In addition to falling inflation, the financial markets continue to benefit from a robust US economy, but the positive impetus should soon begin to wane: the tailwind from the pandemic is likely to fade in the US over the next few months, while the headwind from the deterioration in financing conditions will increase. It remains difficult to predict when the braking forces will gain the upper hand. However, there are several indications that this will be the case in the first half of 2024: shrinking money supply, the burden of higher interest rates and increased labour costs.
Focus on the quality of equities
»In view of the still robust but fragile economic situation, investors have no choice but to take a long-term view,« says Dr. Daniel Hartmann, Chief Economist at the asset manager Bantleon. »The equity exposure should initially be at a neutral level.« However, as soon as the economic news situation in the US deteriorates noticeably, a more defensive positioning is recommended. »If our base scenario of at least a mild recession in the US comes true, we continue to believe that significant price setbacks on the global equity markets are likely. However, if the USA scrapes past a recession, volatile ups and downs without a clear trend are also possible.« The upside potential is limited by the high valuations, particularly in the USA.
In this challenging environment, Hartmann recommends that investors focus on equities that can withstand rising interest rates and economic headwinds, i.e. that have low debt levels and robust profit margins, among other things. These could be companies from the consumer staples and telecommunications sectors, but also solidly positioned utilities.
Further price gains for government bonds with good credit ratings
High-quality government bonds have recently benefited above all from the falling inflation trend. This is also reflected in the declining inflation expectations. Among other things, inflation expectations derived from 5-year EUR inflation swaps have fallen back towards 2.00% for the first time since the beginning of 2022. At the same time, the key interest rate level priced in on the money futures markets has fallen significantly.
»Inflation rates in the USA and the Eurozone are likely to continue to fall in the coming months,« predicts Hartmann. At the same time, the deterioration in the economic environment should provide additional support for government bonds. Finally, the central banks will also react to the changed conditions. Instead of fighting inflation, concerns about dwindling growth will increasingly come into focus. Even if the major economic crisis does not materialise, stagnating growth should be enough to justify a reduction in key interest rates to a neutral level. »We therefore assume that key interest rates will be cut by the Fed to at least 3.50% and by the ECB to 3.00% in 2024. The probability of even greater interest rate cuts towards 2.00% is significantly higher than the reverse.« The SNB should at least make a small interest rate cut to 1.50% or 1.25%.
»We therefore still see room for downward movement in key interest rate expectations, although considerable monetary easing has already been priced in on the money futures markets,« explains the Chief Economist. »Accordingly, we are forecasting further yield reductions and associated price gains for government bonds, although the downside potential in Germany is significantly smaller than in the US: yields on 10-year German government bonds are likely to fall to 2.00% and yields on 10-year US Treasuries to 3.40% by mid-2024.« Even sharper declines are expected for short maturities. The yield curve should therefore steepen and normalise over the course of next year. The declining yield trend will obviously not be a one-way street. Negative inflation surprises in particular could trigger temporary setbacks. »Yields on Swiss Confederation bonds are unlikely to escape the global downward trend. However, given the low level already reached (10-year: 0.70%), the potential is no more than 20 basis points.«
Opportunities in investment-grade corporate bonds and covered bonds
»In addition to government bonds, other bond categories offer promising return perspectives in the environment outlined above,« says Hartmann. »Here, too, the keyword is quality.« If the global economy cools down but does not fall into a severe recession, the widening of risk premia for covered bonds and corporate bonds with high credit ratings is likely to be limited. »Thus, there is a good chance that at least the current yield levels (in Europe: 3.00% to 4.00%), if not slight price gains, can be realised. In contrast, we remain sceptical about high-yield bonds. As soon as a risk-off environment becomes established, this segment will come under heavy pressure, especially as the refinancing requirements of many junk issuers will increase sharply over the next few quarters due to the sharp rise in interest rates.«
In an environment in which the global economy comes under pressure but does not crash, Hartmann believes that opportunities will also arise in the emerging markets: »Some solidly positioned East Asian countries in particular – including India, Indonesia, Vietnam, the Philippines and Malaysia – are likely to perform well in 2024 and once again expand at an above-average rate, which should benefit equities and bonds alike.« The latter is all the more true as the foreseeable turnaround in global monetary policy will give many emerging markets room to cut interest rates.
Be careful with commodities, peripheral government bonds and linkers
The Chief Economist is sceptical about commodities, inflation-linked government bonds (linkers) and peripheral government bonds in the short to medium term: »Industrial metal prices will only really pick up when the global economy turns noticeably upwards. However, we do not expect this to happen until the second half of 2024, although we also see little downside potential due to the structural supply deficits. In turn, inflation-linked government bonds are likely to be held back by the further fall in inflation rates.« Finally, the southern European countries will also find themselves in rougher seas in 2024. In Italy in particular, there is a risk of a significant setback in growth. »The risk of risk premia on Italian government bonds rising from their current very moderate levels compared to German government bonds is correspondingly high.«
