• Equity markets continued to march high in the first quarter. Though the "Fed pivot" trade of fourth quarter 2023 lost some of its luster, increased confidence about a soft landing buoyed investor sentiment in early 2024. 
   
• Despite benchmark interest rates shifting slightly higher across the yield curve, both equity markets and gold prices established a series of new record highs during the first quarter.
   
• Massive levels of deficit spending globally may have prompted a structural shift toward a higher rate of nominal drift. Resilient companies whose performance patterns tend to drift in concert with nominal growth may benefit.
• It’s been our experience that the gold market sometimes serves as the metaphorical canary in the coalmine, sussing out potential dangers before they manifest in asset prices more broadly.

Among the more curious developments during first quarter 2024 was the concurrent new highs established by both equity markets and gold prices despite interest rates—both nominal and real—that persist at levels not seen since before the global financial crisis. High interest rates generally would be expected to weigh on equity valuation multiples, while the price of gold historically has been inversely related to changes in the real interest rate. Perhaps the most plausible explanation for this phenomenon is a fundamental shift to a higher rate of nominal drift in the global economy, the cause of which can be traced to the very large primary deficits currently facing many of its largest participants. In our view, the persistence of higher levels of nominal drift ultimately may result in multiple expansion for the resilient businesses well-positioned to benefit from it.

Set Adrift
The world’s largest economies—including the US, China, the euro zone, Japan and India—have been growing their stocks of government debt at a fairly rapid rate, continuing to run primary deficits even as mounting interest expenses drive total debt burdens still higher. The stimulative impact of this spending appears to have buoyed activity in general, with everything from equities and gold to wage growth (4.7% in the March reading of the Atlanta Fed’s Wage Growth Tracker³) and corporate earnings and revenues (forecast at 10.9% and 5.1%, respectively, for S&P 500 companies in 2024⁴) being marked higher.

While the loose financial conditions that have resulted from ongoing deficit spending appear to have promoted economic resilience in the face of a higher cost of capital, they also are complicating the Federal Reserve’s efforts to fully rein in inflation. The hot inflation print released in early April was a good reminder of the ongoing push-pull between fiscal and monetary policies. At 3.5% on a headline basis, the March consumer price index was above expectations and may derail the 2024 rate cuts that both the market and the Fed appear to want. Interest expenses on the country’s massive debt pile will continue to increase as lower-yield bonds roll off and are replaced with bonds at current rates, creating a whole other set of problems for the country.

The challenging fiscal picture in the US brings to mind what we refer to internally as the “India paradox.” Typically, high interest rates—and thus high discount rates—could be expected to weigh on equity market valuation multiples. Not so in India. Despite a 10-year government bond yield that has averaged more than 7% since 2014, the MSCI India Index has delivered an annualized return of 13.6% over the past decade and trades at a trailing price-to-earnings ratio of 26.2x as of the end of March. For comparison, the MSCI USA Index also trades at a P/E ratio of 26.2 and has a 10-year annualized return of 12.9% in an environment of 2.4% 10-year Treasury yields.⁵ While this confluence of high interest rates and high multiples in India may seem illogical at first glance, it seems less so if you consider the stimulative impact that deficit spending has had on the country’s nominal economic growth, which has averaged around 10.2% since 2014 (including the Covid-related contraction in 2020)—well in excess of long-term interest rates.⁶

Without a primary deficit—as was the tendency in US budgets from World War II through 2000—nominal drift is driven solely by interest rates and assets are priced at a risk premium to that. Primary deficits can fuel levels of nominal drift in excess of prevailing interest rates, often to the particular benefit of certain sectors and companies that serve as claims on nominal growth and whose performance patterns tend to drift in concert with it. This tendency has been quite evident in India, for example, where there are a number of large consumer staples businesses whose exposures to nominal economic drift may represent a very attractive risk premium relative to Indian sovereign debt despite the high valuation multiples that they command.

Nominal drift may also explain the persistent success of certain names in the US tech space, where multiples continue to expand for companies viewed as “staples” in today’s high-tech world. It’s reasonable to think that the persistence of higher levels of nominal drift in developed markets ultimately may result in multiple expansion for businesses well-positioned to benefit from it. Like in India, this may include traditional consumer staples companies, whose modest valuation multiples in developed exchanges imply a low-risk claim on nominal drift.

 Gold Surges Despite Headwinds
Tumultuous geopolitical conditions continue to feed into the investment environment from the top down, even without the emergence of a truly global conflagration. Deteriorating global relations have prompted ever-rising defense budgets across the developed world, for example, contributing to the deficit spending and nominal drift we mentioned above. They’re promoting a risk premium in oil prices, while supporting better-than-expected demand and sticky supply levels. And they also may be a key factor behind gold’s resilience in the first quarter and throughout the current rate-hike cycle.

Despite the seeming headwinds of higher real interest rates and a stronger dollar, the gold price broke sharply higher in March, rallying more than 8% over the month to finish at an all-time nominal high above $2,200.⁷ It’s been our experience that the gold market sometimes serves as the metaphorical canary in the coalmine, sussing out potential dangers before they manifest in asset prices more broadly. Global central banks, perhaps themselves extra-sensitive to these dangers, have been massive buyers of gold in recent years, which has helped support the metal’s price. At 1,037 tonnes, net purchases of gold by central banks in 2023 was second only to 2022’s record level of 1,082 tonnes; buying has continued to be strong in 2024, with central banks adding an additional 64 tonnes to their coffers year to date through February.⁸ Notably, emerging market central banks have been the primary buyers, led by the People’s Bank of China, which has upped its gold reserves for 16 consecutive months.

The Price of Resilience
For some time now, assets promising growth have been assigned premium valuations, suggesting a low level of risk aversion in the markets. Should the environment become more complex—if the soft-landing scenario fails to play out, or sovereign debt concerns promote a broad repricing of government paper, or if any one of the global military hotspots ignites into broader conflict—the market may start to value potential resilience over expected growth. This is not as strange as it seems; in the mid to late 1990s, companies as straightforward as Coca-Cola and Clorox, for example, were trading at earnings multiples of 50x or more.⁹ Resilience has traded at a premium in the past, and there’s no reason to believe it won’t do so again under the right circumstances.