- Home »
- Insights »
- CIO View »
- CIO View Quarterly »
- Step by step, uncertain direction
It is quite possible that we will be happy in twelve months' time if our current market forecasts come true. Although they are quite cautious anyway. In the case of equities, the low single-digit return potential is fed almost exclusively by the expected dividend payments. And in the case of bonds, although we expect higher returns than in some previous years, possible further increases in key interest rates or risk premiums put pressure on the return potential. These forecasts are based on our core scenario. But the basis for the forecasts is less reliable than valuations in many parts of capital markets would suggest. The first two months of the year have impressively shown how shaky the macro-economic foundation currently is. In January, investors believed to see only positive things. For example, a stronger-than-expected economy in the U.S. with declining inflation concerns. Already in February, the tide turned, partly because some of the published economic figures were revised downwards. Which should serve as a reminder of how badly some data series have been messed up by the Covid episode. They could send wrong signals for a few more quarters. In any case, the ugly word stagflation quickly made the rounds, even if we think little of it at present. To give just one example of how quickly market opinions have changed: Since the beginning of February, inflation expectations[1] in the U.S. have risen by more than a full percentage point to now 3.4%.
In January, investors believed to see only positive things. For example, a stronger-than-expected economy in the U.S. with declining inflation concerns
In our opinion, there is further potential for surprises when it comes to inflation and (central bank) interest rates: 1) Inflation rates at today's level were last seen in the 1980s[2]. 2) Despite a more restrictive monetary policy, labor markets remain strong. And financing conditions remain supportive. And there is no real stress in the financial markets. Despite higher interest rates and inflation, consumers, especially in the U.S., remain surprisingly willing to spend[2]. 3) Monetary policy works with a time lag of several quarters, which could push central banks to overreact. Added to these problems is a reaction of the capital markets that is difficult to predict: how long would the market celebrate a looser monetary policy before worrying about the danger of a protracted fight against inflation? It gets even more complicated the other way round: how long would the market's fright over a tighter monetary policy if it also increased the conviction that inflation would be largely under control by 2024? And wouldn't this looseness then again counteract central bank efforts (see point 2b above)?
I am giving much space to these considerations in order to illustrate that not only central banks but also investors have to shimmy from one macroeconomic data point to the next in this environment - "data dependent", as central bankers call it. The forecast framework that was ultimately adopted is as follows:
- Growth/recession: In general, economies have performed better than feared, but are still weak in absolute terms. For the U.S., we continue to expect a mild recession in the course of the year, the Eurozone should narrowly escape it. The subsequent recovery is likely to be moderate (1.1% for 2024 for both regions). In China, on the other hand, we expect more than 5% GDP growth for 2023 and 2024.
- Inflation and central banks: We think central banks will do almost everything to get inflation back under control. We see inflation rates below 3% for the Eurozone and the U.S. by the end of 2024, even if the decline in core inflation is currently slower than hoped. However, we also see the first signs of slowing activity in some areas (credit demand by companies and house builders, temporary employment, M1 money growth) caused by the previous interest rate hikes. We expect the Fed funds rate to peak at 5.5%, and the ECB deposit rate at 4%, in the second quarter. From the Bank of Japan, we expect a gradual end to yield curve control, followed by two small, symbolic rate hikes.
- Fixed income: We think government bond yields have not yet peaked and see in 12-month 10-year Treasuries at 4.3% and 10-year Bunds at 2.9%. Only for 2-year Treasuries do we see declining yields (target: 4.4%), which is why we like this segment. Corporate and emerging market bonds may see a widening of the risk premium, but the high current yields offer some risk buffer, especially based on good corporate balance sheets. We expect a slight appreciation of the euro and yen against the dollar.
- Equities: With high interest rates, stagnant earnings, but still high profit margins in developed markets, we see little upside for global equities. Our 12-month targets are 4,100 for the S&P 500; 16,300 for the Dax and 480 for the Stoxx 600. We believe European small caps, Asia and the communications sector will outperform.
- Alternatives: We expect Brent oil to trade at 100 USD per barrel and gold at 1940 USD/oz in 12 months.
