Festive Fed spirit accelerates year-end rally

Market index returns

Week to date since December 6, 2023 as of December 13, 2023

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Index definitions: Global Real Estate = FTSE EPRA/NAREIT Developed Index; Global Infrastructure = Dow Jones Brookfield Global Infrastructure Index; Natural Resource Equities = S&P Global Natural Resources Index; Commodity Futures = Bloomberg Commodity Index; TIPS = Barclays US TIPS Index; Global Equities = MSCI World Index; Real Assets Index = 30% FTSE EPRA/NAREIT Developed Index, 30% Dow Jones Brookfield Global Infrastructure Index; 15% S&P Global Natural Resources Index; 15% Bloomberg Commodity Index, 10% Barclays TIPS Index. Source: Bloomberg, DWS. Past performance is not indicative of future results. It is not possible to invest directly in an index.

Market commentary:

This week’s main event was Jerome Powell’s kick-off of a bull-market holiday bash. Following the Federal Open Market Committee (FOMC) meeting, markets were moving and shaking – 10-year U.S. Treasury yields retreated below 4% while 2-year yields also plummeted ~36 bps and the U.S. dollar index spot sank below $103 (DXY), lending support for global equities which notched healthy gains. Against this backdrop, Real Assets classes were generally bid higher. Global Real Estate led gains, outpacing broader equities on notable strength across U.S. property markets where 10 of 11 U.S. property sectors are now delivering positive year-to-date returns – sector-level gains across this space are ranging from solid (~5% for U.S. office stocks) to spectacular (>30% for U.S. data centers). Global Infrastructure securities followed, with mixed results at sector and regional level, accompanied by TIPS and Natural Resource Equities which were close behind. Languishing in last place were Commodities, which sustained additional losses amidst concerns over global demand (particularly out of China) which have continued to exert significant pressure on energy and metals.

Why it matters: As we inch closer to year end, we are increasingly open- minded that the “immaculate disinflation” could perpetuate into the first half of the 2024 as decelerating inflation provides a continued tail wind to real growth outcomes. Labor market developments remain the linchpin in pulling off the historically improbable (and often-Googled) “soft landing”. We are also mindful that the lagged effects of rate hikes to date have not been fully felt and are reminded by one of our favorite economists that the U.S. Federal Reserve (Fed) cut policy rates 100 bps before the cycle peak in 2007 and by 170 bps prior to the cycle peak in 1990. Geopolitical developments also remain a major variable and as we head into a presidential election year in the U.S., volatility could creep higher. Finally, central banks have diverged (if only temporarily) in their inflation-fighting strategies, leaving the global economic turnaround story open-ended.

Digging deeper: First up, we consider if Powell’s words are for the birds or if they might carry weight and look to recent inflation prints for some key clues. We then turn to the energy and metals sectors to review notable transactions and developments during the last week.

Fowl play at the Fed?: On December 13th, our friends at the U.S. Federal Reserve (Fed) sent stocks surging with dovish rhetoric and calls for cuts (three totaling 75 bps in 2024) following its decision to leave benchmark interest rates untouched at 5.25-5.50%. Far from an innocent turtle “dove”, Fed Chairman Jerome Powell is instead screening more in the camp of a loose goose-a-laying (referring to both his telegraphed loosening of monetary policy and loose lips). Across the pond, while he may have ruffled the feathers of a partridge in its pear tree over at the Bank of England (BoE) and a French hen at the European Central Bank (ECB), it was not enough to drive them to take flight. In statements released on December 14th, both central banks remained steadfastly committed to keeping monetary policy tighter-for-longer until more progress is achieved in the fight against inflation, holding rates steady at their respective levels. Investors will have to wait a little longer for the swan song of this global rate-hiking cycle…and with that, we’re all out of birds.
Inflation flatline = Fed lifeline: The Fed’s optimistic pivot followed the release of Consumer Price Index (CPI) and Producer Price Index (PPI) data in the U.S. Headline CPI increased 0.1% month-over-month in November and stepped down from 3.2% to 3.1% on an annual basis. Core CPI (ex food and energy components) increased in line with estimates, up 0.3% month-over-month and 4% year-on-year. Lower energy prices have helped significantly in battle against price pressures, particularly for wholesale prices (PPI) which were flat month-on-month and climbed at annualized pace of 0.9%, down from 1.2% in October – actuals were rosier than expectations on both counts, lending evidentiary support to the Fed’s (perhaps overly-positive) announcement.
The Permian playbook: We’re noticing a pattern here. In past issues, we have highlighted moves by ExxonMobil (via Pioneer) and Chevron (via Hess) that saw two titans of energy strategically expand and diversify their portfolios amidst a wave of consolidation across the oil sector. While Chevron’s already significant presence in the Permian Basin prompted a diversification away from the oil-rich region, another player is coming to town and taking its cues from ExxonMobil, seeking expansion and doubling-down. This week, Texas-based Occidental Petroleum announced it would acquire privately-owned, Permian-based shale producer CrownRock L.P. in a deal worth $12B, a significant move that will effectively make it the second-largest shale producer in the U.S. and continue fundamentally reshaping the industry as major players compete for increasingly limited access in prime geographic drilling locations.
Silver and gold, silver and gold…: How do you measure it’s worth? This question, posed in song form by Sam the Snowman in the holiday classic movie Rudolph the Red-Nosed Reindeer, is also top of mind for us this season. Gold has unique properties including industrial use cases, a long-term store of value, a potential hedge against inflation, a reserve currency, and a “safe-haven”. Right now, those properties are making it worth quite a lot! This week, Gold slipped below the psychologically important $2,000/oz level on December 11th, but bounced back strongly and re-established support as the Fed signaled that rate cuts were closer on the horizon than they originally appeared and markets began betting on even more aggressive action. From here, we continue to expect more investor participation – our thesis is supported by recent data from the World Gold Council (WGC) showing net central bank buying in 3Q23 was much stronger than expected. Under the circumstances, we would be remiss to overlook higher-beta Silver which has a wider spectrum of industrial use cases and could stand to benefit exponentially from the same suite of abating headwinds.

