Predictions for 2024
Might as well stick my neck out and make some predictions for 2024. This is like kicking someone in the dark, me saying the below has absolutely no consequence as far as I'm concerned. These are not wild predictions.
IPO markets open back up – Capital needs to be raised and the valuation delta between 2021 valuations and today is the lowest it has been for a while. Those companies that have been able to grow into their valuation somewhat are going to do well. I think there is still some opportunity in private market secondaries, albeit a very fast closing window.
President Trump – He's back with a vengeance. Markets rip, fiscal stimulus continues. Santa rally 2024 here we come. I am very curious to see how misinformation is tackled. Elon's ownership has meant there is quite poor moderation on Twitter (now "X") and the proliferation of AI and LLMs will lead to feedback loops of misleading content. If you are Russia or China, this is a year to be excited about.
Australian house prices continue to increase – There are certain areas of the Sydney market today where the post-tax yield on investment properties is either neutral or positive, first time in a long time. Rents aren't that high relative to the last 6 years. This is very supportive to resi prices. Lots of supply trading below replacement cost too.
2-3x Rate Cuts (Aus & US) – US Fed and RBA have conveyed data dependency before making any interest rate changes. Data will come in poor, markets will sell off, rates cut, markets bounce back very strongly.
EV growth slows. Lithium Bounces – EV growth slows on the back of initial exuberance fading, lack of affordable options and lack of new models that are available for delivery in 2024. I think 2025 is the year it all changes for EV adoption as demand kicks back in with affordability and optionality. This is going to have tangible perceived demand effects on lithium companies. I would never dare pick a bottom here, but the "short lithium" trade is awfully crowded. I could never bet on the when as I am not in the business of catching falling knives, but when this rips, it is going to end up being the mother of all rallies. But we need some constructive effort from a demand and supply perspective again like 2019/20. Perceived future demand needs to improve. Ahem, cyclicals.
Energy gets cheaper, oil has the most stable year on record – Texas crude range trades between US$70 and US$95/bbl for reasons I covered last month. Energy prices fall as energy transition spend has positive effects.
Markets become more complacent – I cover my views on this in the section below. Market volatility is low and will probably keep falling. I don't think volatility will spike significantly in 2024.
Market Complacency
Has anyone noticed just how stable markets are today? Like weirdly stable.
I am sure there are by now quite a few fund managers and investors who have pointed out that markets seem very complacent when viewing it from a volatility perspective as measured by the volatility index of the S&P500 (VIX). Many simply point out that investors are misattributing risks within the market and that this represents complacency.
I don't think so. I think the measure for risk in this case is sullied and is a cause for concern.
I ask you, if you have money in equities today, do you feel complacent and not worried about equity market returns? Why is there such a disparity in the way most investors feel versus what the market is telling us today?
A bit of history first.
- Through 2020/21, Robinhood (the US retail broker) made equity options more accessible
- Options trading boomed in the US among both retail and sophisticated investors.
- While markets were buoyant during the covid period, investors used options for leverage to take advantage of strong market returns.
- As base rates increased, some investors realised they can take the other side of the equation to earn "yield" by selling leverage to other investors.
- This yield is (very simplistically) made up of the risk-free rate and volatility (Vega).
- Volatility at the beginning of last year was quite high on the back of numerous market selloffs.
- Many investors realised selling leverage allowed them to earn strong yields.
- This yield (above the risk-free rate) is simply harvesting volatility risk premia.
Investors can earn the risk-free rate (circa 5%) + earn some additional yield (harvesting volatility by selling leverage) in a simple trade by selling options on a relatively "safe" asset that seems to only go up, such as NVDA or AAPL. This is a massively crowded trade today.
This is not the first time we've seen this:
- Markets have looked complacent (VIX)
- Investors were riding the vol risk premia train (the now defunct XIV stock), and
- We had retail involvement (ah…).
Feels like 2017/18 all over again… This is not a matter of if, but simply a matter of when. We will likely end up with a larger event than the 2018 Volmageddon event. The size of the "inverse volatility" trade is much bigger this time around.
So, the answer to the question, are investors today complacent? No. No they are not.
Volatility is simply very low today as the supply of cheap leverage is very high. No other reason. Investors aren't being complacent; it is those that are chasing yield by being implicitly short volatility via options that are creating complacent markets. When does the music stop? Who knows? VIX got down to single digits last time, so maybe the music keeps playing for some time. Maybe one of the Magnificent 7 misses their earnings target and sells off. However, for now, complacency is here to stay.