Annual Outlook 2024
The recession that many had been dreading didn’t materialize in 2023, and equity markets performed better than expected last year. For US economic activity in 2024, a postponed recession doesn’t necessarily mean a canceled one – the path for a soft landing is narrow and requires a proactive central-bank policy. Meanwhile, sentiment on the financial markets is almost too good at the moment for new highs in the MSCI World equity index in the immediate future. However, bullish sentiment indicators aren’t necessarily always good counterindicators.
Review: The recession that didn’t happen (yet)
A year ago, a recession in the world’s industrialized countries seemed all but assured. Depending on who or what survey one consulted at that time, a 50% to 90% probability of an economic contraction was quoted in the case of the USA, for example. There were plenty of arguments pointing to a downturn. One of them was the fact that central banks around the world had raised policy interest rates more swiftly and sharply than at any time in more than 40 years. Moreover, warning signals were being sounded by a variety of recession indicators like the US yield curve and the Conference Board Leading Economic Index, which had proven to be reliable in the past. The combination of soaring inflation north of 5% and a concurrently low unemployment rate below 5% also boded ill because in previous cycles this had likewise been a 100% accurate leading indicator of a recession. Our outlook for 2023 was somewhat more optimistic than the majority view. Although we, too, anticipated a US recession, we didn’t expect to see it until 2024.
Last year indeed surprised on the upside, at least in terms of economic growth. The world economy grew 1 percentage point more strongly than the consensus forecast, and GDP growth in the United States even outpaced the consensus estimate by around 2 percentage points. Germany was the only major industrialized country that had to tolerate a (quarterly) contraction in economic output. The resilience in the face of the monetary policy U-turn was driven in part by persistently vibrant US consumer spending on the back of extra savings accumulated during the pandemic and solid wage growth. It was also driven by a fiscal tailwind created by investment programs like the Inflation Reduction Act and the CHIPS and Science Act, as well as by an array of other deficit-spending measures aimed at bolstering economic activity. Finally, the time factor has also worked in favor of economic activity thus far. Many businesses, for example, procured capital on cheap terms during the pandemic and accordingly have not been affected yet by stricter refinancing conditions. The same goes for consumers thanks in part to the typically long fixed interest-rate terms on US real estate mortgages. But a postponement of a potential recession doesn’t necessarily mean a canceled recession.
Much better than expected | An upward bend in growth for once
Consensus economic growth estimates for 2023
Sources: Bloomberg, Kaiser Partner Privatbank
Outlook: Frog in a pot?
Viewed objectively, the risk of a recession appears to have diminished in recent weeks, as suggested not just by the sharp increase in the number of Bloomberg News stories containing the catchphrase “soft landing,” but also by Wall Street analysts’ forecast views, which are a bit more laid-back now than they were a year ago – “only” around 50% of them still expect a recession within the next 12 months. However, every recession starts out looking like a soft landing. The problem is that an economic downturn doesn’t follow a linear path. The longer it lasts, the more it becomes self-reinforcing and the more the element of surprise accordingly lies on the downside. Our subjective estimate of a recession happening has therefore become a bit more pessimistic in contrast to other observers’ projections.
Various credit statistics already progressively worsened during the course of 2023. The number of corporate insolvencies rose, banks restricted their lending, and consumers are increasingly falling into arrears on credit card debt and car loans. The longer the interest-rate environment stays at the present level, the more this is likely to have growth-curtailing consequences. The US employment market also has already been cooling down significantly in recent months. If the unemployment rate climbs to above 4% soon, that would flip another recession indicator – the Sahm Rule – into warning mode.
Will there be a recession or no recession? Central banks are likely to be the deciding course-setting factor in 2024. If they proactively react to a deterioration in macroeconomic data by cutting interest rates before inflation is back to the target level, they perhaps can successfully engineer a soft landing. However, central bank officials’ track record argues against this positive scenario. It’s more probable that central banks won’t ease monetary policy until a recession is already underway, just like a frog in a pot that doesn’t notice the increase in the water temperature (until it gets boiled alive).
