Monthly Market Monitor
February 2024
Content Macro Radar
Satellite View
Taking the pulse of economic activity
Geopolitical heat map
6
8
In a Nutshell
4
Asset Allocation
Theme in Focus The emerging-markets puzzle
Notes from the Investment Committee
10
Drawdown: All about Private Banking Predictions: Popular, but not very helpful
18
13
The Back Page Asset classes
21
Kaiser Partner Privatbank AG | Monthly Market Monitor - February 2024
3
In a Nutshell
Our view on the markets
The first moves by major central banks to lower interest rates are now only a matter of time.
Waiting for interest-rate cuts The first moves by major central banks to lower interest rates are now only a matter of time, but if central-bank officials have their way, they will not come quite as quickly and won’t be as vigorous as financial markets are currently hoping. The interest-rate bias at the Bank of Japan, in contrast to its peer group, is pointed upward, which could spark a broad trend reversal for the Japanese yen during the course of this year. Evasive actions by the transport industry The repeated attacks by Houthi rebels on commercial cargo ships in the Red Sea by now have left deep marks on satellite tracking data and have taken a significant toll on European importers: the majority of ships are bypassing the Red Sea, and some goods are becoming scarce. In the months ahead, the USA and its allies look set to continue their (recently successful) interventions initiated in mid-January aimed at restoring free navigation on this vital sea route. How much will the previously inflicted damage affect the world economy and inflation? Technology in the lead again in the new year Equity markets have started off in 2024 the way they ended last year, with significant share-price gains for US technology giants. The new all-time highs on the US equity market after a more than two-year dry spell presage further share-price gains going forward. But des-
Chart of the Month Stocks perform well… | …when unemployment is high Average real one-month return on the S&P 500 index, annualized (1950–2023) 25%
20%
15%
10%
5%
0 <4%
4-5%
5-6% Mean
6-8%
Median
Sources: BCA Research, Kaiser Partner Privatbank 4
Monthly Market Monitor - February 2024 | Kaiser Partner Privatbank AG
>8%
pite the statistical tailwind, intermittent pauses in the uptrend are likely to occur in the near future. The emerging-markets puzzle For a long time, investors lumped Chinese stocks and other emerging markets together in the same pot. But in recent quarters, China appears to have decoupled to the downside. The poor performance of Chinese stocks, less-than-encouraging macroeconomic data, and mounting (geo)political risks are prompting an increasing number of investors to view China and the rest of the world’s emerging economies as standalone asset classes. Rightly so? Predictions: Popular, but not very helpful Market participants trade expectations about the future on financial markets day in and day out. So, it’s hardly surprising that an entire profession devotes itself to concocting forecasts about stock prices and economic variables and that those projections, in turn, are daily grist for the financial media. Even retail investors like to consult the (point) predictions made by purported experts, but they really should be taken with a grain of salt. Will the USA experience a soft landing, or will a recession arrive a little belatedly? That’s one of the most important questions for economic activity and financial markets again in 2024. A look at the US employment market indicates that the chances of a soft landing are still intact. Wage growth is slowing and the number of unfilled jobs is contracting, but at the same time the US unemployment rate remains at 3.7%, close to the all-time low. But would a soft economic landing really be the best scenario for the equity market? Not necessarily. Low unemployment at least in the past has gone hand in hand with below-average stock returns. The best returns have come when the unemployment rate has been high (and stock prices low). This statistic needn’t be a bad omen for the new year on the equity market. It suggests, though, that the five-year return outlook for stocks from the current level isn’t above-average.
Kaiser Partner Privatbank AG | Monthly Market Monitor - February 2024
5
Macro Radar
Taking the pulse of economic activity
The first moves by major central banks to lower interest rates are now only a matter of time, but if central-bank officials have their way, they will not come quite as quickly and won’t be as vigorous as financial markets are currently hoping. The Bank of Japan is exhibiting an interest-rate bias in a different direction. Bank of Japan in good spirits Japan’s central bank kept its ultralow interest-rate policy unchanged at its first meeting of the year, as was widely expected to happen. However, Bank of Japan Governor Kazuo Ueda expressed mounting confidence that the probability of reaching the BoJ’s 2% inflation target is increasing and that an upward wage-price spiral may get underway. In fact, survey results and comments from lobbying groups indicate an increasing chance that wage negotiations with large companies in Japan will result in another round of wage hikes in spring that will surpass last year’s 30-year-high 3.58% gain. An ending of yield curve controls and rising policy interest rates in Japan would stand in stark contrast this year to central banks in America and Europe and could fire the starting gun for the value of the Japanese yen to appreciate.
The US Federal Reserve looks set to embark on a new rate-cutting cycle before the ECB does.
European Central Bank in wait-and-see mode The ECB’s Bank Lending Survey for the fourth quarter of 2023 confirmed once again that the more restrictive monetary policy has long since fed though to the economy and by now even poses a risk to economic activity. Banks further tightened their lending conditions during the observation period while demand for credit dropped significantly once more. One bright spot is that A repeat of last year? | USA stronger than the rest once again Consensus economic growth estimates for 2024 2.5%
2.0%
1.5%
1.0%
0.5%
0 2022
2022
2022 USA
Eurozone
2023 UK
2023 Switzerland
2023 Japan
Sources: Bloomberg, Kaiser Partner Privatbank
6
Monthly Market Monitor - February 2024 | Kaiser Partner Privatbank AG
2023
demand for loans is expected to pick up in early 2024 and that the credit cycle may have already bottomed. However, support for the economy in the form of lower policy interest rates is likely to be longer in coming than the markets are anticipating. They have already priced in a rate cut in April, whereas the ECB president recently hinted at an initial cut in June. ECB officials will probably wait to see the results of the wage negotiation rounds in April and May and the updated economic growth forecasts before loosening the interest-rate screw. Fine-tuning at the Fed The US Federal Reserve looks set to embark on a new rate-cutting cycle before the ECB does. March 20 and May 1 are being bruited at the moment as possible kickoff dates. The decision on whether the timing will be sooner or later will likely depend in the weeks ahead on upcoming inflation and labor market data points. Fed officials will probably watch the employment figures like a hawk because the question about a successful soft landing hasn’t been answered yet and contradictory signals are flashing. Some well-known recession indicators such as the US yield curve and the Conference Board Leading Economic Index (LEI) are standing in contrast to the apparent robustness of the US economy. The LEI fell in January for the 21st consecutive month, prompting the Conference Board to anticipate a recession in Q2 and Q3 of 2024. Bear in mind, though, that the think tank missed the mark with its recession predictions for quarters 1 to 4 last year. However, as we described in our outlook for 2024, we likewise see a substantial risk of a recession in the USA this year, one that tends to be underestimated by the consensus.
