Monthly
Market Monitor
December 2024
Trump wins
The
message sent by voters couldn’t be more straightforward: stable prices are more important than sizzling economic activity.
Chart of the Month
In a Nutshell
Our view on the markets
In a clear-cut outcome, Donald Trump won all of the swing states in the US election and, together with the Republicans, captured both chambers of the US Congress. The message sent by voters couldn’t be more straightforward: stable prices are more important than sizzling economic activity. Trump appears to be taking that into account in his Cabinet selections. His nomination of Scott Bessent to serve as the next Secretary of the US Treasury is uncontroversial and sends a signal to financial markets that America’s federal debt probably won’t spiral out of control after all. However, the threatened punitive tariffs likely will be implemented, at least in small doses and concentrated on China. A deal perhaps can be worked out with Europe.
Buy on the news
Trump not only divides public opinion, but also drives diverging equity markets. Whereas visions of tax cuts and deregulation plans sent US markets soaring after the election, Europe experienced the opposite: uncertainty about US trade policies and geopolitics caused substantial drawdowns. With a performance gap of more than 20 percentage points behind the USA, the European equity market is once again the underdog as the year winds down. A year-end rally arguably would only suffice to make some cosmetic corrections to that statistic. Investors have already turned their sights to 2025 anyway.
How much does a ton of CO2 cost?
Although it makes no difference to our planet where and why CO2 gets emitted, there is no global CO2 emissions price. The vast majority of worldwide greenhouse gas emissions continue with impunity to be released into the Earth’s atmosphere for free. For the small remainder of emissions that are subject to costs, the price ranges from just a few cents to over USD 150 per ton. If even only moderately ambitious climate targets are to be reached, the CO2 emissions price must increase substantially worldwide in the long term. Investors by now can also partake in the potential presented by continually expanding emissions trading.
Germany’s governing coalition spectacularly imploded in November, but this political caesura could present an opportunity at the same time. Germany has long since forfeited its role as the growth engine of Europe and now instead leads the vanguard in economic uncertainty. The new elections to be held on February 23, 2025, give the country an earlier-than-planned opportunity to initiate a political and economic reboot. A new government under the leadership of the conservative CDU/CSU would be faced with the urgent job of implementing structural reforms to strengthen Germany’s ability to compete. Reevaluating the country’s debt brake mechanism will particularly be unavoidable. Unlike many other large Eurozone countries that have to exercise fiscal restraint in the years ahead, Germany has sufficient financial leeway to enact targeted measures to stimulate growth and investment. Even the International Monetary Fund, which is famous for preaching budgetary discipline, views this as a necessity.
Macro Radar
Taking the pulse of economic activity
Trump in search of a new team
In a clear-cut outcome, Donald Trump won all of the swing states in the US election and, together with the Republicans, captured both chambers of the US Congress. The message sent from voters couldn’t be more straightforward: stable prices are more important than sizzling economic activity. Trump appears to be taking that into account in his Cabinet selections. His nomination of Scott Bessent to serve as the next Secretary of the US Treasury is uncontroversial. The finance expert’s “3-3-3” formula promises robust economic growth (+3%) and stepped-up US oil production (3 million barrels more per day), but also a substantially reduced budget deficit of just 3% (down from over 6% at present). Although that is incompatible with Trump’s expensive campaign promises, particularly his vow to extend tax cuts or even implement new ones, the signal to financial markets alone is a strong omen that federal debt will not spiral out of control. The same goes for the planned Department of Government Efficiency (DOGE) to be co-headed by Elon Musk, which probably will hardly succeed, though, in its proclaimed goal of cutting USD 2 trillion from federal spending.
Awaiting punitive tariffs
Donald Trump’s planned punitive tariffs would have at least a near-term inflationary effect in the form of a one-off upward adjustment of the price level. Over the longer term, though, tariffs mainly act as a brake on growth and ultimately have a disinflationary impact. In any event, they are not an effective way to correct global current-account surpluses and deficits, which are a thorn in Trump’s side. That is unlikely, though, to persuade him to completely renounce the use of tariffs. The brunt of his tariffs, however, is likely to be aimed at China. Tariffs to the tune of 20% (instead of the threatened 60%) seem to be a realistic expectation and would already put a noticeable strain on China’s vulnerable economy. With regard to Europe, Trump might leave it at slapping targeted tariffs only on automobiles if a presentable deal can be negotiated.