Optimism at the wrong time? | A soft landing often turns into a recession
“Soft landing” news stories (as a percentage of all Bloomberg News articles)
Sources: Bloomberg, Kaiser Partner Privatbank
USA: Braking maneuver
Regardless of whether the United States sees a soft landing or a recession in the new year, the road to either outcome passes through a deceleration of the pace of economic growth compared to the surprisingly strong year 2023. Over the last 12 months, economic output in the USA likely far exceeded the country’s potential growth rate by around 2.5 percentage points. According to data from Bloomberg, GDP growth forecasts for the USA for the year 2024 have recently been ranging between 0.2% and 2.2%, depending on whether the forecaster is in the optimists’ or the pessimists’ camp. The wide gap between those estimates reveals that even in the fourth post-COVID year, there is still a certain amount of disagreement (and uncertainty) about the aftereffects of the pandemic disruptions and a return to the old laws of economics. However, there are ample arguments for a braking of economic growth. Excess savings from the pandemic will definitively run out over the course of 2024, and the cooling job market is also likely to depress consumer confidence. The fiscal impulse likewise looks set to exert a negative impact in 2024. Although the USA will run a massive federal budget deficit again, what matters for growth is the delta, i.e. the year-on-year change in the deficit. The delta is negative and will thus exert a braking effect on economic growth.
This deceleration plays right into the US Federal Reserve’s hands because the rapid disinflation process, which was another positive surprise in 2023 alongside the robust economic growth, appears destined to continue. Goods price inflation (excluding food and energy), which accounts for 26% of the core inflation basket, has already completed the disinflation process and has recently been hovering at the 0% line. Services inflation excluding housing and energy (30%) has also been receding sharply lately and looks set to drop further if the employment market continues to return to normal. The biggest chunk is rent price inflation, with a weight of 44%. Due to the way in which it is calculated – one could even call it a design flaw –, rent price inflation is very sticky and still stood at around 6.5% in the last inflation print. Based on real-time lease transactions, though, year-on-year rent price increases have already pulled back from 16% to 3%. This will gradually flow into the inflation calculation over the course of the coming months. Core inflation in the USA could already be close to the 2.5% mark by mid-year, giving the Fed leeway to cut interest rates.
The permanent political dysfunction in Washington, D.C., could also pose a risk to US economic activity in 2024. Although Congress averted a government shutdown and a payment default last fall (the next debt ceiling debate has been deferred until January 2025), the ousting of Kevin McCarthy from the speakership of the House of Representatives and the subsequent three-week period of chaos without a successor give reason to expect continued political volatility in the near future. In any event, the US election campaign will quickly gain momentum at the start of 2024 and will largely dominate the media landscape throughout the entire year. A comeback by Donald Trump would have to be viewed in a critical light, including with regard to the economy. Be it a rollback of President Biden’s infrastructure programs or tighter restrictions on immigration, many items on Trump’s agenda would act as a brake on economic growth in the near or long term. However, given the USA’s towering piles of debt, even Trump would likely have no financial maneuvering room left for further tax cuts.
More disinflation in the pipeline | Falling rent prices will flow into the calculation soon
Components of core inflation and Zillow Rent Index
Sources: Bloomberg, Kaiser Partner Privatbank
Europe: Without a locomotive
While the recession question in the USA can still be considered up in the air, the answer regarding the Eurozone seems clearer: an economic contraction in the next nine to 15 months is likely with a probability of more than 60%. It is perhaps even already underway given the negative growth in the third quarter of 2023 (–0.1%). There are a variety of reasons for Europe’s weak growth profile. For one thing, fiscal stimulus in Europe was not as large or as effective as quickly as in the USA (for example, money has been drawn only very slowly from the NextGenerationEU reconstruction fund). Moreover, the transmission mechanism of the tighter monetary policy in the Eurozone works much more rapidly. Whereas around 70% of businesses in Europe obtain their financing through banks (at variable interest rates), US businesses procure 80% of their funding on the capital market (at fixed interest rates). The flow of credit to businesses and households in the Eurozone ground to a complete standstill in the fourth quarter in the face of record-high European Central Bank policy rates.
