Never
The market revolves around the perception of inflation
In 2023, global financial markets saw a significant rise in stocks, with the S&P 500 (SP500, SPX) up 22.4% year-to-date, outperforming global bonds. Market sentiment turned positive as inflation perceptions turned positive, reflecting the response to the Covid situation in 2020. The remedy this time is to alleviate temporary inflationary pressures and an economic slowdown that contributes to market stability. The normalization process will result in inflation rates, real interest rates and budgets that are more historically typical, resulting in valuations moving closer to historical norms.
Graphic 1: The stock markets expect low but positive growth
Source: Alpinum Investment Management
The fourth quarter brought exceptional gains, particularly in fixed income, reflecting shifting expectations that favor significant Fed rate cuts in 2024. This shift is reflected in the decline in US Treasury yields to 3.9%, which assumes interest rate cuts of 150 basis points in 2024. While the positive earnings surprises in the S&P 500's third quarter are acknowledged, concerns remain about deteriorating global economic conditions, particularly in developed economies. There is a risk that the negative growth dynamics will be underestimated given the geopolitical uncertainties. Market vulnerability is highlighted, with concerns over the global economic outlook including slowing growth, increasing consumer spending headwinds and elevated valuations.
United States
The US Consumer Price Index (“CPI”) showed a moderate trend in November, with headline and core inflation declining year-on-year to 3.1% and 4.0%, respectively. Due to lower energy and gasoline prices, optimism grew that inflation could reach 2% by the end of 2024. Investor expectations for a decisive rate hike by the Federal Reserve in December faded, followed by revised expectations for federal funds rates, which are expected to reach a 150-basis point cut in 2024. Despite signs of peaking interest rates, November's FOMC minutes reiterated the The Fed's commitment to sustainably raised interest rates.
Figure 2: Implied Fed interest rates
Source: Alpinum Investment Management
In the third quarter, US GDP posted robust growth and exceeded expectations, accelerating from 2.1% q/q to 5.2% q/q per year. The economy showed resilience, driven by increased consumption and positive contributions from private inventory investment, government spending and fixed investment in housing. Despite signs of an economic slowdown, including a slight increase in jobless claims and rising credit card delinquencies, optimism for a soft landing remained, supported by continued economic momentum and tight labor markets. The S&P 500 index rose 22.4% year-to-date and core government bonds recovered, with the 10-year U.S. Treasury yield falling below 4.2% despite Moody's negative outlook on U.S. government debt. In the real estate sector, U.S. home prices peaked in September with a monthly increase of 0.7%, slightly below the 0.8% increase in August. The annual increase in property prices accelerated from 2.6% to 4.0%. However, new home sales fell 5.6% in October, falling short of expectations for a 5.1% decline, with September's increase revised to 8.6% from 12.3%. Rising 30-year mortgage rates, which hit a 23-year high in late October, contributed to subdued housing demand.
Europe
Eurozone economic indicators presented a mixed picture in recent releases. CPI data from Germany and Spain showed an easing in price pressures, with both monthly and annual readings falling short of expectations. The European Commission's indicators for economic, industrial and services confidence exceeded expectations in October and provided positive sentiment despite slight deteriorations in economic and industrial confidence. Germany's economic contraction of 0.1% in the third quarter compared to the previous quarter is better than expected, but underlines the general weakness of the euro area's largest economy. The weak inflation data supports expectations that the ECB has completed its rate hike cycle, with the likelihood that it will maintain its restrictive monetary policy stance. However, credit indicators warn about the potential impact of tighter policies on the economy and European stocks are expected to face headwinds in the coming months. Eurozone retail sales fell further in September, while preliminary PMI estimates for November were slightly less pessimistic, with the composite PMI rising to 47.1.
Graphic 3: “Magic eight” of the EURO STOXX 50
Source: Alpinum Investment Management
Europe has its “Magic Eight” (the equivalent of the “Magnificent Seven” in the US), large-cap stocks contribute significantly to the gains of the EURO STOXX 50 (SX5E): Air Liquide (OTCPK:AIQUF), ASML, L'Oréal, OTCPK:LVMHF, Sanofi (SNY), SAP, Schneider Electric (OTCPK:SBGSF) and Siemens (OTCPK:SIEGY). With a share of 21.8% of the market capitalization of the EURO STOXX 50, they were responsible for 50% of the price gains since 2015 and contributed 6.5% to the current 19.5% in 2023. However, its downtrend is considered expensive, with a price of 21.2 12.6 times expected earnings compared to the EURO STOXX 50. Finally, in the United Kingdom, the economy continued to grow in the third quarter due to strong trading performance despite declines in consumer spending, business investment and government spending avoid a decline. The outlook for UK gilts continues to be influenced by inflation and interest rate expectations, with signs that economic activity has bottomed out.
China and emerging markets (“EM”)
China's central bank, the People's Bank of China (PBOC), followed market expectations by stepping up liquidity injections while maintaining a 2.5% interest rate on 1.45 trillion yuan of one-year medium-term credit facilities (“MLFs”). With 850 billion yuan of MLF loans expiring, the operation resulted in a net injection of 600 billion yuan into the banking system. In the third quarter, China exceeded economic growth forecasts due to robust retail sales and government stimulus measures, offsetting the impact of the housing crisis. However, October trade data showed a mixed outlook, with an unexpected rise in imports contrasting with sluggish global demand for Chinese goods. China's CPI and PPI for October pointed to deflationary pressures and argues for a targeted stimulus approach over expansionary measures.
Figure 4: Core and headline inflation in China (year-on-year)
Source: Alpinum Investment Management
Property prices continued to fall, particularly in lower-end cities, registering a fifth consecutive month of decline. The Chinese government is taking decisive steps to address the housing crisis, asking banks to fill a $446 billion funding gap. Money and credit data for October showed weakness, with overall social financing below expectations and bank lending declining. Monetary supply indicators point to a slowdown in growth: M0 and M1 money supply growth fell to 10.2% y/y (from 10.7%) and 1.9% y/y (from 2.1%), respectively, falling below expectations 2.5% year-on-year. The declining ratio between M1 and M2 suggests weakening confidence in the private sector. The recent weakening of the US dollar has eased pressure on the renminbi. The onshore CSI 300 fell 14.0% year-to-date, reflecting subdued domestic demand and ongoing deflationary pressures in the Chinese economy.
Investment conclusion
The economy faces a slowdown due to increased capital costs, but resilient consumers and a supportive government stance are preventing the threat of a severe recession. Markets are expecting a controlled economic slowdown and a “soft landing”. The “new normal” includes slightly higher structural inflation, increased government spending and continued regulatory support for struggling banks, as well as shifts such as “re-shoring” or “near-shoring”. Potentially, the implementation of peace in Ukraine and the dynamics of the US election year could become events with significant potential, generating an overall positive market reaction.
Chart 5: Returns associated with downside risks
Source: Alpinum Investment Management
Tie up: Given rising default rates and the recent tightening of credit spreads, “credit” as an asset class is fairly valued, but selective bottom-up opportunities still abound. We remain positive on duration exposure as it is a valuable portfolio diversifier in the current economic cycle. We emphasize shorter maturities to mitigate the risks associated with a potential steeper yield curve later this year. We are generally positive on fixed income, both IG and HY bonds. However, our strongest belief remains in European credit, short-term high-yield bonds and CLOs.
Shares: Limited upside potential for US stocks due to high (US) multiples and weak profit margins. When it comes to stocks, we prefer markets outside the USA and pursue a diversified strategy. In general, we maintain our positive bias and neutral positioning in equities and have an overweight position in credit exposure.
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