Next round of rate cuts
Political and macroeconomic uncertainty looks set to stay elevated until the 47th US president settles into the White House. This, together with the continued robust state of US economic activity, is a reason for the Federal Reserve to slow its rate-cutting pace a little. The
financial market lately has been pricing in only a 50-50 chance of a next rate cut at the last FOMC meeting of the year on December 18. The situation looks entirely different for the European Central Bank, which has already stuck its neck out with the telegraphed prospect of another 25-basis-point rate cut on December 12. A larger rate cut than that could get interpreted as a panic move, but would be appropriate in light of the deteriorating macroeconomic situation in the Eurozone.
The SNB is already talking about negative interest rates
The Swiss National Bank is traditionally reserved in its communications. One side effect of this is that the SNB has downright stunned financial markets on more than one or two occasions in the past. The SNB’s final monetary policy assessment of the year on December 12 also has potential to spring a surprise – a big 50-basis-point rate cut cannot be ruled out. Inflation in Switzerland lately has been receding faster than the SNB expected it would, and more downward pressure (falling energy prices and a drop in the national mortgage reference rate used to set housing rent prices) is already in the pipeline. New SNB President Martin Schlegel recently emphasized that although the central bank, too, “doesn’t like negative interest rates,” they nonetheless remain part of its toolbox.
The SNB has downright stunned financial markets on more than one or two occasions in the past.
Asset Allocation
Notes from the Investment Committee
Fixed Income
Sovereign bonds
Corporate bonds
Microfinance
Inflation-linked bonds USA
High-yield bonds
Emerging-market bonds
Insurance-linked bonds
Convertible bonds
Japan
Emerging markets
Alternative Assets
Gold
Duration Hedge funds
Currencies
US dollar
Structured products
Private equity
Swiss franc Private credit
Euro
British pound
Equities: Trump causes ups and downs
• Donald Trump divides public opinion, but that’s not all. His imminent return to the White House and the Republicans’ double victory in the US Congress also are dividing equity markets into winners and losers. Whereas visions of tax cuts and deregulation plans have sent US markets soaring since Trump’s election win, Europe has experienced the opposite: uncertainty about US trade policies and geopolitics have caused substantial drawdowns. The European equity market is once again the underdog as the year winds down – it has now underperformed US indices in eight of the last ten years. With a performance gap of more than 20 percentage points, the discrepancy between the USA and Europe has seldom been as wide as it is this year.
• A year-end rally on the European equity market arguably would only suffice to make some cosmetic corrections to that statistic, but investors have already turned their sights to 2025 anyway. However, next year as well, Europe remains a longshot bet for which there are hardly any good arguments apart from the region’s relatively cheaper stock valuations and investors’ current low allocation to equities. That could suffice to spark brief tactical rallies next year, particularly if the risks associated with Trump do not materialize in the magnitude currently feared. But it would take additional ingredients – mainly a substantial pickup in European economic activity and a resulting increase
Infrastructure
Real estate
11/2024
Monetary/fiscal policy
Corporate earnings
Valuation
Trend
Investor sentiment
11/2024
in corporate earnings growth – to sustainably turn the trend around toward a lasting outperformance.
• Meanwhile, in the USA, next year the question will arise again as to whether the high concentration of Big Tech companies in blue-chip indices will eventually have (adverse) consequences. Investors love the Magnificent Seven for their continual profit-margin growth and rich cash flows, as well as for their low sensitivity to changes in general economic activity. However, trouble could loom if AI mania subsides and the high growth expectations get disappointed. It would also be an unpleasant surprise if the new administration were to be less friendly than hoped toward Big Tech and if antitrust issues stay on the agenda. Yet the lofty valuation alone does not in itself imply a negative return expectation for technology stocks or the overall market. Analysts, as they so often do, are again forecasting a stock-market gain of around 10% for next year not just out of a lack of knowledge, but also from experience.
A year-end rally on the European equity market arguably would only suffice to make some cosmetic corrections to that statistic, but investors have already turned their sights to 2025 anyway.
“Buy on the news” characterized the action on fixed-income markets in November.