Consensus estimates
Kaiser Partner Privatbank interest rates view 2023
2024
2025
GDP growth (in %)
Last
3M
12M
Key interest rates (in %)
Switzerland
0.8
1.2
1.5
Switzerland
1.75
→
↘
Eurozone
0.5
0.5
1.4
Eurozone
4.00
→
↘
UK
0.3
0.4
1.2
UK
5.25
→
↘
USA
2.4
1.5
1.7
USA
5.50
→
↘
China
5.2
4.6
4.4
China
2.50
→
→
Inflation (in %)
10-year yields (in %)
Switzerland
2.2
1.6
1.4
Switzerland
0.82
→
↘
Eurozone
5.4
2.3
2.1
Eurozone
2.16
→
↘
UK
7.4
2.8
2.1
UK
3.76
→
↘
USA
4.1
2.7
2.3
USA
3.88
→
↘
China
0.3
1.0
1.7
China
2.43
→
→
Kaiser Partner Privatbank AG | Monthly Market Monitor - February 2024
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Satellite View Geopolitical heat map
The repeated attacks by Houthi rebels on commercial cargo ships in the Red Sea have, in the meantime, left deep marks on satellite tracking data and have taken a significant toll on European importers: the majority of ships are bypassing the Red Sea, and some goods are becoming scarce. In the months ahead, the USA and its allies look set to continue their (recently successful) interventions initiated in mid-January aimed at restoring free navigation on this vital sea route. How much will the previously inflicted damage affect the world economy and inflation?
Unlike prior to the COVID-19 pandemic, this time there is no real shortage of cargo ships.
Vital passage The route through the Red Sea and the Suez Canal is one of the most important arteries for global trade. It normally takes modern cargo ships 30 to 45 days to make the trip from China to Europe. That’s much faster than taking the alternate route around the continent of Africa, which lengthens the trip by seven to 20 days. In normal times, approximately 15% of worldwide maritime trade, including 30% of the world’s container traffic, passes through the Red Sea. Moreover, before the outbreak of the current crisis, around 12% of the world’s total seaborne petroleum trade and 8% of worldwide liquefied natural gas (LNG) shipments passed through the Red Sea. According to calculations by the Kiel Institute for the World Economy, the volume of containers shipped along the express route plunged to around a third of the usual level at the start of January. The forced evasive action by the transport industry has also been reflected in recent weeks in sharply rising freight rates. It currently costs around 6,000 US dollars to ship a standard container from China to northern Europe. That’s four times higher than the transport price level last autumn, but is still far below the peak container shipping rate of around USD 15,000 registered in ear-
A matter of perspective | Near-term shock, but more digestible Freight rates in US dollars per FEU (forty-foot equivalent unit) 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000 0 2018
2019 Global
2020 China- Europe
2021
2022
US East Coast- Europe
Sources: Bloomberg, Kaiser Partner Privatbank 8
Monthly Market Monitor - February 2024 | Kaiser Partner Privatbank AG
2023
2024
ly 2022. In contrast, costs for routes that do not pass through the Red Sea – routes from North America to Europe, for example – have hardly risen lately. This indicates that the global shipping industry has enough capacity thus far to cope with the longer travel times between Asia and Europe. Only a marginal impact on inflation Unlike prior to the COVID-19 pandemic, this time there is no real shortage of cargo ships. Many ocean carriers responded to the shipping bottlenecks at that time by commissioning new ships to be built. Last year alone, the global container fleet capacity expanded by 7%. Moreover, this time there are hardly any traffic jams at ports, whereas before up to 14% of transport capacity was stuck in port backups. Third, unlike in the COVID-19 period, there is no overdemand for goods at present. Altogether, the current trade disruption’s effect on inflation (in Europe) is thus likely to be marginal. Passing on to customers all of the increases in freight rates, which are negligibly small anyway for most goods, would probably raise the overall level of consumer prices in the Eurozone by around 0.4 of a percentage point. The actual near-term impact, though, is likely to be only around half as high because muted consumer demand will inhibit some companies from passing on the full increase in transport costs to consumers. As soon as security is restored in the Red Sea, even this small inflation effect is bound to go back into reverse. The same goes for industrial output, where near-term delays due to delivery hold-ups are likely to be made up for in subsequent weeks. The current turmoil in the Middle East is unlikely to play much of a role in the European Central Bank’s monetary policy.
Kaiser Partner Privatbank AG | Monthly Market Monitor - February 2024
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Asset Allocation
Notes from the Investment Committee
Equity markets have started off in 2024 the way they ended last year, with significant share-price gains for US technology giants. The new all-time highs on the US stock market after a more than two-year dry spell make a statistical case for further share-price advances. Asset Allocation Monitor -
It’s much more likely that the new all-time highs on the US equity market after a more than two-year dry spell presage further share-price gains going forward.