The medicine is working | Higher policy interest rates slow lending growth
Year-on-year lending growth in the Eurozone
Sources: EZB, Kaiser Partner Privatbank
Less generous support from the state during the pandemic, the Ukraine war on the doorstep of Europe, an energy-price and inflation shock, rising interest rates, and falling house prices – it’s entirely understandable that European consumers are not in a buoyant shopping mood amidst all this adversity. Consumer sentiment in Europe has remained depressed to date. While retail sales in the USA are already setting new records, retail sales in the Eurozone are still below the pre-pandemic trend level. Light at the end of the tunnel is in sight, though, because the mathematical sign in front of real incomes looks set to flip back to positive in the Eurozone as well during the course of this year. Nevertheless, an economic-growth-driving boom in consumer spending is unlikely to happen so quickly. Manufacturing sentiment is also still subdued – a stabilization at a low level at best has been observable lately. This deals a particularly hard blow to manufacturing- and export-heavy Germany, where industrial production for energy-intensive sectors has recently been lagging 15% below the 2015 level. If winter 2023/24 turns out to be less mild than last winter, this would further up the pressure on Germany’s manufacturing industry. We don’t necessarily think that Germany has relapsed to being the “sick man of Europe” yet, but the country nonetheless is unlikely to make a rapid comeback as an economic growth engine in the face of further challenges (including competition from Chinese electric vehicle manufacturers) coupled with a mediocre political performance at best by the “traffic light” coalition government and a new multibillion-euro hole in Germany’s federal budget in the wake of the November ruling by the Federal Constitutional Court.
From stagflation to stagnation – could ultimately end up being the motto for Europe for 2024.
“From stagflation to stagnation” could ultimately end up being the motto for Europe for 2024. The solid employment market to date should act as a buffer on the downside, but the growth projections by major institutions like the OECD (+0.9%), the ECB (+1.0%), and the IMF (+1.2%) could prove overly optimistic. The good news in the stagnation scenario is that inflation will continue to recede. It recently has already fallen faster than the consensus had expected. In theory at least, this would give the European Central Bank leeway to cut interest rates starting in the second half of 2024 (whether the ECB will use that leeway is the other question). And one other thing shouldn’t be forgotten: the Eurozone growth figure applies to a conglomerate of almost two dozen countries. Within that cluster, there are bound to be some outliers to the upside again this year just like in 2023 with Spain and Greece, for instance. Switzerland likewise looks set to grow faster than its neighbors again in 2024 at a rate of around +1%, albeit at a slower absolute pace than the historical average.
China: Stabilization at a lower level
There could be more than just stagnation or a surprise on the upside in export-heavy European countries if consumer and business sentiment in China snaps back to life in 2024. The Chinese growth engine never really kicked into gear in 2023. The “reopening” of China’s economy after the end of the COVID lockdown turned out to be a flash in the pan. Although China’s export sector resumed replicating past successes, consumer spending and business investment expenditures stayed below expectations. At times it even looked as though the government’s growth target, which had been dialed down to +5%, had drifted out of reach. However, ever since the Politburo meeting in July, if not before, stabilizing growth became a priority objective for the leadership in Beijing. With the aid of dozens of selective support measures, the government succeeded in putting a floor under growth. Those measures particularly included a massive expansion of China’s public budget deficit (by 1 trillion renminbi) to lend local governments a hand. Other measures were aimed at bolstering consumer spending and China’s real estate market. Even the People’s Bank of China got involved in the support operation by lowering interest rates. So, in the statistical final reckoning for 2023 – of hardly confidence-inspiring quality, mind you – a 5 is likely to precede the decimal point for GDP growth, as desired by Beijing.
Looking ahead to 2024, the government of China is likely to stay its pragmatic course and to continue maneuvering the national economy along the target growth finishing line (which will probably be near 5% again). Meanwhile, bigger spurts of growth are no longer likely to be forthcoming from China, mainly because underlying structural problems remain in place. They particularly have to do with the housing market. The real estate market, depending on how one defines the business sectors associated with it, accounts for 15% to 30% of China’s gross domestic product. Home ownership accounts for 60% to 70% of a typical Chinese household’s total assets, so real estate prices have a correspondingly big impact on psychology and consumer confidence. Ever since the government of China defined its “three red lines” to restrict borrowing by property developers and ever since President Xi Jinping proclaimed that “houses are for living in, not for speculation,” real estate prices (on the secondary market) have fallen by 15% to 20% in large cities and by up to 30% in smaller cities. Meanwhile, around half of China’s largest private property developers are in arrears on their payment obligations. By now there is hardly anyone left who believes that real estate prices invariably always rise. Although a real estate crash (like the one in the USA during the great financial crisis) doesn’t loom because the government imposes high minimum down payment requirements on the Chinese to absorb the price correction thus far, households’ net asset shrinkage is nonetheless leaving its marks – consumer sentiment seems to be permanently in the cellar.
A matter of confidence | Chinese consumer confidence is in the cellar
Consumer confidence in China
Sources: Bloomberg, Kaiser Partner Privatbank
China bearishness, in fact, may currently be experiencing a local climax.