What we are watching: For one, we are watching the energy sector given the gaping chasm between the Organization of Petroleum Exporting Countries (OPEC) and the International Energy Agency (IEA) on their assessments of oil demand in 2024. We are also curious how the express outcomes of COP28 will ultimately play out. To wrap this week, we touch recent activity in the natural resources space and what could follow in the near future before offering up more insights on opportunities in real estate.

OPEC’s waning influence: This week, members of the OPEC were jingle-bell-rocked by the IEA’s oil outlook, which characterized oil market sentiment as “decidedly bearish” and cited evidence of significant demand erosion that is expected to continue into 2024. Accordingly, it revised its global consumption growth forecast downward by 400k bbl for 4Q23 and slashed it by half for 2024, reflecting demand of just 1.1m/bpd. It also put OPEC’s market share at just 51%, reflecting that a massive uptick in U.S. production volumes (along with Brazil and Guyana) have eroded its territorial command of the oil kingdom. OPEC’s assessment for 2024 demand is (unsurprisingly) at odds, reflecting world oil demand at 2.25m/bpd and its position as “cautiously optimistic”. Time will tell.
Concerns over a COP out: By this, we’re referring to COP28, of course, or the UN’s climate change conference in Dubai which closed just this week and finally produced an agreement – one that, according to the COP 28 statement released on December 13th, “signals the “beginning of the end” of the fossil fuel era by laying the ground for a swift, just and equitable transition, underpinned by deep emissions cuts and scaled-up finance.” For some, however, the agreement came up short due to lack of clarity on the timeline for a fossil fuel “phase-out” and the absence of committed financing to assist developing countries. Nonetheless, in the wake of the first agreement of its kind, it is clear that the age of Energy Transition is upon us and that the world must begin to adapt. One notable recent example of this was authorization by the U.S. government of a new type of nuclear reactor (the first in over 50 years). Successful navigation of regulatory frameworks by energy innovators is critical to delivering quick and affordable solutions at scale. We’ll be watching for further development in this space in 2024.
Natural Resources through rose-colored glasses: This week, while broader Natural Resources Equities held up relatively well, one particularly constituent ruined the party for the rest of the Base Metals & Mining sub-category: namely, Anglo American PLC. During our review period, the company’s share price plunged over 24% following an announcement that it would significantly curtail production, particularly for Copper. What to make of this? Well, for one, there is blood in the water and the sharks are circling – speculation abounds Anglo American regarding a takeover opportunity. But additionally, the implications for Copper compound an already dire supply situation. Since November, ~4% of global copper supply has been removed from balance sheets and the supply/demand has flipped from marginal surplus into outright deficit. Our rosy take? There could be some incremental intermediate-term upside for Copper.
Opportunity? Is that you knocking?: New year, new opportunities. As we recharge and reset, our CIO Office has offered some food for thought in the form of their 10 themes for the year ahead. These are topics that we believe will be relevant for investors both in 2024 and beyond. Alternatives feature in several of these themes, but perhaps most prominently in “Real Estate – time to enter”? We’re glad they asked! As investors adapt to cooler conditions, interest in Real Estate is heating up. Examining the current landscape, understanding bifurcation between sectors, and identifying emerging opportunities will be of paramount importance for active managers. Importantly, the same stalwart fundamentals supporting private real estate will also have positive implications for the listed real estate space. We’ll end by quoting our very own Co-Head for Global Real Estate Research, Kevin White: “Fortune may favor the brave investor who can look through the dip, capitalize on attractive valuations and ride the next cycle.”

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