10
+
Cash
Equities
Fixed Income
Global
Sovereign bonds
Switzerland
Corporate bonds
Europe
Microfinance
UK
Inflation-linked bonds
USA
High-yield bonds
Japan
Emerging-market bonds
Emerging markets
Insurance-linked bonds
Alternative Assets
Convertible bonds
Gold
Duration
Hedge funds
Currencies
Structured products
US dollar
Private equity
Swiss franc
Private credit
Euro
Infrastructure
British pound
Real estate
Equities: Technology in the lead also in the new year • Equity markets kicked off 2024 the way they ended 2023, with significant share-price gains for US technology giants. Most of the advance by the S&P 500 index in January was attributable solely to the strong performance of Microsoft and Nvidia. The rest of the market’s performance was also a repeat of 2023. Small caps and emerging markets underperformed, and Europe landed in the middle of the performance rankings. Momentum begets momentum – an immediate end to the upturn in stock prices is not foreseeable at the moment, at least not without an attenuation of the robust uptrend beforehand. It’s much more likely that the new all-time highs on the US equity market after a more than two-year dry spell presage further share-price gains going forward. Since 1926, the S&P 500 index has gone through six bear-market slumps of similar duration that were each followed by a breakout to new record highs. In five of those six cases, the year afterwards was an up year with an average gain of 9.2%. • However, despite the statistical tailwind, intermittent pauses in the uptrend are likely to occur in the near future. Although US blue-chip indices are at an all-time apex, more stocks have hit 52-week lows lately than
Scorecard
Monthly Market Monitor - February 2024 | Kaiser Partner Privatbank AG
-
+
-
+
Macro Monetary/fiscal policy Corporate earnings Valuation Trend
01/2024
Investor sentiment
01/2024
52-week highs. Alongside the narrow market breadth, the bullish sentiment in the meantime is another reason to exercise caution in the near term. Moreover, the earnings reporting season underway has a certain degree of potential to disappoint the market. Earnings expectations admittedly were revised downward substantially in the runup to the current reporting season, as so often happens. But recently, even upside earnings surprises have frequently not resulted in correspondingly positive stock-price reactions. Downside earnings surprises, in contrast, have been punished more harshly. Last but not least, profit margins will be under close scrutiny in the current reporting season and in the quarters ahead. Receding inflation and a slowdown in economic activity foreshadow an erosion of pricing power in some industries.
• While large caps are currently trading at record-high price levels, small-cap and mid-cap indices in many countries are still stuck in a bear market and are 20% to 25% below their last highs. A big opportunity for investors on a 3- to 5-year horizon is taking shape in this segment. To sidestep the tough challenge of perfectly timing the opportunity, it is advisable to enter this segment in a staggered manner over a stretched-out time frame. Meanwhile, investors shouldn’t fight the momentum in growth stocks. Instead of making a straight bet on value stocks, we recommend blending in sizable exposure to defensive markets like Switzerland, which have potential to catch up in the wake of their lackluster performance last year. Fixed income: Companies lock in low interest rates • The capital markets units of investment banks were busy in the first weeks of this year. After yields on government and corporate bonds plummeted in November and December 2023, new issuance activity surged at the start of 2024. A new record-high volume of investment-grade bond issuance was even registered in January. Many companies’ chief financial officers evidently viewed the recent market interest rate movements as a good opportunity to lock in cheap funding. Bond markets, in fact, have already pulled well away from the lowest interest rate level since then. The yield on 10-year German government bonds has climbed from a low of 1.9% in late December back to around 2.4% while 10year US Treasury notes have been trading at a yield of around 4.2% at last look. • For now we view the recent market movements as being merely a correction of the previous strong price gains. The record yield levels last autumn likely marked the peak of the current interest rate cycle, as suggested by the at least verbally initiated pivot by central banks and by receding inflation rates. At the current level, government bonds are an attractively priced interest-bearing hedge against the still latently extant risk of a recession this year, a risk that the market is tending to underestimate at the moment. Investors should combine this insurance with a small amount of exposure to highyield bonds, which have a sufficient yield buffer for a negative macroeconomic scenario but which at the same time promise double-digit percent returns in a scenario in which the US economy continues to perform robustly. Alternative assets: Time for real estate? • “Concrete gold” fell out of favor with many investors in the course of the interest rate turnaround over the last two years. The attendant price drawdowns caused discontent. Moreover, the unexpected freezing of liquidity in some subsegments of the
market – such as in semi-liquid private real estate funds, for example – put investor sentiment to the test, with a negative outcome and a certain loss of confidence in investment vehicles of that kind for the time being. But as 2024 gets rolling, investors shouldn’t tar all of the different ways of investing in the real estate sector with the same brush. More liquid options like US real estate investment trusts (REITs) and Swiss real estate funds have already undergone necessary price adjustments, so at least there are no longer any valuation mispricings standing in the way of a minimum strategic allocation to those asset classes. The Swiss market, in addition, stands out for its continued attractive fundamentals and, last but not least, also due to the strong Swiss franc. The time for private real estate also looks set to return – the current phase of market turbulence holds some occasional good entry opportunities in store for professional managers. However, our preference for now lies in other private-market asset categories, particularly private credit. Currencies: US dollar picks up • EUR/USD: The euro depreciated mildly against the US dollar in January, but there were no major price drivers in play. The European Central Bank and the US Federal Reserve have both recently been trying to stave off market expectations of impending (and lots of) interest rate cuts, so neither currency has a competitive advantage at the moment from an interest rate perspective. From an economic activity standpoint, though, the enduring robustness of the US economy argues in favor of the dollar again this year. However, the greater potential for surprises lies with the euro. We are maintaining a neutral stance on this currency pair. • GBP/USD: The British pound ranked among the strongest currencies in January, benefiting in large part from unexpected bad news regarding the latest inflation data. However, this is likely a statistical outlier on the way to disinflation. There’s a lot in the fundamentals suggesting that inflation will soon drop toward the 2% target and that the Bank of England will find itself compelled to cut interest rates. The pound is more a tactical buy than not at the moment. • EUR/CHF: The EUR/CHF exchange rate has rebounded in recent weeks from the December euro selloff, but is still in an intact downtrend channel. Judging by recent comments, the Swiss National Bank for the time being no longer wants to actively use the franc to combat inflation. However, the SNB also has equally little intention of weakening the franc. Given the strong fundamentals, we do not foresee a turnaround in the exchange-rate trend for the time being. The EUR/CHF cross would first have to overcome the 97-centimes level for that to happen.
