In fact, several analyses spanning the 30 major shocks since 1940 concluded that, yes, there is often short-term volatility in the day or two after the event occurs, but at three months, returns were positive 60% of the time. And at three years? That’s 90% of the time. For most investors, geopolitical events are disruptions, but they are generally not turning points. However, elevated geopolitical tensions suggest the need for some hedges, most notably gold and energy-related stocks, to protect against the risk of higher oil prices.

What Could an Electoral Rematch Mean for the Markets? So far, the Democratic and Republican primaries (Iowa, New Hampshire, and South Carolina) suggest a rematch between Joe Biden and former President Donald Trump. It is worth mentioning that these elections are of great relevance for domestic and foreign policy; however, statistics show somewhat scattered results, where the historical average return of the S&P 500 in an election year stands at 13.1% (excluding 2008, when the global financial crisis emerged). Therefore, investors should not base their investment decisions solely on this event but consider a broader analysis that encompasses other economic and financial factors.

Consensus expects sales of the Magnificent 7 to grow at a rate 4x (times) higher than that of the S&P 493.

*CAGR: Refers to compound annual growth rate.

Source:  Goldman Sachs

After December inflation accelerated to 3.4% annually, where shelter costs, which have a significant weight, continue to look at a very gradual pace; and after knowing the first revision of the 4Q23 GDP, which showed a robust annualized growth of 3. 3% (beating expectations of 2%), the Federal Reserve (FED) made the unanimous and widely anticipated market decision to again leave the target range for the federal funds rate unchanged (for the fourth consecutive occasion) at 5.25% – 5.50% (the highest level in the last 22 years).

In this context, the statement noted that recent indicators suggest that economic activity has been expanding at a solid pace, with employment prevailing strong, while inflation, although it has declined over the past year, still remains elevated. Therefore, and as part of a modification from previous statements, the Committee emphasized that it believes the risks to achieving its employment and inflation targets are moving toward a better balance.

Another important change in the statement was that it modified the following wording: “to determine the degree of additional monetary policy tightening that might be appropriate to eventually return inflation to 2%”, replacing it with “in considering any adjustment to the target range for the federal funds rate”. This could be interpreted to mean that the hiking cycle may have come to an end, while the Committee will continue to take into consideration all incoming information, the developing environment and the balance of risks when making future decisions.

Finally, among other changes in language, and no less relevant, is the Committee’s strong message that it is in no hurry to start reducing the federal funds rate range, stating that “the Committee does not expect it to be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2%”.

In his press conference, Jerome Powell considered that rates are at the peak of this tightening cycle and did not rule out the possibility that they could remain elevated if necessary. The overall message focused on the FED needing further evidence that inflation is consistently heading towards its target, and he was positive about the results achieved over the last year, reaffirming the importance of carefully assessing economic developments before making future decisions.

Expectation for Federal Funds Rate

Source: AllianceBernstein

In recent days, Taiwan concluded its presidential election, with Vice President Lai Ching-Te emerging as the winner, securing another four years for the Democratic Progressive Party (DPP). Notably, this marks the first time in Taiwan’s electoral history that a ruling party has clinched a presidential election for a third term. Lai’s inauguration is scheduled for May 20th, 2024.

The elections witnessed a high turnout of around 70%, and it’s worth mentioning that Lai’s 40% share of the presidential vote was lower than his predecessor Tsai Ing-wen’s 57% in the 2020 election. Additionally, the DPP lost its absolute majority in the Legislative Assembly, decreasing its share from 54% in 2020 to 45.1%. Both opposition parties increased their share of seats: the Kuomintang (KMT) from 33.6% to 46%, and the Taiwan People’s Party (TPP) from 4.4% to 7.1%. Consequently, no party holds a majority position. Historically, the KMT has been considered more open to the idea of closer relations with mainland China.

It’s important to note that this scenario aligns with market expectations and, generally, is not anticipated to alter the current course of events in the region. While the outcome is considered unlikely to significantly impact Taiwan’s economic growth in 2024, there will be a continuity of policies implemented by previous DPP-led governments. Regarding relations with mainland China, Lai expressed his interest in maintaining “healthy and orderly” exchanges, reiterating his openness to talks based on more equitable terms.

In conclusion, the positive outcome of this event may bring some calm to the geopolitical sphere in Asia and the world in the short term. However, it’s challenging to rule out the possibility of continued tension in relations with mainland China in the coming years, especially given the close interaction between Taiwan and the United States in the evolving economic landscape, heavily influenced by the semiconductor supercycle and Artificial Intelligence (AI) development.

Global semiconductor wafer capacity installed by region (market share).

In electronics, a wafer refers to a thin, circular slice of semiconductor material from which microchips/semiconductors are produced.

Source:  UBS

The December consumer price index (CPI) accelerated by 0.3%, slightly higher than expected, bringing the annual rate of inflation to 3.4% from 3.1% in November. Also, core CPI inflation, which excludes food and energy, increased by 0.3%, although in line with expectations. However, in its annual variation, it decelerated to 3.9% (versus 4.0% in November and October). Therefore, the overall trend shows that core CPI continues to moderate gradually. According to these data, analysts believe that the FED’s preferred price index, known as the “Core Personal Consumption Expenditures Price Index (Core PCE)”, would have increased by 0.2% last month, which would bring the annual variation from 3.2% to 3.0% (vs. 2.4% expected for the end of this year).

