Key interest rate expectations too optimistic?

Looking at the current month of December and therefore also the rest of the 2023 financial year, the positive sentiment should continue. The current year-end rally could therefore go on, but whether this will also be the case in the coming year remains to be seen. 2024 is likely to be more difficult on the capital markets and (temporary) distortions must be expected. In our view, many market participants are too optimistic with regard to key interest rate cuts in the near future.

The high level of interest rates has not yet had its full impact on the economy. This development is only just beginning. It is therefore possible that corporate profits will come back more strongly than expected. For this reason, we are taking a more defensive stance on equities and are keeping an eye on special situations. However, we do not currently expect a massive slump on the markets. Bonds should perform better than equities in 2024, as bond markets have historically always risen after a pause in interest rates. In the short term, however, an excessive reduction in interest rates could be priced in - a correction would open up another entry opportunity.

The authors

From the strategy team of DJE Kapital AG 

DJE's strategy team continuously monitors and evaluates the markets using its proprietary FMM methodology based on fundamental, monetary and market technology indicators.  

Chances: 

  • Year of bonds 2024: Bonds from investment grade onwards with medium maturities as well as selected longer-dated (government) bonds and selected emerging market bonds (also in local currency)
  • Defensive equities: Companies whose business model is largely independent of the economy with high margins and which ideally also have a certain cost-cutting potential
  • Safe haven assets: gold or Swiss francs
  • Artificial intelligence (AI): Special situations such as AI should also have a tailwind in 2024. Top technology companies will continue to invest heavily in AI. The digital transformation is particularly strong in America. 

Risks:

  • Interest rate cuts too heavily priced in: With regard to the Fed's interest rate cuts in 2024, market expectations appear too optimistic: No matter what the Fed communicates, the markets expect even faster rate cuts.
  • US fiscal policy: If US fiscal policy becomes more restrictive, the US economy could come under greater pressure.
  • Real estate sector: Caution should be applied with regard to commercial real estate and companies with high exposure to this sector. Distortions are also to be expected for private residential real estate in various regions (e.g. UK, Netherlands, Sweden, Germany, Australia).
  • Banks: The rise in bad loans, low demand for credit and increased pressure on net interest income could make 2024 a difficult year for the banking sector. The pressure on the banking sector would also have a negative impact on the supply of credit and future investments.
  • Recession in Germany and Europe: The recession could be deeper and longer than expected. Stocks that are heavily dependent on European or especially German domestic consumption should be avoided. The old German business model (cheap energy, well-trained skilled workers and a strong export market) remains under severe pressure.
  • Private equity: Significant valuation risks are conceivable and represent one of the major unknown risks for 2024.

Fundamental:

The US economy has been very resilient so far. However, it could come under pressure if fiscal policy is tightened further. Without the very expansive US fiscal policy (deficit of around 7.5% in 2023), the US economy would probably already be in recession.

  • Federal Reserve Chairman Powell could equate a mild or minor recession with a "soft landing"
  • In principle, we are currently on day 0 of the transmission of high interest rates into the economy: higher financing costs and presumably weaker customer demand could weigh on corporate profits
  • Major distortions in some real estate markets are likely
  • The situation in the banking sector could become significantly more difficult
  • The German economy is likely to remain under pressure in 2024: the former German business model is under severe pressure and there is no replacement model yet; many production processes are still very analogous 

Monetary: 

Inflation has peaked in the US and Europe. Thanks to the most massive and fastest interest rate hikes in history, the Fed (and the ECB) have brought inflation under control. However, the issue of consumers losing purchasing power due to inflation (second-round effects due to high wage demands) is still ongoing. These effects will persist for some time to come, and there may well be distortions here too.

  • The fall in (US) inflation from around ten percent to the current level of around three percent is likely to have been easier to achieve than the reduction from 3 percent to 2 percent that is still being targeted ("last mile problem").
  • Contrary to general market expectations, 2024 could be a year of monetary inactivity.
  • Normally, the US Federal Reserve does nothing in an election year

Market technical indicators: 

The very good performance in November was also due to a very positive market trend at the end of October. There was a very high level of pessimism at the end of October, but this has since subsided. At present, the market technique is at best only neutral based on important indicators such as NAAIM (indicator for the average equity exposure of active US fund managers), Fear & Greed (measures whether fear or greed prevails among investors; if the market is too optimistic, i.e. too "greedy", even small disappointments can lead to sell-offs) or the cash ratios in the fund manager survey. Greater pessimism continues to prevail for the euro (vs. the US dollar).

 

Note: Marketing advertisement - All information published here is for your information only and does not constitute investment advice or any other recommendation. The statements contained in this document reflect the current assessment of DJE Kapital AG. These may change at any time without prior notice. All statements made have been made with due diligence in accordance with the state of knowledge at the time of preparation. However, no guarantee and no liability can be assumed for the correctness and completeness.