The capital markets units of investment banks were busy in the first weeks of this year.
Kaiser Partner Privatbank AG | Monthly Market Monitor - February 2024
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Trends on financial markets – regardless of whether pointed upward or downward – usually continue for longer than investors imagine they will. This momentum effect has been extensively described and proven in financial literature. Smart beta ETFs and trend-following CTA hedge fund strategies exploit the momentum factor. Strong momentum, which often further intensifies particularly during the final stage of price declines, is the reason why investors should avoid trying to catch the proverbial falling knife. Nevertheless, every trend comes to an end – at least a temporary one – at some point, usually when the majority of investors are already fully invested in a market (uptrend) or are already mostly divested (downtrend). At the moment, the Magnificent Seven US tech giants are particularly at risk of a stock-price correction. Investors tactically should exercise caution here and should lock in existing profits.
Chart in the Spotlight Time to take profits? | Investors are (overly) enamored with the Magnificent Seven Question: What, in your opinion, is the most crowded bet on financial markets at the moment?
Sources: BofA Global Fund Manager Survey, Kaiser Partner Privatbank
12
Monthly Market Monitor - February 2024 | Kaiser Partner Privatbank AG
Theme in Focus
The emerging-markets puzzle
For a long time, investors had lumped Chinese stocks and other emerging markets together in the same pot and viewed them as being the same bet – a bet on global economic growth. But China appears to have decoupled in recent quarters – to the downside: the country’s poor stock-market performance has been accompanied by less-than-encouraging macroeconomic data and mounting (geo)political risks. An increasing number of investors by now are viewing China and the rest of the world’s emerging economies as standalone asset classes. Rightly so? In the following article, we’ll attempt to solve the emerging-markets puzzle. Two variants of emerging markets When China gets up and running, so do the other emerging-market countries – and vice versa. This correlation long applied to emerging-market equities. Stock prices were also closely correlated for the most part with net capital inflows and outflows. But for three years now, a decoupling of China from the rest of the world’s emerging-market countries has been observable, and the divergence increased further in 2023. Whereas the MSCI Emerging Markets ex-China index has treaded water on balance since 2021, the MSCI China index has plummeted by around 50% over the same period. The China bear market has been interrupted only once during that time by a vigorous 60% rally at the end of 2022, which was driven especially by hopes of a burst of economic growth after the end of the pandemic lockdown. During a period of euphoria between November 2022 and March 2023, a net USD 48 billion flowed into the Chinese equity market temporarily. What happened afterwards, though, was a huge disappointment: Chinese stocks ranked among the worst underperformers in 2023 with an aggregate share-price decline of 11% for the year, and the disillusioned investors withdrew their previously invested capital almost entirely by year-end. The performance of emerging markets excluding China stands in stark contrast to that. Emerging-markets ex-China were able to keep pace with the developedmarket stocks in the MSCI World index both last year and in a comparison over the last five years, at least if strongly outperforming US stocks are left out of the picture. Against this backdrop, it’s no wonder that (institutional) investors are increasingly asking themselves whether Chinese stocks and the rest of the emerging markets are two different kettles of fish and accordingly should be treated differently. Looking at the recent divergence in capital flows, it seems that some investors have already answered that question for themselves. What is the solution to the emerging-markets puzzle? And what are the prospects for the two variants of emerging markets?
Arguments for a (tactical) China bounce… In any event, investors shouldn’t simply write off China, the world’s second-largest equity market. After three consecutive down years and a negative performance of –60% since peaking in February 2021, now might be the worst possible time to turn one’s back on Chinese stocks because not only are they utterly oversold at the moment, they are also extremely cheaply valued. A valuation premium of +10% versus the rest of the emerging-market countries a year ago (measured in terms of price-to-earnings ratios) has since turned into a valuation discount of –40% at last look. In absolute terms as well, the Chinese equity market’s price-to-earnings valuation multiple of less than 10x is close to its historical low and is at a level that in the past consistently promised share-price gains of more than 20% over the subsequent 12 months. One invariable precondition for that, though, was relatively strong corporate earnings growth. Given the current disinflationary trend in China, it remains to be seen whether corporate earnings can deliver the requisite fuel for a rally again this time. Another precondition for the start of a tactical rebound is in place, though: Chinese stocks have rarely been as unpopular as they presently are – the positioning of
When China gets up and running, so do the other emerging-market countries – and vice versa.
Decoupling | China is driving in a different lane MSCI indices
Sources: Bloomberg, Kaiser Partner Privatbank Kaiser Partner Privatbank AG | Monthly Market Monitor - February 2024
13
mutual and hedge funds is near a five-year low. Economic growth expectations for China for 2024 are also low and have been heading south lately. Finally, market participants likewise have low expectations about the government of China taking actions to bolster the stock market. If economic growth accelerates out of the blue in the weeks and months ahead, this perhaps would fire the starting pistol for a temporary relief rally in Chinese stocks. A tactical buy? | Chinese stocks are cheap right now in both absolute and relative terms Price-to-earnings multiples 25x
20x
15x
10x
5x
2015
2012
2009 China
Emerging Markets
2018
2021
Emerging Markets ex China
Sources: Bloomberg, Kaiser Partner Privatbank
This means that in contrast to many another emerging-market country, China soon can no longer be regarded as a genuine bet on economic growth.