Fixed income: Buy on the news
• “Buy on the news” characterized the action on fixed-income markets in November. Bond prices had previously been under pressure for weeks. The yield on 10-year US Treasury notes had been sharply on the rise since September, reflecting concerns about an overheating economy, accelerating inflation, and mounting public debt under a Trump 2.0 presidency. The bond markets have breathed a post-election sigh of relief for the time being because the risks now are already priced in and perhaps may never even materialize. That hope is pinned at least to the nomination of hedge fund manager Scott Bessent to serve as the next Secretary of the US Treasury. It signals that Trump’s cabinet picks are aware of the financial market’s sensitivity to a further deterioration in US federal finances. Unlike other candidates bruited for the top Treasury spot, Bessent epitomizes proven macroeconomic expertise. He also endorses slashing the US federal budget deficit. The immediate risk of a US Treasury bond selloff appears to be averted for now. However, markets next year will keep an eye on whether the Trump administration really does cut back spending – if that doesn’t happen, 10-year yields in the USA could head toward 5% and thus force the necessary fiscal change of course.
• Since any jumps in yields above the 4.5% level on long-term US Treasury bonds are likely to be ephemeral, temporary selloffs of that kind in the months ahead would present an opportunity for tactical buying. However, if there is no recession next year, as the majority of economists currently expect, Treasury bonds will provide diversification but are unlikely to give a boost to returns in 2025 because the US Federal Reserve in that case will lower its policy rate by another 100 basis points at the most from the present level. The fair value for the yield on 10-year Treasurys would then be in the 4%–4.5% range, which constrains return potential from the current level.
Alternative assets: Bitcoin soon in six-digit territory?
• The price of Bitcoin has surged by more than 40% at its peak since the US election and now has the psychological sound barrier of USD 100,000 in its sights. The crypto industry's support for Republicans is now clearly paying off. Research by the New York Times reveals that crypto firms donated more than USD 130 million in support of Republican congressional candidates. US Securities and Exchange Commission Chairman Gary Gensler will resign in January and will likely be replaced by a successor friendly toward the crypto industry. A new crypto advisory council will reportedly advise the Trump administration from January onward. If the plan for a national Bitcoin reserve is put into action, that would give a further boost to global acceptance of crypto and to the institutionalization of cryptocurrencies as an asset class.
• Despite this positive outlook, though, Bitcoin and the like look set to remain very volatile next year. Anyone who nonetheless would like to invest in this young asset class has to be immune to potentially resulting investor mistakes. Anyone who doesn’t have strong nerves can easily walk right into the “buy high, sell low” trap. Interested investors would be wiser to view their crypto exposure as a strategic allocation and to only rebalance it every once in a while.
Currencies: Euro under pressure
• EUR/USD: The EUR/USD exchange rate stayed under pressure in November and fell for a time to a two-year low beneath the 1.04 mark. A lot at the moment argues against the euro. Economic data for the Eurozone have come in lower than expected in recent weeks. New punitive tariffs could additionally decelerate economic growth in the Eurozone in 2025. The European Central Bank will likely see itself forced to counter this dimmed outlook with further interest-rate cuts, which would widen the interest differential to the detriment of the euro. The only thing going for the euro right now is that it is heavily oversold after having depreciated 8% against the US dollar in the span of two months.
• GBP/USD: The British pound has been a star performer and the second-strongest G10 currency in 2024, right behind the mighty US dollar. Economic activity in the UK has surprised on the upside in recent quarters just like it has in the USA. The British employment market has held up resiliently, the housing market has stabilized, and an increase in real income has given a boost to consumer spending. The Bank of England, together with the Fed, thus ranks among the slower central banks in the ongoing rate-cutting cycle. The pound’s interest-rate advantage looks set to stay in place for the time being, but sterling today is no longer inexpensively valued, so a repeat of this year’s outperformance shouldn’t be expected.
• EUR/CHF: The EUR/CHF exchange rate threatened for a time in November to drop below the 92-centime mark. It’s possible that the Swiss National Bank intervened at that point to avert a technical selloff for now because the picture on the EUR/CHF chart has worsened further lately. It would take a breakout above the 95-centime level to send a short-term all-clear signal. From a fundamentals standpoint, there’s a lot pointing to a further depreciation of the euro in 2025. The SNB will likely take pains to at least slow down this trend, but it probably cannot stop it given the high currency risks already on its balance sheet.
