Major asset classes have started the new year on diverging paths without pricing in a uniform macroeconomic environment for 2024. To hedge against the risk of a hard landing, we would prefer government bonds with longer maturities. Overall, we consider the opportunities and risks to be balanced and maintain our neutral rating for equities.
The year 2024 has started very much the same way 2023 ended: geopolitics continue to dominate the headlines and central banks are attracting a lot of attention, while financial markets continue to focus heavily on short-term inflation and economic data.
Against this backdrop, we decided to take a look at what different asset classes were pricing in. While equities are pricing in a near-perfect scenario - fast receding inflation combined with double-digit earnings growth - bond markets are expecting five to six rate cuts by the US Federal Reserve, which seems only consistent with a hard landing on the economic side. Our own conviction is that there will be a buying opportunity in equities, but we prefer to be "Neutral" for the time being. Regarding government bonds, we have a similar view and think the asset class is likely to become more attractive again.
Our macroeconomic article offers a comparison of the economic performances of the United States and Europe. We observe that per capita productivity has grown much faster in the US than in Europe since 2010, and that this trend has only accelerated in the years since the pandemic. On the currency side, we express a positive stance on the JPY. The yen is currently trading at historically low valuations. Considering the divergent dynamics in terms of monetary policy - the US Federal Reserve plans to cut interest rates, while the Bank of Japan is expected to start raising rates - this creates a supportive backdrop for the JPY to appreciate against the USD.
Regarding equity markets, our article focuses on the recent performance of the S&P 500 and the Japanese stock market. It also examines the commodities sector, providing insights into current market trends and potential investment opportunities. In this regard, we continue to see opportunities in gold mining companies. The recent divergence from the gold price is extremely rare and the positive catalysts we identified as drivers at the time of our positive call on gold miners remain intact. Finally, when it comes to fixed income, we reiterate our expectation that the curve is likely to steepen in an environment where yields appear set to fall. We see limited potential at the long end and would prefer the three to five year government bond segment, which offers a combination of attractive yields and potential price gains from falling interest rates.
All in all, we are "Neutral" on major asset classes. Within each class, we express our convictions where we see investment opportunities.
While financial markets tend to be poor indicators of fundamentals in the short to medium term, the gravitational force of fundamental data has a clear impact over the long term at the latest. Beyond the long-term structural view, the medium-term economic cycle has recently turned against Europe. While much of the widespread pessimism about Europe is justified given the fundamental divergence, it should be emphasised that long-term economic and financial opportunities may emerge once the "capitulation" in economic sentiment ends, and general conditions finally improve.
Financial markets seem to start 2024 with different views embedded in different asset classes. While equity markets are focused on a goldilocks scenario with optimistic economic assumptions, fixed income markets are focused on rapid inflation decline and a potential hard landing on the economic side. The monetary decisions from the Fed will likely continue to drive overall asset performance in 2024, but the state of the economy will also play a role in the direction markets will move in. For the time being, we are "Neutral" on equities and government bonds.
The leading S&P 500 index has climbed to a new all-time high. The driving force behind this is a sustained expansion in valuations, especially in the technology sector. Meanwhile, the broader-based Russell 2000 is trading far behind. In Japan, the indices are also approaching a new all-time high after approximately 34 years. Structural advantages such as a much more shareholder-friendly corporate policy are offset by new risks of a possible monetary policy trend reversal by the Bank of Japan and thus potentially more headwinds from the currency front. Overall, we consider the opportunities and risks to be balanced and are maintaining our "Neutral" view on equities.
Following the sharp fall in long-term government bond yields in the last few weeks of 2023, we believe that a certain amount of countermovement is likely. Apart from the high-yield segment, where we are avoiding the weakest issuers, we are currently "Neutral" in all other fixed income segments. For government bonds, we prefer the three to five year maturity range where we expect the best risk/return profile, while for corporate bonds we would go a little shorter in order to limit credit risks. To hedge against the risk of a hard landing, we would prefer government bonds with longer maturities.
Our market assessment reveals that the Japanese yen (JPY) is currently at historically low valuations, making it an attractive choice. In addition, differences in external economic fundamentals favour the JPY over the US dollar. Regarding monetary policy, the US Federal Reserve’s plans to reduce interest rates and the anticipated rate hikes by the Bank of Japan create a scenario where the USD is expected to weaken against the JPY. Finally, with yields in the US potentially stabilising, there is optimism for a sustained JPY appreciation.
Geopolitical tensions have increased uncertainty in the capital markets and gold’s diversification role remains important. Investors continue to view the precious metal as a safe haven, so it is not surprising that it has remained an attractive asset in recent years.