14
…and structural bearish reasoning So, in the near term, the prospects for China are more constructive than current sentiment suggests. The medium-term outlook, though, is less inspiring. To wit, China’s potential growth looks set to trend downward toward 4% in the years ahead. This means that in contrast to many another emerging-market country, China soon can no longer be regarded as a genuine bet on economic growth. Moreover, the government of China will probably continue in the years ahead to place top priority on structurally transforming the country’s economic model and reducing financial risks. Beijing is unlikely to fire a bazooka to stimulate the financial market solely to placate investors (and speculators). Meanwhile, Chinese authorities’ regulatory attitude toward the biggest companies in the MSCI China index remains unpredictable and is downright hostile at times. After sending repeated signals last year that the crackdown on the technology sector is over, the regu-
Monthly Market Monitor - February 2024 | Kaiser Partner Privatbank AG
latory authority sprang a surprise in late December with a draft regulation that would restrict consumer spending on online gaming (and which sent shares of gaming operators tumbling). The political climate in China is structurally challenging also for stocks other than internet platforms. Although Beijing’s industrial policy has chalked up successes, for example in electric vehicle manufacturing, it is also creating adverse side effects. For one thing, it is causing production overcapacity and disinflation, which are cutting into corporate profits. Moreover, the industrial policy heavily relies on financing via the stock market. Consequently, initial public offerings and secondary stock issues to raise further capital soak up more money than flows back to shareholders through dividends and stock buybacks, acting as an implicit brake on performance. China’s crisis-wracked real estate market, in turn, still hasn’t hit bottom yet, a fact that will continue to gnaw away at consumer and investor confidence. As long as this key economic sector hasn’t found a new equilibrium, a long-term upward valuation rerating of the Chinese equity market seems rather unlikely. But the structurally bearish line of reasoning for China doesn’t end there. There are also (geo)political issues such as the rivalry between China and the USA, as well as the Taiwan question. The impact of these risks on Chinese businesses and China’s stock market are difficult to model. China has already lost allure for foreign investors, as evidenced in the meantime also by data on foreign direct investment in the country, which plummeted dramatically and even turned negative in 2023 (foreigners withdrew net capital). More and more institutional investors in the future are likely to view China as being more of a trade than an investment, also on the equity market – a trade, to boot, that’s hard to time and depends on the benevolence of the government in Beijing. Against this backdrop, more than a few investors will probably use a potential rally in the months or quarters ahead to unload positions in China and rotate into other emerging markets. A closer look reveals that this process has been underway for quite a while now, as exemplified by the iShares ETF on the MSCI Emerging Markets ex-China index, whose asset volume nearly tripled last year while the iShares MSCI China ETF registered net outflows.
Change in favorites | Investors are voting with their feet Assets under management in iShares ETFs (in USD billion) 10
8
6
4
2
0
2021
2022
iShares MSCI China ETF
A bet on economic growth | Asian countries (and technology) dominate even without China Sector composition of MSCI Emerging Markets and MSCI Emerging Markets ex-China indices Country alloca on
Sector alloca on
30% 25% 20% 15% 10% 5%
lE
sta te
es li
Re a
U
hc ar e
…
alt
on
He
ica un
er
m
um Co
Co
m
ns
um ns Co
er gy
l…
Di er
du In
En
sc
St ap
r…
als str i
ial
s
ls M
at er
cia an
IT
0
EM ex China
EM including China
Sources: MSCI, Kaiser Partner Privatbank
Country alloca on
Sector alloca on
30% 25% 20% 15% 10% 5%
er Ot h
d ila n Th a
sia In do ne
M ex ico
Af
ric a
ia
th
ra b
EM ex China
So u
iA
Sa
ud
Br az il
Ko re a ut h
So
Ta iw an
In di a
in a
0 Ch
…and is now the time to jump in? Whether emerging markets ex-China will be able not only to keep pace with but even outperform developed-market stocks in 2024 will depend in good part on whether US technology stocks continue their strong run. The prerequisites for a solid performance are at least in place. For instance, emerging economies’ growth premium versus industrialized countries looks set to climb to the highest level in five years in 2024. The end of the rate-hiking cycle in the USA, the prospect of a return to interest-rate cutting soon, and a prospective weakening of the US dollar round out the positive macro setup. Asia additionally is bound to benefit from a reallocation of global trade and production chains away from China (keyword: de-risking). Exporters of raw materials also look set to profit – from growing demand for the critical input materials needed for a successful climate turnaround. One fly in the ointment, though, is the fact that many of the emerging-market countries that look attractive on paper – including India, Mexico, and Vietnam, for example – already have a lot of advance praise priced in. And last but not least, although China stands squarely in the spotlight when looking at (geo)political risks, a Trump 2.0 scenario, under which a 10% tariff on virtually all imports to the USA (regardless of the country of origin) would potentially loom, would also be harmful to the rest of the emerging-market countries.
2023
iShares MSCI Emerging Markets ex China ETF
Sources: Bloomberg, Kaiser Partner Privatbank
Fin
What’s inside the Emerging Markets ex-China wrapper… But what do investors actually acquire when they buy emerging markets without the inclusion of China, the hulk that dominates in the conventional MSCI Emerging Markets index with a weight of more than 26%? The answer is at least interesting. The MSCI Emerging Markets ex-China index remains heavily dominated by Asia – the top three countries alone (India, Taiwan, and South Korea) are all located in Asia and together make up almost three-quarters of the index. At the same time, the emerging markets ex-China universe is even more tech-heavy (27.7% vs. 22.1%) while consumer goods and telecom stocks in particular become less important. Consequently, the narrower index will tend to be affected more strongly by the economic cycle in industrialized countries and less affected by typical emerging-market drivers. However, the altered risk and return characteristics are even more interesting because when China is stripped out of the emerging-markets universe, one bids adieu to a sizable chunk of risk (volatility). During the period from 2001 to today, the observed volatility of the MSCI China index, for example, has been around 50% higher than that of the MSCI Emerging Markets ex-China index but with only a marginal outperformance at the same time. There’s a lot suggesting that better long-term risk-adjusted returns without China in the mix will continue to be achievable in the future.