The growth model based on investment spending and exports that has brought China success since the 1990s has long since passed its use-by date. What’s needed would be to foster domestic consumption as a driver of growth, but the government of China thus far hasn’t dared to make the necessary model switch. Since the social safety net in China isn’t very fine-meshed, the Chinese have a very high savings rate and consumer spending stays below potential. Demographics pose an additional challenge: China appears destined to grow old before the country gets really rich. But it’s too soon to intone a swan song for China. China bearishness, in fact, may currently be experiencing a local climax. In critical strategic sectors such as electric vehicles and wind and solar power, China has developed into the world’s largest exporter in a span of just a few years. As a low-cost producer in fast-growing areas of the world economy, China most likely will continue to have an important role to play in the years ahead.
Monetary policy: Behind the curve
Over the course of the last 12 months, central banks raised policy rates much more forcefully than the analyst community predicted a year ago in its respective outlooks for 2023. At 5.5%, the top of the US federal funds target range is now more than twice as high as the long-term equilibrium rate of interest estimated by the Fed (2.5%). Monetary policy is thus patently restrictive. That goes even more so for the Eurozone with its policy interest rate of 4.5% and its much weaker economic growth dynamics. Looking ahead, though, the one thing clear at the moment is that the global rate-hiking cycle has reached its end. Smaller central banks that had raised interest rates early on in the current cycle in response to rampant inflation have recently begun to return to cutting them. However, the big, important players – the Fed and the ECB – are straggling behind these first movers and are behind the proverbial curve. How quickly they will lower interest rates to be able to keep the economy on the narrow path to a soft landing is a complete mystery, due in large part to their contradictory messaging. Some European Central Bank officials in particular currently seem to be ignoring the rapidly receding inflation and the evidently successful transmission of the tightened monetary policy to the credit cycle. There’s a high risk of another monetary policy mistake and a really unnecessary recession, especially in the Eurozone.
At the top of the flagpole | The first central banks are already lowering interest rates again
Net percentage of central banks with rate cuts/rate hikes over the last three months
Sources: Bloomberg, Kaiser Partner Privatbank
In the end, it’s highly probable that inflation in the major industrialized countries will turn out to have been just as transitory as US Federal Reserve Chairman Jerome Powell conjectured two years ago. A pullback to near the monetary policy target of 2% already appears likely by mid-year 2024 given the current inflation trend. This means that a foresightful central bank would already have to revert back to lowering interest rates in the spring. Financial markets are already pricing in an initial 25-basis-point rate cut by the Fed. But even in this proactive scenario, whether or not it would come to a recession would then still depend on how quickly the Fed afterwards would continue to lower the federal funds target rate toward the equilibrium interest rate level. One thing, though, is very unlikely in any case: a higher-for-longer stance without a single rate cut by the Fed in 2024 – a possibility that has been bruited again and again in the financial media in recent weeks. In the past, the elapsed time between a final rate hike and an initial rate cut ranged between two and 15 months. Since the last rate hike dates back to July 2023, recurring non-events at the Fed’s eight FOMC meetings scheduled for 2024 would result in a new record-long interest rate plateau and would certainly also lead to a homemade recession.
Now let’s take a concluding look at two smaller central banks and two diametrically opposite situations. In Switzerland, inflation has already pulled back to below the 2% mark since summer 2023. Although the Swiss National Bank is striving to get inflation down preferably to the 0%–1% range, Swiss central bank officials are in a comfortable spot compared to their colleagues abroad. The SNB most likely will take a wait-and-see stance in 2024 and will probably tend to hold off on making any moves before the bigger central banks do. The SNB’s current policy rate spread vis-à-vis the Fed and the ECB is very wide in historical terms – a narrowing of the interest-rate differential to a certain extent would surely be welcomed by the SNB, in part because this would tend to strengthen the Swiss franc. The Bank of Japan, in contrast, faces a different and tougher challenge. Over the past several months, the BoJ has gradually loosened its control of the yield curve and widened its target trading range for 10-year Japanese government bonds. The question now is whether this will soon be followed by an official cessation of the yield curve control program and especially by a decision by the BoJ to abandon its negative interest rate policy (NIRP). The annual spring round of wage negotiations, in which Japan’s largest labor union is calling for a 5% pay rise, will likely be a key point to watch. If the BoJ is convinced that deflation has been vanquished for good in Japan, that could indeed spell the end of NIRP. But by ending NIRP, the BoJ would run the risk of triggering an interest rate shock. A likely attendant rise in long-term market interest rates to 2.5%–3% would inevitably be accompanied by big book losses on bond holdings at commercial banks and even at Japan’s central bank. The BoJ probably would prefer a choreographed rise in market interest rates over a period of several years, but markets usually don’t behave the way one wants them to.