Donald Trump’s resounding election victory was thunderously applauded on the US equity market. Investors at the moment mainly see the rewards of tax cuts and looser regulation outweighing the risks of punitive tariffs and reduced immigration. The list of “Trump trade” winners since November 5 particularly includes small caps, which would not only benefit from the positive effects of Trump’s policy agenda, but would also be more resilient even in an adverse “trade war” scenario due to their focus on the domestic US market. Financial and energy stocks have likewise performed well lately, but it remains to be seen how sustainable their upmoves are. During the 45th and now 47th US president’s first term in office, typical “Trump trades” had only a short half-life. A “drill, baby, drill” policy in the USA, coupled with spare OPEC+ production capacity, rising output outside the oil cartel, and muted global demand for petroleum, gives reason to expect a tendency toward declining oil prices and lower earnings for oil multinationals. Conversely, things may turn out better than feared for the clean energy industry over the next four years even if there will be less official talk about “sustainability.”
Chart in the Spotlight
The idea is that as soon as the traded CO2 price exceeds the cost of averting emissions, companies begin to decarbonize because that becomes the only way to maximize profits.
Theme in Focus
How much does a ton of CO2 cost?
Although it makes no difference to our planet where and why CO2 gets emitted, there is no global CO2 emissions price. The vast majority of worldwide greenhouse gas emissions continue with impunity to be released into the Earth’s atmosphere for free. For the small remainder of emissions that are subject to costs, the price ranges from just a few cents to over USD 150 per ton. If even only moderately ambitious climate targets are to be reached, the CO2 emissions price must increase substantially worldwide in the long term. Investors by now can also partake in the potential presented by continually expanding emissions trading.
Greenhouse gas emissions trading: On the dispensation of indulgences...
The public debate over markets for CO2 emissions not infrequently focuses on the unregulated trading of voluntary carbon credits to finance, for example, forest protection or other environmental projects. However, with a volume of just USD 2 billion per annum, the voluntary carbon credits market is not only relatively small, but is also very questionable to boot because, normally, unregulated carbon offset credits are issued solely on the basis of advance estimates of a project’s success while systematic evidence of actually achieved emissions reductions is missing. A study conducted by the Swiss Federal Institute of Technology in Zurich in collaboration with the University of Cambridge found, for example, that only 12% of carbon offsets sold actually result in emissions reductions.1 Whereas the unregulated trading of voluntary carbon credits is thus often disparaged as being nothing more than the buying and selling of “climate indulgences,” the trading mechanism in the much larger (USD 800 billion) market for mandatory carbon credits is perfectly clear.
…and regulated markets
That market works on the “cap & trade” principle. An upper limit (the cap) determines the maximum total amount of CO2 that is permitted to be emitted. A corresponding quantity of emission allowances is then allocated to market participants, partly for free and partly through auctions. Companies that generate high emissions must purchase additional emission allowances while those that cause less emissions can sell their carbon credits (the “trade” part of cap & trade). This trading establishes a market price for greenhouse gas emissions. That price and the continual lowering of the upper emissions limit over time are intended to give corporate participants in the emissions trading system an incentive to reduce their emissions. The idea is that as soon as the traded CO2 price exceeds the cost of averting emissions, companies begin to decarbonize because that becomes the only way to maximize profits. The incentive price needed to bring about a reduction in emissions varies depending on the industry in question because not all emissions are equally easily avertable. Whereas the cost incentive threshold for complete decarbonization is estimated at around USD 60 per ton of CO2 in the steel sector, for instance, it is much higher in the cement industry (USD 130), the aviation sector (USD 230) and the maritime shipping industry (USD 350).
Europe: Leading by example
The market for European emissions allowances (EUAs) exemplarily demonstrates that regulated CO2 emissions trading actually works. It was launched back in 2005 and has since cut emissions in the industries it covers by almost 50%. Today the European Emissions Trading Scheme (EU ETS) is already in its fourth implementation stage. In contrast to the earlier stages, today practically no more carbon credits are issued to companies for free, but are instead allocated through an auction mechanism. The fine for companies that exceed their emissions allowance has been sharply increased. In addition, the upper limit for total emissions will be lowe-
red by 2.2% per annum in the future, which is a much faster pace than in previous stages.
