There are a few themes that I want to highlight going into 2024. I’m also going to give you an idea of how the market should react if these themes play out.

• Geopolitical risk will drive the market.

• Inflation will become a problem, again.

• Interest rates will stay higher for longer than expected.

Geopolitical Risk

Over the last decade, geopolitics have had an outsized effect on our economy and more directly on the stock markets. Specifically, from Covid in 2020, to the follow-on effects of inflation, to the War in Ukraine, our stock market has been driven by geopolitics.

In 2024, there are 3 areas I’m watching closely.

· China versus Taiwan, Philippines, and the United States – China has spent the last decade preparing for a military invasion of Taiwan. Knowing that the US would likely defend Taiwan, they’ve structured their military to counter the American military strengths. For example, our Navy is the largest and strongest in the world; our aircraft carriers give us the ability to project force anywhere in the world on a rapid basis. China has spent years designing “carrier killer” missiles whose only purpose is to keep our carriers out of the fight over Taiwan. China has also been aggressive in the South China Sea, using their coast guard to ram and generally harass Filipino navy vessels. Keep an eye out on this area as well, including the Spratly and Paracel islands. If China takes direct action against Taiwan or the Philippines, things will get very ugly and very quickly. Things don’t have to get that bad to impact our economy though. Our economies are intertwined and it’s likely that a rise in tension would increase the possibility of economic sanctions. This could be a redux of President Trump’s tariffs or it could be something new, however the result is the same. It would be a net-negative for the economy.

Probability of Happening: 4/10 Potential Impact: 9/10

· Russia versus Ukraine specifically and NATO generally – News leaked earlier this week that NATO is planning defenses, as they believe Russia is considering an invasion of Poland. Is this the most likely outcome? No. Would it be a hit to the world economy? Yes. It’s not on the level of a conflict with China, however this could end up quite costly.

Probability of Happening: 2/10 Potential Impact: 6/10

· Israel & the West versus Hamas, the Houthis, and Iran – The new conflict on the block is also the one with the highest likelihood of devolving into a larger, regional conflict. I wrote about this a bit back in October, immediately after the October 7th terrorist attacks in Israel. At the time I believed that fighting would spread across the Middle East fairly quickly. I was wrong on the timing but correct directionally. Since October 7th, Iran has increased attacks by its proxy forces across the region. Iranian allies have attacked US and Israeli forces in Syria, Iraq, Lebanon, and in the Red Sea. The Houthis in the Red Sea are one of the more alarming, albeit unsurprising, parts. Nearly 15% of the world’s seaborne trade transits the Red Sea, including 12% of the world’s seaborne petroleum. With recent attacks on shipping, some carriers are looking at alternate routes, including going around the Cape of Good Hope. Other carriers are continuing the Red Sea transit, while incurring a higher insurance cost for their cargo. Routing ships around Africa adds 7-10 days to the trip, with a corresponding increase in shipping costs. Likewise, insurance costs have nearly tripled over the last few weeks for ships transiting the Red Sea. No matter which option a shipper takes, the bottom line is that the conflict is increasing shipping costs, which we as consumers will have to pay.

At the risk of sounding like an Oxi-Clean commercial…But Wait! There’s More! Iran lobbed missiles at a reported Israeli safehouse in Northern Iraq over the weekend. Initial reports indicated the US consulate in Erbil being hit by one of the missiles, but that was later disputed. The takeaway here is that Iran raised the stakes by engaging with Israel directly. So far, they have been content to use their proxies; a direct attack on anything Israeli is an escalation. Keep an eye on this, even in the short term. The majority of the world’s waterborne oil passes through the Straights of Hormuz, near Iran, and Bab al-Mandab Straight, near Yemen. If the current conflict grows and Iran takes a larger, more direct role, they have the ability to impact crude oil prices significantly.

Probability of Happening: 6.5/10 Potential Impact: 7/10

Bottom line, geopolitics will likely determine if 2024 is a good year in the markets.

Inflation is Back, Baby

Is it really? The data doesn’t actually show it, at least right now. The Consumer Price Index has stabilized around 3% and that’s actually pretty good news.

It doesn’t necessarily feel that way though, since prices are still significantly higher than two years ago. I get that. Prices aren’t going to drop; it’s actually a bad thing if prices are dropping across the board. Deflation sounds like a good idea but it's a pretty sure sign of economic pain in the future.

My take on inflation goes back to the potential events I mentioned above. If any of them happen, or their intensity increases, inflation will likely be a problem again.

If the world stays relatively normal, I actually don’t think inflation will be an issue.

Can You Take Me Higher?

According to Reuters, the market is pricing in 4 interest rate cuts this year, with the first coming by May. Yahoo Finance estimates the market expects even more aggressive rate cuts, with 6 total for the year. Base case, I think the market is wrong and the Fed won't cut rates nearly that much.

Historically, the Federal Reserve is reactive, not proactive. They ignored rising inflation in 2021, keeping rates low for too long. I expect that they’ll act similarly in 2024, waiting too long to cut rates and potentially pushing the economy into recession.

Beyond that, my expectation is that one of the conflicts I mentioned earlier will either break out or increase in intensity. Any of those conflicts alone would likely be enough to spur inflation again by disrupting supply chains and increasing the cost of shipping.

Bottom line, I wouldn’t expect interest rates to drop significantly in 2024.