Geopolitics: After the election is before the election
The recession question will also play a crucial role in the most important geopolitical event of the year in 2024: the presidential election in the United States. Why? Because in the last 50 years, no sitting US president has succeeded in getting reelected when the US economy contracted during an election year. Despite more than robust economic activity in recent quarters, for two years now the majority of US citizens have been largely dissatisfied with the job that Joe Biden has been doing. A slowdown in economic growth would additionally hurt Biden’s reelection chances. Alongside the elevated probability of a recession, Biden’s advanced age is another factor driving uncertainty. Biden’s likely opponent – Donald Trump – is only three-and-a-half-years younger and would already be 78 himself on Election Day (November 5), but this hasn’t played a role thus far in the public’s perception. The risk of yet another domestic and foreign policy swivel, albeit a better-prepared one this time compared to when Trump took office in 2017, is considered a much bigger concern. Specifically, an extensive rollback of Biden’s agenda looms if Trump gets elected. The Inflation Reduction Act and programs aimed at promoting climate-friendly technologies would probably be gutted. Fossil fuels, though, could experience a revival. On the foreign policy front, a new round in the trade war with the European Union would loom because Trump intends to impose a blanket 10% punitive tariff on all imports. The new-old president would also further tighten the thumbscrews on China. Trump’s conduct with regard to the geopolitical challenges in Ukraine and the Middle East would be the hardest thing to predict. A withdrawal from those conflict hotspots and from NATO would leave behind a hard-to-fill vacuum.
Trump 2.0? | The betting market sees Donald in the lead
Probability of victory in upcoming US presidential election (based on betting odds)
Sources: Realclearpolitics, Kaiser Partner Privatbank
However, elections are on the docket also outside the USA. People in more than 40 countries, including geopolitical heavyweights like Russia, India, South Africa, and the United Kingdom, will go to the polls in 2024. European Parliament elections are also on the agenda in June. The election calendar kicks off on January 13 in a particularly volatile hotspot: Taiwan. A reelection of the Democratic Progressive Party (DPP) could catapult Taiwan’s strained relations with China to the next escalation level. Although a Chinese invasion of Taiwan still seems unlikely for the next 24 months at the least, unconventional warfare and painful economic sanctions would be quite conceivable and easy to mobilize. But a more favorable scenario is also possible, at least in the near term. If opposition parties less hostile to China (the Taiwan People’s Party (TPP) and the Kuomintang (KMT)) succeed in ousting the ruling DPP, that could open a window of opportunity for the next four years for China and Taiwan to seek a rapprochement and resolve tensions (temporarily).
Investors should never let their investment strategy be rattled by short-term convulsions and volatility.
In the bigger picture, there’s a lot suggesting that the long-term trend of permanently elevated geopolitical instability will remain intact in 2024. A multipolar world is on the rise, and the United States’ international hegemony looks set to get challenged again, particularly by China, Russia, and Iran. It would take a defeat of the anti-establishment movement in the USA, a lasting abatement of animosities between NATO and Russia, a freeze of Iran’s nuclear program, and a phase of strategic rapprochement between China and the USA to bring about a global stabilization. Some of that could actually happen in 2024, but none of it is very likely to transpire. Investors should always keep their eyes on the increasingly important geopolitics factor, but at the same time should never let their investment strategy be rattled by short-term convulsions and volatility because in the long run, very few geopolitical events leave lasting marks on financial markets.
Equities: Overly exuberant sentiment?
During the last outlook season, analysts’ forecasts for the equity market were unusually and extremely pessimistic. In diametric contrast to the customary optimism and the typical projections of annual stock-price gains in the 5%–10% range, for once explicit share-price drawdowns were predicted on average. Naturally, things turned out differently, and the expected or hoped-for “” – a check mark denoting a cheap buying opportunity during the course of 2023 – never made an appearance. Quite the contrary, in fact, the final reckoning for 2023 showed big gains of around 25% for the S&P 500 Index and also more than 20% for the MSCI World Index. The picture was distorted, though, in both Europe and the USA by the largest-cap stocks. For example, the “Magnificent Seven” – the seven largest tech stocks in the USA – gained more than 100% while the S&P 500 Equal Weight Index climbed only 12%.