Within the report, the monthly performance in the energy component came as a surprise, higher than expected, with an increase of 0.4% (-2% annually), driven by a 1.3% increase in electricity prices (+3.3% annually). Meanwhile, food CPI rose 0.2% (+2.7% annually), in line with recent increases. Food away from home increased 0.3% (+5.2%), which implied a slight improvement over what was seen in previous months.

In other categories of interest, new vehicle prices advanced 0.3% in the month (+1% annually), while used vehicle prices climbed 0.5% (-1.3% annually), although used vehicle prices are expected to moderate again in the coming months. Basic services prices (excluding energy services) advanced 0.4% last month (+5.3% annually). That said, shelter-related increases, which have a significant weight, continue to moderate at a very gradual pace. In this sense, rents increased 0.5% (+6.2% annually), a similar performance to the previous month. Finally, prices for health care services rebounded 0.7% last month (-0.5% annually), pressured by another increase in the cost of insurance.

With all key data now available (inflation and employment), we believe that the Fed would not be in a hurry to accelerate cutbacks to the reference rate, as there is still room for improvements, especially concerning Core CPI. Moreover, it is challenging to think that the upcoming FOMC meeting at the end of January can provide further clues about how the Fed might act in the very near term. What can be anticipated is that the talk of higher rates for a while should prevail until a more pronounced cooling within the economy is observed. Finally, it is worth noting that, despite all of the above, the consensus assigns a 69% probability of seeing a 25-basis point (bp) cutback at the subsequent meeting on March 20th.

Change (%) in the last twelve months in CPI and Core CPI

Source: U.S. Bureau of Labor Statistics

The quarterly earnings results season is set to begin this week. In this regard, consensus forecasts anticipate an annual earnings growth for the S&P 500 of 1.3% (YoY) for the fourth quarter of last year. If this number is confirmed, it could mark the second consecutive quarter of YoY earnings growth for the index. However, this result represents a lower growth rate compared to third-quarter results, which showed an advance of 4.9% YoY. It is noteworthy that analysts considerably reduced their estimates (-6.8%), given that at the beginning of the quarter, they had expected an increase of 8% YoY. This decrease is higher than the 5-year historical average (-3.5%) and the 10-year historical average (-3.3%) for a quarter.

Five of the eleven sectors are projected to report YoY earnings growth, led by the communication services, utilities, and consumer discretionary sectors. On the other hand, the consensus estimates that six sectors will report YoY declines in earnings, led by the energy, healthcare, and materials sectors.

On the sales front, the consensus anticipates a YoY increase of 3.1% (compared to the 3.9% expectation at the beginning of the quarter), which could represent the twelfth consecutive quarter of sales growth if this number is confirmed at the end of the season.

With this combination of factors, the net income margin would be 11%, lower than the 12.2% of the immediately preceding quarter, as well as last year’s 11.2%. Finally, in terms of perspective, analysts expect YoY earnings growth of 6.0% for 1Q24 and 11.8% for the full year 2024.

JP Morgan will kick off on January 12; therefore, investors will be especially attentive to the development of the season due to the rally that took place at the end of 2023, with the resilience in earnings performance, to some extent, as support, along with the perspective that interest rate cutbacks could occur throughout this year.

S&P 500: expected earnings growth for the 4Q23

Source: FacSet

During their mid-December meeting, FED officials maintained the reference rate within the range of 5.25% to 5.5%. It was observed that the new projections hinted at the possibility of a series of cutbacks totaling three-quarters of a percentage point (75 bps) throughout the year.

Within this context, the meeting minutes unveiled that nearly all participants expressed the notion that, reflecting improvements in their inflation outlooks, it would be appropriate to establish a lower target range for the federal funds rate by the end of 2024. Emphasis was placed on the progress made in reducing inflation and in balancing the labor market, albeit with recognition that these tasks remain ongoing.

However, the minutes also indicated a degree of uncertainty about how or if this would occur, as “members considered that the reference rate is likely to be at or near its peak for this adjustment cycle. Nevertheless, the path of monetary policy will depend on how the economy evolves.” Specifically, some members mentioned the possibility of maintaining the reference rate at an elevated level if inflation does not continue its downward trajectory. Other officials left open the possibility of additional increases contingent on evolving conditions. Participants underscored the importance of maintaining a careful, data-dependent approach in making future decisions. They reaffirmed that it would be appropriate for the policy stance to remain on a tightening path for some time, until inflation is clearly declining sustainably toward the Committee’s 2% long-term objective.

In line with this cautious perspective, the President of the Federal Reserve Bank of Richmond, Thomas Barkin, recently expressed caution about monetary policy, highlighting the inherent risks in attempting to guide the economy toward a “soft landing.”

The FED will make its first announcement of the year on January 31st, with widespread anticipation that the reference rate will remain unchanged.

Expectations for the Federal Funds Rate

Source: JP Morgan