Lekker's 5 Key Themes for 2024

Maintain a framework and adjust as new information presents itself.

Jan 01, 2024

I think the new year predictions are fun to do and a good exercise to expand your horizons of possibilities. However if they’re too ‘pie in the sky’, they become somewhat less useful. I guess it just depends on what you want to get out of them. For me, I am going to focus this piece on big picture themes that are top of mind and that I expect to be relevant throughout the year. Some of them may be consensus or may not be, but I expect them to influence the events of 2024. The real money will be made in understanding the timing around them, foreseeing shifts in the trends and the second order effects they have. I will pose some questions and potential predictions alongside these themes.

1. The Push and Pull of Cyclical vs. Secular Trends

Let’s start with this summary thanks to Yahoo finance.

Secular trends are long-term, structural changes that can have a profound impact on industries and companies. Secular trends tend to be driven by technological innovations, demographics, or government policy and regulatory changes. In contrast, cyclical trends are shorter-term fluctuations influenced primarily by the business cycle. Such boom-or-bust periods tend to have a much shorter shelf life than secular trends. While it is easy in hindsight to differentiate between secular and cyclical trends, the task is far more difficult in real time. Is the pullback in the stock market, sector, or individual stock merely a cyclical trend or something deeper and more dangerous? Is a company’s earnings disappointment a signal of a secular trend shift or merely a function of a downturn in the business cycle? Are the spikes in interest rates and inflation the beginning of a new secular trend or merely cyclical byproducts of one-off government intervention due to the pandemic?

Let me highlight one of those important secular trends I believe in.

The lack of sustainability across developed nation monetary and fiscal regimes. Quantitative easing and similar government policies have led to extreme wealth and income inequality due to the steering of profits to capital and away from labor. The decades long globalization of supply chains has squeezed all of the possible cost cuts from manufacturing, agriculture and most base goods. Yes, technology is a large driver of those cost reductions, but it’s all one trade. Lower cost of capital puts technological innovation into overdrive. Meanwhile we’re seeing first hand the discrepancy between the technological innovation and the work force’s ability to catch up and adapt (ie fast food restaurant kiosks eliminating human labor but UAW workers getting 25% pay raises). Either way, you’re looking at a declining work force for one reason or another (aging demographics or lack of skills) that will force governments into further UBI style policies. All of this is inflationary and supportive of long-term interest rates.

But to highlight the contrast between secular and cyclicality:

I believe we are in a downshift of this broader trend. What’s that mean? I think Q3 2023’s GDP print was a local high. For most of the past one or two years, the economy has been heavily supported by fiscal spending. In my October piece I noted the ever increasing portion of GDP growth being fueled by the government. While the consensus I hear is “it’s an election year, they’ll maintain rampant spending”, there’s a potentially equal as likely gridlock style outcome where yes they keep spending what’s already been passed, but it is weaker on a YoY basis than 2023. To me this would result in a cyclically slowing economy, albeit may not be negative growth or a recession at all. But in this situation you would expect inflation and interest rates to be relatively tame, the dollar flat to weak and stocks continuing to do well.

Prediction #1:
This cyclical downshift brings the US 10 year treasury yield and DXY lower to bottoms near ~3% and ~93, respectively. I expect this to occur near the end of Q3 2024, coinciding with a bottoming of inflation as well.

2. Fiscal Dominance Becomes a Household Term

This is another theme I’ve been talking about at length, most recently in my Q4 2023 outlook. To this day, too many people are focused on monetary policy and the short-end of the interest rate curve. Yes it’s important what the Fed is going to do with FFR and its balance sheet, but the more important arm of the government right now is the Treasury - hence the term fiscal dominance. What clues to watch here? Long end rates both outright and in relation to the short end (the yield curve). Long rates are the less manipulated part of the curve, albeit still heavily manipulated, but if you know and understand it, the information is valuable.

What’s the reality of the situation? Well Janet Yellen and the US Treasury has to fund large fiscal deficits by issuing more treasuries. The size of deficits the US is running are typically only seen to combat recessions. Meanwhile, the Fed is trying to reduce its balance sheet which presents another net seller of treasuries in the market. Eventually this trend is not sustainable. There is not infinite demand for anyone’s debt.

One of the large outlets that has been used to absorb this issuance is the RRP, which are excess reserves held in the banking system. The depletion of this account from ~$2.3T in the middle of April and $2.15T in the middle of June, to ~$750B today shows its being used as an outlet for issuance. Unfortunately for Yellen, this will dry up which at the current pace is estimated for end of Q1 2024. Then what? Well the Treasury and Fed still have bonds to offload.

