This article first appeared in Forum, The Edge Malaysia Weekly on November 20, 2023 - November 26, 2023

Like Warren Buffett said, “It’s only when the tide goes out that you learn who has been swimming naked.” Two notable tales of grief this month bookended a period of overexuberance. The first demise came with FTX founder Sam Bankman-Fried being found guilty of committing fraud almost one year after his crypto exchange entered bankruptcy, following suspicion that billions of customer funds had been misappropriated. Separately, co-working pioneer WeWork, a one-time darling of the gig economy workspace model, filed for Chapter 11 protection in the US. In both cases, investors were seduced by the prospects of lofty returns and received their comeuppance from failing to do their due diligence.

But capital markets seem to have turned a page and exuberance has returned, with Bitcoin rebounding sharply after bottoming out in the wake of FTX’s collapse, gaining over 60% year to date and becoming the top-performing asset of 2023. Tech stocks have also rallied strongly, with the renowned “Magnificent Seven” gaining 52% in the first 10 months of the year. The rally has been so forceful that just by excluding these seven tech companies, the broader S&P 500 would have declined by 2% during the period.

At the beginning of 2023, rising interest rates stoked concerns about tech valuations, with such stocks typically trading at multiples of their annual revenues. However, OpenAI’s unveiling of ChatGPT catalysed a resurgence of optimism. By introducing generative artificial intelligence to the mainstream, the company unleashed powerful animal spirits. Generative AI applications have proliferated across language, art, music and other applications. The largest generative AI-related start-ups in the West have collectively raised about US$15 billion (RM70 billion) so far, according to venture capital firm Accel. OpenAI itself has gone from strength to strength, with its valuation rising from US$29 billion in April to a reported US$80 billion at the time of writing.

Contrast this with the market anxiety seen in March, when a bank run brought down Silicon Valley Bank almost overnight, causing alarm that regional US banks would soon follow. Contagion fears have now faded from memory, so much so that the US Federal Reserve was emboldened to redouble its inflation fighting efforts with further interest rate hikes in May and July.

Put simply, 2023 has been favourable to the US. Short-run perceptions shape reality, and the country has achieved the remarkable feat of convincing markets of her ability to tame inflation without derailing growth. Research from HSBC shows consensus gross domestic product (GDP) forecasts reached a low point earlier this year, with expectations of less than 0.5% growth. Estimates have since been repeatedly revised higher throughout the year to surpass 2% — outpacing that of other developed economies. This sanguine market outlook reflects the receding recession risks.

Such resilience has led Goldman Sachs to lower its predicted probability of recession to 15% by 2024, while revising the GDP growth estimate upward to 2.1%. The investment bank anticipates the US will be last among advanced countries to cut interest rates, possibly as late as 4Q2024. These factors bode well for the continued strength of the US dollar against global currencies, particularly emerging economies that struggle to match the Fed’s aggressive tightening. Reflecting this sentiment, the International Monetary Fund (IMF) foresees lacklustre global growth next year, worried about debt distress in many emerging markets.

One notable influence on markets would be the fleeting economic bounce observed in China following the lifting of all Covid-19 restrictions. The country is grappling with deflationary forces as consumers contend with diminished wealth prospects following multiyear weakness in the property sector. The recently concluded Singles’ Day sales event garnered muted coverage as lead retailers such as Alibaba and JD.com chose not to disclose sales figures, diverging from the practice of previous years. As noted by JPMorgan, consumption has yet to gain traction, partly due to limited fiscal support received by Chinese households. Consequently, inventory has grown domestically and led to falling prices, which has inadvertently led to disinflationary pressures being exported worldwide. China has not mastered the narrative orchestration that has allowed the US to spin gold from investor and consumer confidence.

Case in point: the US’ ballooning debt load poses ongoing concerns, testing the patience of policymakers and experts but not sufficiently to jeopardise market sentiment. The US government may need to pay US$1 trillion in annual interest payments resulting from higher interest rates and borrowing requirements. This fiscal burden prompted Moody’s to lower the outlook on the country to “negative” last week, although it refrained from downgrading the US credit standings, something other credit rating agencies have already done. With the presidential election looming in 2024, political wrangling over the national debt will likely intensify.

On the other side, the continued strength of the US dollar (resulting in a weaker yen, renminbi and euro) would constrain global liquidity and slow down trade. War, adverse weather patterns and a lack of consensus on how to deal with deflation may just tip the world into recession.

For now, the implicit bargain between Mr Market and the US underpins investor confidence, which is based on the belief that the US can grow its way out of its debt problems through productivity gains. The transformative prospect of generative AI offers potential as a panacea, which is partly why tech stocks have outperformed this year. In a fascinating development, social media influencers have reportedly outsourced part of their content creation to digital AI clones of themselves. Whether generative AI does deliver long-term productivity growth remains an open question. Moreover, whether the US alone can pull the rest of the world out of the doldrums also remains in doubt.

As a result, JPMorgan takes a more cautious stance, anticipating a 60% probability of recession materialising by late 2024 or early 2025. Such a downturn could emerge either from persistently high inflation compelling central banks to tighten further, or from cost pressures (especially due to tight labour markets) eventually squeezing corporate earnings and necessitating spending cutbacks. Finally, there is the overhang of geopolitical risks to consider with conflagrations already in Europe and the Middle East, while US-China relations continue to be combative. Any surprise escalation would easily drive capital into a flight-to-safety mode. Not a time to let one’s guard down.

Tan Sri Andrew Sheng writes on global issues that affect investors. Tan Yi Kai is a Malaysian multi-asset trader based in Hong Kong.

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