Is everyone already invested? | Retail investors anticipate rising stock prices
Bulls-to-bears ratio among US retail investors
Sources: American Association of Individual Investors, Kaiser Partner Privatbank
One year later, the sentiment picture looks completely different now. In the wake of a vibrant year-end rally, retail investor sentiment is extremely bullish, and the majority of analysts expect not just rising stock prices for 2024, but also a return to soaring corporate earnings growth of around +10% on the heels of flat profits in 2023. The majority thus sees a Goldilocks scenario that includes a soft economic landing. However, the fact that there wasn’t a recession in 2023 doesn’t mean that there won’t be one in 2024. A real honest-to-goodness recession would entail earnings contractions of 5% to 15% and a stock-price correction of at least 20% coupled with elevated volatility. The bulk of the stock-price declines would typically be expected to occur during the actual recession – the equity market usually hardly prices in an economic downturn in advance, at least it hasn’t in the past. So, like many other recession indicators in the current cycle, investors also can’t count on the stock market as being a reliable early warning barometer. That makes it all the more important to enter the new year on the stock markets with a balanced strategy that’s as resistant as possible to a recession.
Recessions are painful for stocks… | …and rarely get priced in beforehand
Maximum drawdown of S&P 500 Index during recession phases
Sources: Bloomberg, Kaiser Partner Privatbank
That makes it all the more important to enter the new year on the stock markets with a balanced strategy that’s as resistant as possible to a recession.
In our view, growth stocks continue to belong in such a portfolio despite their relatively higher valuations. They are likely to outperform during a recession thanks to their longer duration and less cyclical corporate earnings. The same goes for defensive stocks and bond proxies, which would profit from falling interest rates during a recession. Finally, shares of typical blue-chip companies with high profitability and sound balance sheets should also be blended into the portfolio. Value stocks and small caps, in contrast, would underperform at least into the last third of a recession, when good entry opportunities would then emerge. In regional terms, the mix described above would be tilted toward the USA (again) in 2024 due to an overweight in technology stocks. The defensive Swiss and UK markets could experience a comeback after a lackluster performance in 2023. The rest of the European market, though, would not be advisable to favor in a scenario of weak economic activity despite the cheap stock valuations there and the relatively low equity investment ratio among institutional investors.
In the big picture, the MSCI World Index has been stuck in a “fat & flat” rangebound channel for two years now. If the more positive scenario ends up prevailing in 2024 and central banks seize their chance at engineering a soft landing, this trading range could at least temporarily widen upwards to an upper bound that would include new all-time highs. However, it’s possible that the trading range would only widen without anything changing in the relatively flat performance because the US equity market at least is already quite ambitiously valued at the moment. In the long run, valuation is a critical determinant of performance – it determines around 80% of the return over the subsequent ten years. The current valuation of the S&P 500 gives reason to expect only a rather restrained average return of +4% per annum over the next decade, but with a lot of uncertainty due to the distortion caused by a handful of tech stocks. If the Magnificent Seven are stripped out, the expected average annual return increases to over +8%.
Fixed income: Improved prospects
Similar to what occurred with forecasts for equity markets for 2023, the majority of market observers also erred in their outlooks for bonds last year, as did we. Falling yields and rising prices – 2023 actually was supposed to have been the year of bonds, so the consensus went. Things in fact turned out differently, though, as bond yields climbed far beyond the maximum levels deemed possible, accompanied by corresponding price plunges. Most experts were caught on the wrong foot by the better-than-expected US economy and by a rising term premium, which meant that investors in the meantime had begun to resume demanding a higher premium for holding long-term bonds (during the bygone era of quantitative easing and forward guidance, when central banks steered long-term market interest rates, term premiums were atypically negative at times). The final surge in yields in autumn ultimately had all the ingredients of a classic selloff and temporarily propelled the yield on 10-year US Treasury notes to a high of 5% in mid-October. Yields have already pulled back again a fair bit since then, and bonds experienced a torrid year-end rally in sync with stocks. The change in direction was caused by a change in mindset among market participants. As a consequence of recurring pleasant surprises in inflation data and in light of an evidently cooling US employment market, their focus by now has turned to the timing of the first rate cut by the tone-setting US Federal Reserve. An initial rate cut by as early as March has already gotten priced in recently.