What’s worse is that the huge decline in rates over the past few months coupled with the ascent in risk assets should all else equal reduce demand for fixed income and treasuries in particular. These two factors combined pose an obstacle on the horizon for the government which leads to my next prediction.

Prediction #2:
A late Q1 liquidity scare as the RRP is drained to nearly zero is met with calls (and finally action) to end the Fed’s balance sheet run off. With the choice of lowering the Fed funds rate or ending balance sheet reduction, the Fed will choose the latter if nothing else than for optics. The market will treat this like any other QE (or QT reduction) reaction - risk assets and gold up, interest rates down and dollar down. I expect this to start causing problems for risk assets in late January through March, with the ultimate resolution occurring around the March 19-20 Fed meeting.

3. Inflation Victory Laps Get Loud

Let me share with you a little look back of historical inflation peaks and troughs, in particular around the 1970’s era.

What you’ll notice is these cycles take lots of time, more than anyone in this day and age has the patience for. But if you are able to sift through the noise you can put the pieces of the puzzle together.

Prediction #3:
Beginning in Q2 and into Q3 ahead of the November election, the Fed and incumbent administration will declare victory in the war against inflation. Ironically, these proclamations reach a fever pitch just as inflation is bottoming around September 2024, approximately 27 months after the June 2022 peak. As a result, stocks and risk assets post record breaking numbers in Q2 and Q3. The narrative will be something along the lines of “no matter who wins the election, red or blue, both candidates will spend egregiously”. The reality is this continued heavy spending combined with lower interest rates will be the spark that reignites another bout of inflation and will ultimately be bad for long duration and risk assets.

Another extremely interesting historical look back is the election years during the inflationary period around the 70's. There’s a very clear trend here - strong markets during the election year with lackluster performance in the months after.

4. Real Interest Rates are the Signal

This is another area I’ve been a broken record on but I think it’s important. ZIRP and benign inflation has lulled market participants asleep for decades but the cat is out of the bag. There is a cost of money and capital and that will continue to show. SPACs going public with five years until revenue and another three capital raises required to bridge to project completion are a thing of the past.

Real rates are nominal interest rates less inflation expectations. Here’s a brief explanation. In the current environment, all of the easy juice has been squeezed out of inflation - meaning that it is approaching an asymptote for how low it can go. Meanwhile, as can be gleaned from Fed and market sentiment, interest rates have room to go lower. The combination of these two factors indicate real rates should perform better, ie a drop in interest rates will have an outsized impact in lowering reals.

The environments this historically occurs in also coincides with a steepening yield curve for a variety of reasons, which leads to my next prediction.

Prediction #4:
The US yield curve (can be measured via 2s10s) will steepen for the majority of the year. Its first run at a flat curve (ie 0 bps inversion / 2yr=10yr yield), will cause problems for risk assets early in the year. After awhile the market will shrug the inverting curve off and ‘it will be different this time’…until its not in the back half of the year. Falling real rates will benefit all assets, but particularly gold in a more sustainable, long-term fashion. 2023 was the first of a multi-year secular bull market for gold and $2,400 on the bullion in 2024 would not surprise me. But if you like gold, you’re really going to like Bitcoin.

5. Crypto is the Phoenix from the Ashes

This leads me to my fifth key theme of 2024. All of the above topics could deserve their own post, but this one in particular because it is the ultimate culmination of every mega trend.

Cyclical vs. secular: Crypto is in a secular bull market, while also making its first steps into a new cyclical bull market. These two together create big outcomes.
Real interest rates: Bitcoin is a more levered, digital version of gold. 2020-2021 brought the initial early signs of Bitcoin’s ability to compete on the same playing field as gold. That trend will be cemented and amplified with the launch of the ETFs in 2024 and improved investor access.
The emerging market catch all: Crypto is the modern version of the long emerging markets trade. As an industry, it will see the most relative capital inflows, budding innovation and has an innately global footprint. It provides a fiat currency debasement hedge (Bitcoin), new application networks akin to the internet (smart contract blockchains like Ethereum and Solana) and the fastest growing population. You can compare it to any individual sovereign, country or financial market and nothing beats it.

Prediction #5:
Major cryptocurrencies (Bitcoin, Ethereum, Solana) break all-time highs in 2024, with many assets in the ecosystem flourishing even more. If the cat wasn’t out of the bag already due to the asset class sustaining numerous 70-80% drawdowns and always coming back stronger, the ETF surely cements it now. It’s here to stay and if you’re a serious asset allocator you can no longer ignore it or shrug it off.