Opportunities through special situations

Looking ahead to the current month, we remain cautious, even if a short-term recovery (due to market technical factors) is possible. The monetary situation can still be classified as negative. However, if you focus on special situations, you should be able to get through this phase well.

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.  

Opportunities

• The changed interest rate environment
  There are opportunities for companies that benefit from the changed interest rate environment, such as insurance companies or stock exchange operators
• Quality companies with high margins
  Companies that, in addition to high margins, also have low debt and high pricing power (e.g. from the pharmaceutical and tech/AI sectors) are likely to outperform in the expected contraction in key figures
• Energy sector
  The fundamental environment remains good: including declining drilling activity in the USA and gas field closures in Israel
• Japan region
  There is relatively good money supply growth here, and Japan is also a “nearshoring profiteer”. Japanese stocks are not overweight in global funds and are not analytically expensive
• Emerging markets
  In selected emerging countries such as Mexico or Indonesia there is a positive risk-reward ratio
• Bonds from investment grade onwards with terms of up to 5 years

 

Risks

• Quantities of money
  We see the significant decline in the M1 monetary aggregate in the USA and Europe as a risk, but there is still a lot of existing liquidity to provide support
• Interest rate cut expectations
  The market's expectations for 2024 are optimistic: To date, the market has not priced in the possibility that there could be no 50 basis point rate cut by the end of 2024
• Monetary policy tightening
  It works with a delay. This means that greater pressure on corporate profits will become realistic in 2024
• Possible disruptions in parts of the financial sector in 2024 …
  At medium-sized banks or financial companies with a high level of involvement in real estate financing
• Recession
  We see a deep and prolonged recession in Germany and Europe as a possible risk, and we are correspondingly cautious about titles/stocks that are heavily dependent on German or European domestic consumption
• Caution …
  Do we see as necessary for cyclical consumption in general (including luxury and cars), industry, real estate and banks with a high level of involvement in real estate financing

 

Fundamental Indicators

• USA: Soft landing is becoming increasingly unlikely
• Economic risks in Germany and Europe continue to increase
• Distortions are conceivable in some areas of the financial system

 

The key question is whether there will be a recession in the USA or not. At the moment, US corporate profits are still developing mostly well, and a hard landing is not priced in. Monetary policy tightening always affects the economy with a delay, which means that company profits and margins in both the USA and Europe could come under greater pressure in 2024; a soft landing for the US economy is becoming increasingly unlikely.

Financial stability and economic risk: Distortions often occur one to three years after the end of monetary policy tightening. Loan defaults - which cause both financial instability and economic risk - are already rising significantly, and the curve will not go down any time soon. Distortions are conceivable in some areas of the financial system - medium-sized banks with a larger share of mortgage business or private equity companies.

If deposits are withdrawn, particularly at small and medium-sized banks, the banks will have to realize losses (from securities held to maturity) and could thus find themselves in a problematic situation. However, the US Federal Reserve (Fed) is only likely to react to problems in the banking sector if major banks get into difficulties. In the event of recession and financial instability, the Fed will respond. However, the central bank is likely to accept a possible increase in US unemployment; Even if the US unemployment rate rises to 5% in 2024, this is unlikely to lead to interest rate cuts by the Fed (a deeper recession would also mean a 7-8% unemployment rate).

Japan region: This has some of the best monetary growth and good corporate profit development; Japanese purchasing manager indices rank at the very top in international comparison. Europe and especially Germany could face a prolonged period of weak growth, and the economic risks here continue to increase.

Monetary Indicators

• A delay in monetary policy tightening could become apparent in 2024
• Interest rate cut by the Fed unlikely for now
• Decline in globalization has an inflationary effect

 

The very low interest rates for a long time were the drivers for the share markets; The central banks recognized the inflation issue too late and reacted too late. But then monetary policy reacted very decisively with the strongest monetary tightening in the post-war period. The economy is always only affected by such tightening with a time lag. A negative effect on the economy and financial stability in 2024 therefore remains realistic.

From a short-term perspective, core inflation in the USA is already within the target range; However, a further increase in the key interest rate in November or December is not ruled out. A further interest rate hike in the USA in December is even considered likely. After this, the key interest rates are likely to remain at this level for longer. In our view, the market has not yet priced in this new reality.

The next US presidential election will take place in November 2024. The Fed will probably do nothing in an election year – as has often been the case in the past – i.e. interest rate cuts by the Fed are unlikely in the coming year. In addition, the end of globalization as we have known it so far seems inevitable. The relocation of production to China in particular has had a deflationary effect for years. However, the retrieval of production processes is now increasing inflationary tendencies and also suggests that interest rates may remain at a higher level for longer than generally expected.

 

Market Technology Indicators

• Positive: sentiment slumped

 

Sentiment is supportive in the short term. There are several anti-cyclical reasons for this: the currently observed decline in equity investment in the NAAIM Exposure Index (indicator of the average equity exposure of active US fund managers), an increase in the put & call ratio in the USA (more put options are bought than call options) and a decline in the Fear&Greed indicator (which measures whether investors are more likely to be fearful or greedy; if the market is too optimistic, i.e. too “greedy,” even small disappointments can lead to sell-offs, so a decline in this ratio is to be seen as positive) . In our view, market technology opens up opportunities for a short-term recovery.

 

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