Even though bond prices have already passed their nadir, the prospects for 2024 and beyond look constructive. The more-than-three-year bond bear market appears to be over now. Bonds are no longer an interest-free risk and should be at least neutrally weighted in a mixed portfolio. Moreover, looking ahead to 2024, what we wrote a year ago stills applies today: (US Treasury) bonds are an interest-bearing, purchasing-power-boosting (positive real yield) hedge against an economic downturn. In the event of a recession, US long-term yields would presumably fall toward 3%. But US Treasury bonds would probably still pay off even in the better economic scenario, in which case the 10-year US yield would likely drift sideways around the 4% mark, which would generate at least a mid-single-digit percent return. In this more favorable economic activity scenario, high-yield bonds are likely to deliver an even better performance and returns well in double-digit percent territory. Given this practically binary economic and market outlook for 2024, it makes sense for investors to combine both bond categories – safe government bonds and riskier high-yield bonds – using a barbell approach.
The bear market is over | Positive returns in almost every scenario
Bloomberg US bond indices
Sources: Bloomberg, Kaiser Partner Privatbank
In an environment of policy interest rates that look set to probably start falling again soon, cash is losing attractiveness and should be reduced to a normal-sized allocation in the new year. However, it continues to make sense to hold a cash reserve for sudden investment opportunities. In the new TARA (there are reasonable alternatives) environment, one can forgo with a clear conscience more exotic fixed-income plays, especially if they entail elevated geopolitical risks (e.g. microfinance) or a particularly unattractive liquidity profile (e.g. peer-to-peer loans). One niche, though, continues to merit attention in 2024: insurance-linked bonds (cat bonds) will profit again in 2024 from high base interest rates and attractive risk premiums due to a persistent supply-and-demand imbalance in the reinsurance market. Double-digit percent returns on cat bonds are the baseline expectation for the next 12 months, regardless of whether or not there’s a recession. Another year with more-than-average adverse weather events is the only thing that would impair this positive outlook.
Currencies: A bet on economic activity
Despite somber sentiment and an economy in significantly worse shape in Europe than in the USA, European currencies gained ground against the US dollar in 2023 substantially (Swiss franc and British pound) or moderately (euro). That they did so despite Europe being outperformed by the US economy and in the face of a comparatively higher policy interest rate in the USA was attributable in large part to the persistent overvaluation of the greenback, which is estimated to be 20% to 30% overvalued depending on the model used. Although valuation models are not a good timing tool for currencies, just like they aren’t for stock markets, an overvaluation of that magnitude impedes sustained currency appreciation. So, it’s hardly surprising that the consensus forecast for the US dollar for 2024 isn’t particularly bullish. Especially in a no-recession scenario with a simultaneous acceleration in economic growth in the Eurozone, a “euro bet on economic activity” would pan out and would clear the way for the EUR/USD exchange rate to climb to above 1.13, its acme in 2023. The bet would backfire, though, if a deep recession in multiple Eurozone countries were to prompt the ECB to cut interest rates before the Fed does. Although we see a low probability of that coming to pass, if it does happen, the EUR/USD cross would likely drop back to parity. However, in the third conceivable scenario – a recession in the United States –, a slump in the euro wouldn’t be guaranteed. Even if the US dollar is fundamentally a countercyclical currency that exhibits strength in times of global economic downturns, it could depreciate this time because much on currency markets is relative and interest-rate and economic growth differentials would narrow in favor of the euro in the event of a US recession.
Parity for the euro/Swiss franc cross increasingly receded into the distance over the course of 2023. The nominal EUR/CHF exchange rate continually fell in 2023, as did its “fair” value in terms of purchasing power parity as a result of much lower inflation in Switzerland than in the Eurozone. Since this inflation differential will shrink in 2024, at least this appreciation driver for the Swiss franc looks set to weaken. The EUR/CHF downtrend could thus develop into a sideways trend in the quarters ahead, but we do not expect to see acute franc weakness because since interest rates in Switzerland are at a less restrictive level than in the Eurozone, the Swiss National Bank will probably lower its policy rate later than the ECB does. Moreover, the SNB continues to have an interest in keeping the Swiss franc strong and has been actively fortifying it through quantitative tightening (via the sale of euro-denominated assets). Furthermore, the Swiss franc’s traditional virtues, such as Switzerland’s large current-account surplus and the franc’s role as a safe haven in an unstable geopolitical world, continue to work in favor of the currency.
