Inflation cools - stock market rejoices. Scenario analysis - how bad would a recession be? Positioning of major investors for 2024.
Chart of the week
New figures on the development of inflation (CPI) in the USA were published last week. The chart shows the official inflation figure with the yellow columns and inflation excluding the two volatile components of energy and food with the black line.
Why this is important
Core inflation was unchanged and inflation excluding energy and food decreased. These figures led to a sigh of relief. Inflation is falling and the US Federal Reserve will not have to raise interest rates any further. This was exactly what the stock market loves and share prices shot up.
What is important for the stock market is the environment for companies and how easy it is for companies to finance their business and take out loans.
The chart shows the Chicago Fed's National Financial Conditions Index (NFCI). Every week, the index provides a comprehensive update on financial conditions on the money markets, bond and equity markets as well as the traditional and "shadow" banking system in the US.
Since the central banks began reducing the money supply (QT, Quantitative Tightening) and raising interest rates in 2021, the ability of companies to obtain financing has deteriorated. As the chart above shows, the situation for companies has already improved again since the beginning of 2023. The situation for companies to finance themselves on the financial markets is far less dire than many people think.
Scenario analysis - how bad would a recession be?
The camp of investors who think that we will soon enter a recession because the central banks have set interest rates too high and too quickly and those who expect a soft landing are roughly equal in size.
The chart from the respected investment bank Goldman Sachs shows four different scenarios and what they mean for the stock market.
The base scenario assumes falling inflation and slight growth, i.e. the soft landing scenario. If this proves to be the case, Goldman Sachs expects the stock market to rise by 6% in 2024 (red frame). If there is a recession (second red frame), Goldman Sachs expects the stock market to fall by 16 % in 2024.
A recession is certainly not good, but a 16 % fall in the stock market is a normal correction, as we have often seen in the past. Goldman Sachs gives the recession scenario a probability of only 15 %. It therefore makes no sense to be deterred from investing in a long-term investment strategy.
Positioning of major investors for 2024.
In America, around 70 % of all equities are held by institutional investors. This includes banks, pension funds and funds (normal and hedge funds). How these investors are currently behaving and what changes they are planning is therefore essential for the development of the stock market.
Bank of America conducts a survey of institutional investors every quarter. In this blog, we regularly analyze this survey in order to better assess what lies ahead.
Firstly, institutional investors were asked whether they believe the current share rally is sustainable or just a flash in the pan and the stock market will continue to fall. Here, 61% of investors are of the opinion that the stock market will continue to fall.
Investors are also asked every quarter where they see the greatest risks. With the wars in Ukraine and Israel, it is not surprising that more and more attention has been paid to geopolitical risks since September. On the other hand, the risk of continued high inflation continues to diminish.
What conclusions will institutional investors draw from this for the coming year?
Investors were asked which asset class will be the best in 2024. 54% are convinced that bonds will be the best asset class in 2024. Only 29% see equities as the best asset class.
A lot of money flowed into money market instruments and short-term bonds during the year. This is why institutional investors were asked whether they plan to increase the maturity of their bonds. The answer here is astonishing: only 33% plan to do so.
Many investors currently have a massive overweight in money market investments and tend to be underweight in equities. As the survey above shows, many do not seem to want to change this positioning.
As the past has shown, most investors are often wrong. We are currently adhering to the investment behavior that Warren Buffett is currently pursuing. He is positive on (value and quality) equities and invests his cash holdings in US government bonds with a maturity of one year so that he can increase his equity exposure at any time. We also think that the equity markets could surprise us more positively than most people think.
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