12 ideas for investing in a "Donald Rumsfeld-ian world"

Former US Secretary of Defense Donald Rumsfeld is probably best known for his response to a journalist's question over the Iraq War in 2002, in which he said there are "known knowns", "known unknowns", and "unknown unknowns". 

In the context of Rumsfeld's original answer, he was asked about reports during the Iraq War that the Iraqi government had never actually supplied weapons of mass destruction to terrorist organisations. But in a way, financial markets have also thrown up some surprises even if investors think they knew what they were looking at or had some certainty in their forecasts. 

For example, a global recession was deemed a near-certainty in 2023 - if you like, it was a "known known" in that everybody knew that such a prediction was being made. But it never came to pass because the "unknown unknown" - or the thing we did not know at the time was how elongated this monetary policy cycle's effects would be. Consumers and businesses, on aggregate, were able to prepare for a looming recession because it was being talked about so much.

But how will this more complicated and more challenging world impact where and what you can invest in? In this wire, we'll parse the views of GSFM's Stephen Miller, Payden & Rygel's Ehsan Iraniparast, Man GLG's Andrew Swan, and Tribeca's Jun Bei Liu.

Miller: The "Goldilocks" scenario doesn't have enough nuance

The 'Goldilocks' consensus view of a "benign slowdown and a smooth disinflation" may be supportive of financial assets but Miller argues this scenario does not take into account the number of variables that could easily upset the balance.

"There are a number of structural factors which I think are at inflection points," Miller says. 

"We're in a period of higher neutral interest rates, there are emboldened regulators, growing protectionism, and these emerging mega-forces such as climate, cybersecurity, and AI."

Then, there is geopolitical risk - or as Miller describes it - the most important "unknown unknown". Wars in both hemispheres have the power to make the fight against resurgent inflation very difficult.

"Disinflation is a disjointed process and the last mile for central banks to the inflation target has historically been very challenging," Miller adds. 

Miller sees just three Federal Reserve rate cuts this year (and certainly none as early as March) while the Reserve Bank could cut just once in a "reasonable" economic scenario.

As for how this scenario affects investment opportunities, Miller believes you can find proper diversification in assets that are uncorrelated to equity or bond beta (assets that trade in a more volatile pattern to their respective index) - examples for sophisticated investors include long-short funds, macro hedge funds, and physical gold. 

Iraniparast: The soft landing view

Miller's view is biased toward developed market central banks (the US, the UK, Australia, etc.) - which is important because while the story in DM is one of declining inflation, the EM story has already advanced to rate cuts in many jurisdictions. And, as Iraniparast argues, it gets better.

"Our house view, right now, is in fact the soft landing," Iraniparast says. "Our in-house economics team feels like the Fed will cut three times this year," he adds while recognising there is still a wide range of outcomes for markets. There is, however, a key caveat.

"I think that in the US, at least, the valuations are not particularly attractive be that in stocks or credit spreads or perhaps even the Dollar," he says. 

Within emerging markets debt, a lower US Dollar is providing opportunities for assets in countries where the politics are stable and rates are coming down. 

"We think the uncertainty around global growth and inflation make the carry (the difference between a bond's yield and the cost to finance its purchase) and duration in local government bonds favourable relative to other opportunities," he adds.

Liu: The valuation expansion is mostly done. It's time for cyclicals

In equities, 2023 was marked by the incredible rise in AI-fuelled stocks (and the equally incredible lack of returns from most other major sectors). But of course, indices are not made up of every sector except the ones where you don't think there are opportunities. And as a result of the AI boom, soaring prices was the name of the game.

So will it be the same again this year?

"We've probably already seen the bulk of the valuation expansion happen in the past 12 months because that's when interest rate expectations moved from higher to lower," Liu says. "On aggregate, Australian shares don't look too cheap nor does it look super expensive," she adds.

As for where Liu is finding her best long position opportunities, she turns to cyclical sectors with a view that a recession will not come in 2024. 

"People continue to spend and there are some areas of softness. For example, we've heard that, for the hotels and restaurants, people are not really going out, they are eating at home but they still buy furniture and everything else," Liu says. "For JB Hi-Fi (ASX: JBH), for example, people still have earnings going down 25% in the next 12 months. So when you look at the share price rally, it's just that it looks expensive based on very depressed earnings expectations."

Liu also has a positive view of the major supermarkets, Coles (ASX: COL) and Woolworths (ASX: WOW), given their ability to pass on price increases and maintain high-single-digit profit margins.

In the materials space, it's all about China - where a $100+/tonne iron ore price is very much at odds with the country's manufacturing and real economy. 

Liu also says she's finding opportunities in parts of the beaten-up healthcare sector like ResMed (ASX: RMD) and CSL (ASX: CSL). Finally, she has a view that dividends will fall among the major banks due to falling earnings. Look to the Commonwealth Bank (ASX: CBA) result on February 15 for clues as to whether price and margin pressures will start to crunch at the other major banks as well.

Swan: China is moving closer to its "must act" stage

Finally, Asian equities were the subject of much interest at this GSFM media briefing. As we've highlighted previously, Chinese equities continue to decline sharply while Indian and Japanese equities smash through multi-year highs. So how did Chinese stocks perform so badly so quickly?

"I think there was a very much an expectation 12 months ago that China would come out of COVID the way the West did. Our view was that was not the case and there would be parts of the economy that would benefit, but the broad-based consumption investment would disappoint and that's very much played out," Swan says before adding:

"But what has surprised us is how quickly China has moved into a deflationary environment and even sort of idiosyncratic opportunities within the economy have been swamped by this deflationary force that's emerging," he adds.

The equity market in China is in turn a reflection of a Chinese economy where disinflation has happened faster than expected and the sentiment among consumers is sour. For foreign investors, valuations are so depressed that fund managers like Man GLG's Andrew Swan believe a "Japanification" is being priced in.

Swan, however, sees an opportunity in the mass bearishness.

"When you get these periods of dramatic sell-off, that's when policymakers normally are forced to respond. We haven't seen it yet, but I think we're getting closer to that environment," Swan argues. 

Outside of China, two broad regions spark Swan's interest the most:

• North Asian equities - where AI and semiconductors form the largest thematic trade right now. Taiwan Semiconductor Manufacturing Company (TPE: 2330) is now the largest company by market capitalisation in Asia.
• South East Asia - where economic growth has been both demand-driven and strong. "What is already a good environment here can get better and the growth cycle can elongate as rates come down," says Swan. "Those markets have done pretty well in the last 18 to 24 months."