Parity beyond reach for the time being | The franc remains strong
Euro vs. Swiss franc
Sources: Bloomberg, Kaiser Partner Privatbank
A major surprise could emerge on the currency market in the new year with the Japanese yen because a very rare constellation consisting of a commencing rate-cutting cycle in the USA coupled with simultaneous rate hiking by the Bank of Japan is conceivable. The BoJ in 2024 looks set not just to stop actively controlling the yield curve, but also to seek an exit from its negative interest rate policy (NIRP). In a country where consumers and businesses have grown accustomed to decades of ultralow interest rates, the monetary policy challenge facing the BoJ couldn’t be tougher. Collateral damage wouldn’t be surprising, which is why Japan’s central bank is trying to proceed cautiously. But no amount of communication can entirely tame the anticipatory nature of financial markets. A foretaste of potential exchange-rate turbulence in the sense of a sharp appreciation in the value of the yen was already served up in early December. A large-scale unwinding of the yen carry trade could cause substantial dislocations in 2024, including in the more speculative corners of other market segments. At the moment, though, we see only a relatively low 25% probability of that happening.
Alternative assets: Selection is key
With an intermittent gain of almost 20% at its peak for the year, gold ranked among the big winners in 2023. The precious metal’s gain for the year came almost entirely in the fourth quarter. The sound of the starting gun for gold’s year-end rally almost perfectly coincided with the attack on Israel by Hamas. Gold thus again turned out to be a good hedge against geopolitical crises in 2023, though it’s not entirely clear whether this was due to causality or coincidence because the rally also coincided with a sharp pullback in nominal and real interest rates. However, this question has little relevance for investors who hold the precious metal in their portfolios for its diversifying properties. Meanwhile, looking ahead to 2024, the interest-rate pivot that is bound to come sooner or later will likely provide continued support for gold by lowering the opportunity cost of holding the yellow metal. The technical indicators on gold’s price chart also look constructive. Although the new all-time high above the USD 2,100-per-ounce mark in early December turned out to be a temporary bull trap, gold’s tendency toward progressively higher highs and higher lows – the very definition of an uptrend – remains intact and augurs sustained higher prices in the medium term.
Onward to new heights? | The road above USD 2,100 is clear
Gold price per ounce in US dollars
Sources: Bloomberg, Kaiser Partner Privatbank
The outlook for real estate investments for 2024 varies tremendously by region, sector, and investment vehicle. “Selection is key” is valid more than ever today. The repercussions of the turnaround in interest rates from ultra-accommodative to exceedingly restrictive hasn’t been completely digested yet by office properties and in many local housing markets in Europe and is not yet entirely priced into most non-exchange-traded real estate investment vehicles. So, the best entry opportunities in the private real estate sector are likely still yet to come. The situation looks different for exchange-traded US REITs and Swiss real estate funds, which have already undergone price corrections in recent quarters.
The outlook for real estate investments for 2024 varies tremendously by region, sector, and investment vehicle. “Selection is key” is valid more than ever today.
The private-market categories private equity and venture capital also performed poorly in 2023, at least in relative terms compared to public equity markets. The year 2023 was thus a mirror image of 2022. Just like with real estate, the cause of this lies in the specific valuation methods employed for private-market assets, which result in a perpetual time lag and smooth out performance. Looking ahead, the adjustment of prices to the new macro regime of sustained higher interest rates hasn’t been completely wrapped up yet particularly in the riskier startup company segment and will probably take another three to four quarters to finalize.
This doesn’t mean, though, that investors don’t have any opportunities right now in this highest-returning of private-market segments in the long run. They do, but selection is key here as well. Semi-liquid private equity funds are assets that normally deliver an above-average return particularly in their first years after launching if they are managed well. The current boom in these investment vehicles provides numerous opportunities over the next two to three years, provided that an investor has access to a corresponding (semi-liquid) private-markets fund (through his or her private bank), which ideally should be diversified across all categories. Infrastructure assets and private credit also belong in the private-markets mix alongside private equity, venture capital, and real estate. Private credit in particular should be an excellent diversifier again in 2024 because this segment directly benefits from the current higher interest-rate levels and is capable at the moment of generating high returns similar to those on private equity investments (11%–13% in USD), but with less risk.