EM including China
Sources: MSCI, Kaiser Partner Privatbank
Kaiser Partner Privatbank AG | Monthly Market Monitor - February 2024
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Puzzle-solving instructions Just like there’s more than one path to solving a real, hands-on puzzle, our emerging-markets puzzle likewise allows us to derive multiple conclusions: The time to sell Chinese stocks is: not now. A technical retracement is very probable in the near future.
• The time to sell Chinese stocks is: not now. A technical retracement is very probable in the near future. Whoever would like to reduce investment exposure to China should wait for that to happen first. • The timing for overweighting emerging markets ex-China also is not ideal at the moment. Although the fundamentals are very constructive, many markets are overbought and ambitiously priced. A neutral allocation to the MSCI Emerging Markets ex-China index is appropriate right now. • Anyone who (compulsorily) maintains a strategic allocation to emerging markets and implements it via the MSCI Emerging Markets index holds concentrated China risk and is implicitly exposed to China’s structural problems and to Chinese stocks’ high volatility. It would be advisable for such investors to adjust the benchmark (e.g. to 50% MSCI Emerging Markets and 50% MSCI Emerging Markets ex-China) and to reduce exposure to China. Whoever doesn’t have to be mindful of tracking risk with regard to the MSCI Emerging Markets index can exclude China entirely from the investment universe. • Whoever isn’t compelled to invest passively should bear in mind that emerging markets are less efficient than the markets in most of the industrialized countries and open scope for outperformance through active management. Partial implementation of exposure to emerging markets through actively managed investment products should be taken into consideration.
Chinese alphabet soup | From A-shares to Red Chips* Five-year performance (in US dollars)
Sources: Bloomberg, Kaiser Partner Privatbank
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Monthly Market Monitor - February 2024 | Kaiser Partner Privatbank AG
• Despite the comprehensively described risks, China also continues to present opportunities. Investors can capitalize on some growth themes – such as China’s rising middle class, for example – also indirectly via developed-market stocks (luxury goods stocks in this case). • The Chinese equity universe is a veritable alphabet soup ranging from A- and B-shares to H-shares and extending to red chips und P chips. The performance of the respective market segments varies greatly at times and is bound to continue to present alpha opportunities in the future for those investors who possess the expertise and access to exploit them. *China's stock alphabet soup explained: • MSCI China: A/H/B shares, Red Chips, P Chips and ADRs • A-shares: companies based in China, trading on the Shanghai and Shenzhen stock exchanges, access via Stock Connect • H-shares: large and medium-sized companies based in China, listed in Hong Kong • B-shares: companies based in China, trading on the Shanghai and Shenzhen stock exchanges in foreign currency • Red chips: large and medium-sized Chinese companies based outside China, listed in Hong Kong, typically state-owned enterprises (SOEs) • P Chips: same as Red Chips, non-state-owned • ADRs: traded in the USA (NYSE, NASDAQ)
Kaiser Partner Privatbank AG | Monthly Market Monitor - February 2024
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Drawdown: All about Private Banking Predictions: Popular, but not very helpful
Market participants trade expectations about the future on financial markets day in and day out. So, it’s hardly surprising that an entire profession devotes itself to concocting forecasts about stock prices and economic variables and that those projections, in turn, are daily grist for the financial media. Even retail investors like to consult the (point) predictions made by purported experts. But all forecasts should be treated with caution and shouldn’t distract investors from sticking to a long-term investment strategy.
Who wouldn’t want to know what will happen tomorrow? The ability to see into the future could be put to use very lucratively, particularly on financial markets.
Let’s flip a coin Who wouldn’t want to know what will happen tomorrow? The ability to see into the future could be put to use very lucratively, particularly on financial markets. A look into the crystal ball is ventured anew every day on stock-trading TV shows when so-called “gurus” draw attention to themselves with their market views. One can safely question the added value of their predictions, and that’s exactly what a number of studies have already done. An investigation by CXO Advisory Group examined the extent to which self-proclaimed “experts” (or those endorsed by others as being experts) are useful guides to timing the stock market. To find out, CXO Advisory Group collected and analyzed a total of 6,584 forecasts from 68 experts on the US stock market over a period from 2005 through 2012. The experts’ forecasting methodologies covered the entire spectrum of conceivable approaches, ranging from analyzing technical indicators to fundamental analysis and observing market sentiment. The investigation found that the accuracy of the forecasts was below 47% on average, which is worse than simply flipping a coin. The distribution of forecasting accuracy almost exactly matched a typical bell
curve, just like one would expect to see from a purely random outcome. The highest individual accuracy rate among the experts examined was in the area of around 68% and the lowest was in the vicinity of 22%. David Bailey et al. came to a similar finding in their study titled “Do Financial Gurus Produce Reliable Forecasts?”, which explicitly references the S&P 500 index. In that study, only 48% of all forecasts were correct, and twothirds of the gurus were wrong in the majority of cases. The roster of “participants” in both investigations included well-known names like Jeremy Grantham (the founder of the value-oriented investment house GMO), Marc Faber (the author of the “Gloom, Boom & Doom Report”), and Jim Cramer (the CNBC superstar). Cramer ranked among the worst competitors, with a forecasting accuracy score of 47% in the CXO study and 37% in the study by Bailey et al. However, Cramer’s low accuracy rate thus far hasn’t harmed the success of his stock-market show “Mad Money”, which has been running for almost two decades now. The reliable failure of his market predictions to come true actually even culminated last year in the launch of an Inverse Cramer Tracker ETF. Meanwhile, the Long Cramer Tracker ETF that was launched at the same time was shut down just a few short months later due to a lack of investor interest.