CO2 emissions trading is gradually coming of age in Europe, as reflected not least in the price for European emissions allowances. Whereas a ton of CO2 traded for a little under five euros in 2016, its price has increased severalfold in recent years. The envisaged mechanism works: if the compulsory upper limit is lowered faster than companies can cut their emissions, this reduction in supply leads (ceteris paribus) to a higher price. The price of CO2 therefore must increase (further) in the long run. In the near and medium term, though, a host of other factors influence price formation. For example, the market registered a recent supply overhang in 2024, mainly due to the early sale of carbon credits to finance the REPowerEU plan and due to the issuance of additional emissions allowances for the maritime shipping sector, which is now also covered by the EU ETS. The logical consequence of the resulting supply overhang was a falling CO2 price (intermittently by almost 50%). This recent episode shows in no small way that prices for greenhouse gas emissions are subject to parameters set by policymakers and thus ultimately are political. Certain price risks therefore cannot be completely disregarded. In the EU example, for instance, there’s at least a theoretical risk that policymakers might reduce the quantity of emissions allowances less quickly than originally planned out of fear of putting European companies at a competitive disadvantage (particularly versus China). That would put the European CO2 price back under downward pressure.
Rest of world: Step by step toward a global price Following the example set by the European Union, an array of other carbon credit trading markets has emerged over the last 15 years. The list of the largest and most liquid trading systems includes the Western Climate Initiative (WCI) in California and Quebec, the Regional Greenhouse Gas Initiative (RGGI) in 11 northeastern US states, and the New Zealand ETS. In the United Kingdom, the UK ETS replaced the country’s previous participation in the EU ETS in January 2021. There are 36 emissions trading systems in operation by now around the world, according to the International Carbon Action Partnership (ICAP). One of the latest newcomers is China, which introduced an emissions trading system for the energy sector in 2021. This marked a major step forward from a global perspective. The introduction of a CO2 price for the world’s largest polluter increased the amount of global emissions covered by a pricing system by 10% in a single bound.
However, despite the constant growth of CO2 markets, today it is still the case that only around one-quarter of all greenhouse gas emissions are subject to a pricing mechanism. Although over a dozen additional emissions trading systems are in the works and look set to be rolled out in countries including Japan, Brazil, Mexico, Indonesia, and Turkey in the years ahead, the interna-
tional greenhouse gas emissions pricing system being advocated by multilateral organizations like the WTO, the IMF, the OECD, and the United Nations remains a pipe dream thus far and is hardly realistic in the foreseeable future. It would be necessary, though, in order to enable the CO2 market to unlock its full potential.
Source: World Bank
Sources: EUTL, ICE, EEX
Uncorrelated performance… | …not without (political) risk
Carbon Fund vs. other asset classes
CO2 emissions as an asset class
The market looks set to grow further in the foreseeable future, and not just with regard to the quantity of CO2 emissions covered. The same applies to the price level, which climate experts say is still too low, at least if society would like to reach even just moderately ambitious climate targets. If the aim is to limit global warming to a maximum of 2° Celsius above pre-industrial levels as envisaged by the 2015 Paris climate accord, it is estimated that a CO2 price of around USD 120 per ton would be needed in 2030.2 This fact leaves a lot of upside potential from the current price levels. It would imply a price increase of 10% to 12% per annum from the current level in the case of the market for European emissions allowances. If one assumes a risk-free interest rate of 4% (the yield on 10-year US Treasurys), that would equate to a CO2 premium of 6% to 8% p.a. Investment vehicles that enable investors to partake in this price outlook are few and far between thus far, but there are some scattered opportunities with a multiyear track record. However, interested investors must be aware of the (political) risks of this still-young asset class and must bear its constrained liquidity in mind. Whoever is willing to put up with that will be rewarded in exchange with uncorrelated returns versus traditional asset categories and, for example, can use an allocation to CO2 markets to hedge the greenhouse gas risk in his or her stock portfolio.
1 Probst, B., Toetzke, M., Kontoleon, A., Diaz Anadon, L., & Hoffmann, V. H. (2023). „Systematic review of the actual emissions reductions of carbon offset projects across all major sectors.“
2 Source: World Carbon Fund (average from four scenarios: Stern Stiglitz Review (USD 75), IEA Net Zero by 2050 (USD 130), Bank of England (USD 150), UK REA Bioenergy Strategy (USD 125))
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