MARKET INSIGHT – February 2024

MARKET INSIGHT

Prime Partners’ monthly analysis of global economic and financial market news.

Nothing much on the surface, but a few rumblings in the depths

At first glance, January looks rather uneventful. No sharp drop in the stock markets after the last two high-flying months of 2023. Nor any new exogenous events to undermine investors’ solid optimism about the shape of the US economy. No one will deny that the temptation to embrace a “goldilocks” scenario for market indices is great in 2024. The robustness of the US economy continues to amaze, inflation keeps receding almost everywhere and, of course, the technological revolution linked to artificial intelligence is on everyone’s lips, across all sectors. Some people add a pinch of historical statistics to this somewhat idyllic picture, reminding us that, in the past, American election years have regularly been good for stock market performance. We would like to add a few cautious nuances to this general mood regarding the financial markets, while acknowledging that the hypothesis of a soft landing for the US economy, engineered over many quarters by the Federal Reserve, does indeed seem to be materializing.

A regular theme in this publication in 2023, US employment underpins the economic momentum in Uncle Sam’s country. More precisely, it is the attitude of consumers that is important, as they alone account for a large part of the success of a “soft landing” scenario that is relatively rarely observed in history.

The Fed therefore intends to capitalize on buoyant consumer spending, which in turn is driven by low unemployment, to ensure that the inflationary rollback it has been working towards for the past 18 months will continue without  “wrecking” growth.

The current US situation is by no means entirely transposable to the other major regions of the world, and we think it wise to bear in mind that Europe cannot boast the same economic vigor. Without resorting to unwarranted alarmism, we have to acknowledge that whole swathes of the old continent’s economies are currently in recession. This is due in particular to the heavy weight of the industrial sectors in these countries, led by Germany, but also to the technological shift toward artificial intelligence, whose trends and players are predominantly non-European.

The FED therefore intends to capitalize on buoyant consumer spending, which in turn is driven by low unemployment.

And what about the situation in China, which still shows no signs of improvement after a difficult 2022? For the time being, the major stimulus measures introduced by the Chinese government are having no effect on the stock market, and investors, both local and foreign, remain highly skeptical in the face of the authorities’ stubborn focus on boosting supply, particularly credit, rather than demand.

In other words, promoting loans is pointless if no one wants to borrow and Chinese citizens prefer to save. And last but not least, foreign capital is having a hard time flowing back into China’s stock markets, as the government’s authoritarian interventionist excesses of recent years have left their mark on people’s minds… and portfolios.

As the year gets underway, we therefore distinguish between these three major areas – the United States, Europe and China – in terms of future economic momentum and, unsurprisingly, adopt the same order of preference for our investments.

If we move down one level in our analysis, there is no doubt that central bank policies will take center stage in 2024. With rate hikes now seemingly behind us, investors will be refocusing on when and how often the central bankers will loosen their grip on interest rates.

Now that the predictions made at the start of the year are in, it seems realistic to say that the market is expecting between 5 and 6 rate cuts by the US Federal Reserve in 2024, which appears excessive to us given the current economic climate. In addition, we do not anticipate any rate cuts before April or May. We believe that the Fed will “judge based on the evidence” at each of its meetings the state of the US economy and the extent to which inflation is not showing signs of rebounding. It also seems likely to us that the European Central Bank will continue to adopt an attitude of “following the U.S. lead”, unless the economic slowdown currently affecting the Old Continent intensifies markedly.

January also signals the start of the reporting season for the fourth quarter of last year, but above all it provides an opportunity to assess the state of companies at the start of the new year. At the time of writing, only a modest percentage of companies have announced their results, but a trend already seems to be emerging: the good performers are being hailed by the market, while more nuanced outlooks for this year are being punished, even if they are accompanied by good Q4 2023 figures.

Market participants therefore seem to be looking for optimistic statements from CEOs for 2024, and are undoubtedly a little weary after a long period of timid guidance, in which an uncertain global environment and penalizing inflation were regularly mentioned. Artificial intelligence will certainly be at the heart of many management pronouncements once again this quarter, in the technology sector of course, but probably more broadly as technological progress spreads throughout the economy and drives productivity gains.

We therefore anticipate an earnings season of generally good quality, but a market with high expectations and no room for disappointment, particularly on the 2024 outlook. After only one month, there is already a wide dispersion of performances across sectors, and by way of example, the famous ” Magnificent Seven ” already seem to be down to just six, with Tesla’s share price off by almost 20% since the start of the year! More than ever, we believe it is imperative to focus on the quality of the balance sheets of the companies we invest in, both in terms of equity and debt, with interest rates set to remain high even after a series of cuts, and also because of the considerable debt refinancing needs from 2025 onwards.

As you will have gathered from reading these lines, our allocations are consistent with those of 2023, and our approach remains constructive and cautiously optimistic. We therefore continue to emphasize good diversification in our portfolios, starting with the fixed-income portion, which combines active strategies on both high-yield and investment-grade corporate bonds. We continue to play the short and long ends of the US Treasury yield curve, as well as dollar-denominated emerging corporate bonds. Finally, we have reduced the weighting of convertible bonds in our mandates, in order to simplify our exposure to this asset class.

As for equities, there has been little change in our allocations either geographically or thematically. The United States remains our favorite market for investing in risk assets, ahead of Europe, where we favor growth at a reasonable price and leading companies with robust, proven business models. Unsurprisingly, China is still out of our favor, despite increasingly attractive valuations following a calamitous 2023 and a similar start to 2024. We remain convinced that technology still offers potential this year, despite an exceptional 2023, albeit largely concentrated on the very largest market caps. We also expect stocks linked to the energy transition to regain momentum in 2024, buoyed by an environment of declining interest rates and the increasingly tangible reality of a changing energy mix.

Finally, our assessment of current economic conditions, which continues to anticipate a soft landing in the US, has prompted us to add an actively managed position in high-dividend Swiss stocks to our allocations. This decision reflects our constructive and cautiously optimistic view of equities.

In conclusion, it would be unwise to overlook potential exogenous factors for 2024, given that a number of electoral milestones are on the horizon, most notably in the United States, and that the global geopolitical climate has deteriorated significantly in recent years. Here again, optimism is the order of the day, along with caution.