No better than flipping a coin | Even gurus don’t have a crystal ball Guru accuracy histogram
Sources: CXO Advisory Group, Kaiser Partner Privatbank 18
Monthly Market Monitor - February 2024 | Kaiser Partner Privatbank AG
Upshot: Stock-market tips from gurus don’t cost you anything, but they don’t provide any added value and may actually even have negative value if they distract investors from sticking to well-thought-out strategies. This risk particularly looms when predictions by gurus merely confirm an investor’s own personal opinions (confirmation bias) and undermine objectivity. Assertions by purported experts should be viewed as being no more and no less than what they really are: purely entertainment.
Crowd wisdom is no help either If it is not profitable to trade on the instructions of individual gurus, maybe it helps to consult the wisdom of the masses, i.e. the “predictions” and expectations that can be deduced from surveys. Investigations concerning this as well have already been undertaken, for example in the study titled “How Accurate Are Survey Forecasts on the Market?” published in March 2023 by Songrun He et al. (Washington University). The researchers analyzed three established surveys in which respondents are polled on array of questions including their outlook for the US stock market for the next 12 months. The three surveys they examined were: • The Livingston Survey, a semiannual survey on the US economy (and the S&P 500 index, among other questions) conducted by the Federal Reserve Bank of Philadelphia (in June and December). The survey polls experts and economists from the financial industry and academic institutions. Around 90 participants are on the survey’s mailing list, and 55 to 65 of them respond to the survey each time. • The CFO Survey, a quarterly survey of chief financial officers in the USA inquiring about the financial outlook facing their respective companies. The survey polls a sample of around 4,500 participants (of which around 400 respond each time). • The set of data compiled and analyzed by Stefan Nagel (University of Chicago) and Thengyang Xu (City University of Hong Kong), which consolidates various data sources – including the UBS/Gallup survey, the Conference Board survey, and the University of Michigan Survey of Consumers – to form a representative survey of a typical US household. Three surveys and three groups of respondents with differing expertise on financial matters. What could possibly go wrong? A whole lot, it turns out, as illustrated by a simple statistic: none of the surveys came close to correctly predicting the actual (historical) stock-market return. The actual long-term return (since 1945) amounts to +7.5% per annum on average, but the average annual return projected by all three surveys was only half as high at +3.8%. But not only were the absolute return estimates far detached from the reality of the market, so were the predictions of the market’s direction (up/down). Neither financial-market pros nor consumers were better than a naive prediction simply projecting a repeat of the previous year’s return. Only CFOs were able to deliver a small, but statistically insignificant, degree of added value with regard to the market trend.
Overly optimistic/pessimistic | The historical return is the better prediction Projected and actual returns for the S&P 500 index
Sources: Bloomberg, Kaiser Partner Privatbank Confusion squared | Market strategists and stock analysts are in disagreement Index forecasts for 2024
Sources: Bloomberg, Kaiser Partner Privatbank
Year-end forecasts Even though the evidence of the scarce utility of predictions is more than abundant by now, forecasting continues to be a permanent fixture in the world of finance. Highly specific point predictions, for example, are part of the daily bread for single-stock analysts as well as market strategists. Crystal ball gazing regularly reaches its climax at the turning of the year in the form of new year-end targets for blue-chip stock indices. Analyzing the year-end forecasts from the last 20 years for the USA’s S&P 500 index, one discerns a certain pattern, to wit: market strategists who make top-down forecasts of the year-end closing level of the benchmark US index by factoring in the macroeconomic outlook are notoriously pessimistic and have projected an average annual return of just +3.4% since 2005, which is far below the actual realized return of +9.0%. In contrast, single-stock analysts, whose point predictions on individual stocks get aggregated into an implicit expected index level (using a bottom-up approach), are systematically overoptimistic and projected an average annual return of +11.8%, which was well above the actual realized performance.
Three surveys and three groups of respondents with differing expertise on financial matters. What could possibly go wrong?
Upshot: The crowd is also inept. There is no such thing as crowd wisdom, at least not with regard to (stock) market predictions. Whoever can’t get around having to quote an estimate would do best to simply assume a random walk by the market.
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A look at the index forecasts for 2024 reveals the same picture of pessimism and optimism. Market strategists see stagnation, whereas single-stock analysts anticipate double-digit percent share-price gains on aggregate. What are investors to make of this? They shouldn’t take the projected numbers at face value, or else confusion is guaranteed. If a person had simply given a prediction tip in line with the average annual return on the S&P 500 since 1945 (+7.5%) for each of the last 20 years, that person would have been a bit too negative, but would have put the community of experts to shame in the matter of forecasting accuracy. Upshot: Investors shouldn’t care about share-price and index targets because even the experts who concern themselves with this subject every day haven’t the slightest idea where prices will be at the end of the year. However, their work isn’t entirely futile because stock and market analyses at least identify the relevant price drivers and can thus help investors to recognize risks and exploit opportunities.
If anyone at all is capable of making good predictions, then it has to be central banks. One could at least make this assumption regarding their interest-rate forecasts.
Central-bank officials also don’t have a crystal ball If anyone at all is capable of making good predictions, then it has to be central banks. One could at least make this assumption regarding their interest-rate forecasts. After all, not only are central-bank officials “genuine” experts who have access to vast quantities of economic data, but they also set policy interest rates themselves. But even that good point of departure provides no protection against misjudgments, as the forecasting performance of the last three years strikingly illustra-
Disillusioning | Even central banks have difficulty making forecasts Policy interest rate and inflation in the USA (and projections by the Fed) 6% 5% 4% 3% 2% 1% 0 2012
2014
2016
2018
Fed Funds Rate
2020 PCE Inflation
Sources: Bloomberg, Fed, Kaiser Partner Privatbank
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Monthly Market Monitor - February 2024 | Kaiser Partner Privatbank AG
2022
2024
tes. Back in late 2021, the US Federal Reserve expected that it would raise its policy rate to a maximum of 2.1% by the end of 2024. In reality, though, it actually had to hike the federal funds rate to over 5% by as soon as summer 2023. The erroneous interest-rate forecast was caused by another misjudgment: the inflation forecast. At the end of 2021, the Fed expected inflation to recede from 5.2% to 2.6% over the next 12 months. In reality, inflation was still hovering at 4.9% at the end of 2022. The past pandemic and post-pandemic years admittedly were extremely difficult to assess, let alone predict, arguably for everyone. But even in less volatile times, estimates by central banks have tended to exhibit a rather short half-life in the past. Upshot: The future is uncertain. That’s why markets and macro variables are impossible to predict with pinpoint precision. Even sophisticated, elaborate models are of little help here. For this reason, the experts at Kaiser Partner Privatbank deliberately abstain from making point predictions on markets and macro variables. In the Monthly Market Monitor, we confine ourselves to keeping track of consensus estimates on economic growth, inflation, and interest rates, and we only make forecasts on interest-rate trends. To those who may think this practice seems to be lacking in ambition, we highly recommend to them these words penned by Warren Buffet in his letter to shareholders in 2013: “Forming macro opinions or listening to the macro or market predictions of others is a waste of time. Indeed, it is dangerous because it may blur your vision of the facts that are truly important.”
The Back Page Asset classes
Performance as of January 31st 2024 Asset class
YTD 1 Month
1 Year
3 Years*
Index
US Dollar
0.5%
0.5%
5.5%
2.8%
USD Interest Rate Return
Euro
0.4%
0.4%
3.7%
1.3%
EUR Interest Rate Return
Swiss Franc
0.2%
0.2%
1.6%
0.3%
CHF Interest Rate Return
USA
-0.2%
-0.2%
0.2%
-4.8%
Bloomberg US Govt 7-10 Yr Bond Index (USD)
USA inflation-protected
0.2%
0.2%
2.2%
-1.0%
Bloomberg US Treasury Inflation-Linked Bond Index (USD)
Germany
-0.6%
-0.6%
3.8%
-5.6%
Bloomberg Germany Govt 7-10 Yr Bond Index (EUR)
United Kingdom
-1.8%
-1.8%
0.9%
-6.2%
Bloomberg UK Govt 7-10 Yr Bond Index (GBP)
Switzerland
-0.7%
-0.7%
4.4%
-2.5%
Bloomberg Switzerland Govt 7-10 Yr Bond Index (CHF)
US Investment Grade
0.3%
0.3%
5.1%
-0.6%
Bloomberg US Corporate 3-5 Yr Index (USD)
EU Investment Grade
0.1%
0.1%
5.8%
-1.4%
Bloomberg European Corporate 3-5 Yr Index (EUR)
US High Yield
0.0%
0.0%
9.3%
1.9%
Bloomberg US Corporate High Yield Index (USD)
EU High Yield
1.0%
1.0%
10.4%
1.6%
Bloomberg Pan-European High Yield Index (EUR)
Emerging-market bonds
-1.2%
-1.2%
6.0%
-3.9%
JPMorgan EMBI Global Core Index (USD)
Insurance-linked bonds
1.8%
1.8%
19.8%
7.6%
Swiss Re Global Cat Bond Total Return Index (USD)
Convertible bonds Equities
-1.4%
-1.4%
4.3%
-3.3%
Bloomberg Global Convertibles Index (USD)
Global
1.2%
1.2%
17.6%
8.6%
MSCI World Gross Total Return Index (USD)
USA
1.7%
1.7%
20.8%
11.0%
S&P 500 Total Return Index (USD)
Europe
1.5%
1.5%
10.8%
10.3%
STOXX Europe 600 (Gross Return) (EUR)
United Kingdom
-1.3%
-1.3%
2.1%
10.0%
FTSE 100 Total Return Index (GBP)
Switzerland
1.4%
1.4%
2.0%
3.8%
Swiss Performance Index (CHF)
Japan
7.8%
7.8%
32.4%
14.9%
Topix Total Return Index (JPY)
China
-10.6%
-10.6%
-28.9%
-23.1%
MSCI China Gross Total Return Index (USD)
Emerging-markets ex. China
-2.5%
-2.5%
10.9%
1.7%
MSCI Emerging Markets ex China Gross Return Index (USD)
Commodities
-0.1%
-0.1%
-11.8%
7.2%
Bloomberg Commodity Index (USD)
Gold
-1.1%
-1.1%
5.8%
3.3%
Gold Spot (US Dollar/Ounce)
Real estate USA
-4.9%
-4.9%
-7.7%
0.3%
S&P US All Equity REIT Index (USD)
Real estate Switzerland
2.5%
2.5%
8.0%
0.5%
SXI Real Estate Funds Total Return Index (CHF)
Hedge Funds
0.0%
0.0%
4.2%
2.9%
Bloomberg All Hedge Fund Index (USD)
Private Equity
-0.3%
-0.3%
18.2%
0.4%
Global Listed Private Equity Index (USD)
EUR/USD
-2.0%
-2.0%
-0.4%
-3.8%
EURUSD Spot Exchange Rate
EUR/CHF
0.3%
0.3%
-6.4%
-4.8%
EURCHF Spot Exchange Rate
GBP/USD
-0.3%
-0.3%
3.0%
-2.5%
GBPUSD Spot Exchange Rate
Cash
Fixed Income Government Bonds
Corporate Bonds
Others
Alternatives
Currencies
*annualised
Kaiser Partner Privatbank AG | Monthly Market Monitor - February 2024
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