Let the good times roll – 12 reasons to be confident

Vacationers should give the service sector a boost

Consumption is in good shape: SECO¹ predicts a strong winter for Swiss tourism to start the year. Such strong tourism illustrates two things: First, consumers are still spending lots of money thanks to a high employment rate and rising wages. Second, it mitigates the stagnation that was recorded in Christmas trade compared to the prior year. The uptick in overnight stays signals a shift in preferences. After purchasing higher-than-average volumes of durable goods during the pandemic, consumers now want more services. As well as bolstering the healthcare sector, this trend has been particularly beneficial to the travel and tourism industry, sending the share prices of numerous airlines, hotels and cable car/mountain railway operators higher.

In short, while not all sectors of the economy are running smoothly, the service industry is prospering. It is worth noting that services alone account for around half of total consumption in Switzerland.

What can we expect in 2024? Twelve reasons to be confident

At the turn of the year, investors are obviously wondering what lies in store for 2024. Many rosy assessments were still quite controversial last January. However, several of these have become the general consensus since the rally at the end of last year. This suggests it is time for a critical reappraisal. But overall, a sense of confidence in the prospect of a soft landing, in tandem with growth slightly below trend and continued—albeit modest—upside potential for the global equity markets, remains the prevalent theme in a baseline scenario. Let us consider 12 factors behind this scenario.

1. Cash flows of US firms are at a record high

US companies generated more cash than ever last year. The situation in Switzerland was similar. This is unsurprising, as most corporate balance sheets are in good shape. The widely predicted credit crisis was limited to individual cases. Tax receipts (and expenditures) reached new record levels in many countries. While the weak spots in industry, residential construction, and consumer goods are concealed by the aggregate figures, these imbalances in the economy as a whole are offset by the strong service sectors. Moreover, there are already nascent signs that demand for goods is recovering from its slump. For example, according to the European Commission, the Economic Sentiment Indicator (ESI) for the Eurozone rose for the third consecutive time in December. Car sales also climbed in December based on data from the US Bureau of Economic Analysis. Even copper, which is known for its economic sensitivity, showed an upward trend in December.

2. Interest rates have returned to their historical norm

After numerous years of zero interest rates, savers are once again being rewarded. This is beneficial to consumer spending, as well as pension funds and private households. Moreover, contrary to multiple prophecies of doom, the interest rate reversal has not sparked a recession thus far. It is understandable that central banks are in no rush to cut their policy rates, as the interest rate turnaround has given them valuable headroom for the next crisis. Interest rate cuts are expected to start only toward mid-year. However, capital market yields are more important than key rates, having triggered the year-end rally of 2023, which was also the most pronounced bond market rally since 1985.

3. Many consumers are wealthy, liquid, and confident

Many consumers are wealthy, liquid, and confident Live long and prosper, as the Vulcan salute from Star Trek goes, is an apposite saying for the baby boomer generation. Their wealth has never been higher with its pension funds, dividends, interest and real estate income reaching an all-time peak last year. The senior citizen generation has the highest purchasing power of our era.

4. Low unemployment

While the high employment rate fosters social harmony, the shortage of workers is creating challenges for many companies. This also harbors the hidden advantage of a comeback in productivity. In the meantime, unprecedented strength in the labor markets is supporting real wages, job security and confidence in the future. This is particularly beneficial to Generation X—the generation with the second-highest level of purchasing power.

5. Productivity is making a comeback

Companies are reacting to staff shortages with measures including digitalization, process optimization, outsourcing, and automation, as well as new technologies such as artificial intelligence (AI). Despite multiple challenges, average profit margins are higher than ever in Switzerland and the US. This is thanks to productivity staging its biggest comeback since the early 1990s, when mobile telephony and the Internet sparked a major surge in productivity.

Moreover, productivity-driven growth has disinflationary effects, as competition forces companies to share their productivity gains with employees and consumers. This in turn bolsters consumer spending, making it a win-win for society and the stock markets.

6. Inflation: it too will pass, exactly as it arrived

Climbing prices are now an anomaly in the goods industry. Prices are still rising only in labor-intensive services, in which inflation started to pick up later due to the pandemic. However, inflation is likely to recede even in this area. Precise analysis of inflation cycles reveals how symmetrical they are. In free markets, if prices rise sharply and rapidly, they tend to come down again just as quickly. This stems from the influential role prices play. Rising prices curtail consumer spending, which in turn puts the brakes on further price rises. In our baseline scenario, we are expecting inflation to fall close to the levels targeted by central banks in the second half of the year.

7. Market leadership – like a snowball that turns into an avalanche

The current bull market began on 11 October 2022 with a small group of stocks referred to as the “MegaCap-8”. If this bull market continues, as we expect, in the next phase investors are likely to focus on other stocks. In the wake of the recent rally, this is because many investors are on the hunt for “laggards”—shares that still look cheap and promising.

Let’s take a look at the market leaders to date, the MegaCap-8 companies, and their performance last year. They made aggregate gains of 75 per cent in 2023, with the S&P 500 advancing 26 per cent. That said—and this is an aspect frequently overlooked by the bears—these numbers are put into perspective by the share price losses these firms suffered in the prior year, which were also above average. Furthermore, their performance is backed up by strong earnings growth rather than just speculative euphoria, for example.

While the bears believe they are seeing a warning signal in this narrow market leadership, this can also be seen as an opportunity. Quality stocks have the greatest return potential. If investors supplement core positions in quality stocks with tactical exposures to US small caps, we think they should be well positioned to benefit from greater upside potential if the markets rise further.

Turning to the topic of valuations, the average forward price/earnings ratio (PER) of 27x for the MegaCap-8 is at a level similar to that of early 2022 and one-quarter below the forward PER of 38x in August 2020. The overall valuation of the S&P 500 stands at 19x including the MegaCap-8 stocks and 17x if these shares are excluded.

8. Two-thirds of the S&P sector valuations have fallen since 2022

In spite of the year-end rally, valuations in eight of the S&P 500’s 11 main sectors are currently lower than they were at the start of 2022. Let’s take a look at some details.

• The PERs of the 11 main sectors in the S&P 500 Index and how they have changed since January 2022 are as follows: real estate (PER: 38x, -27% over the past two years), IT (27x, -6.5%), consumer discretionary (26x, -18.4%), industrials (20x, -4.2%), materials (19.5x, +15%), consumer staples (19x, -12%), healthcare (18x, +3%), communications (17x, -17%), utilities (16x, -23%), financials (15x, -1%), energy (11x, +1%) with the S&P 500 (19.8x, -9%).
• The PERs of the eight cheapest sub-sectors are as follows: reinsurance (6x), passenger airlines (7x), integrated telecommunication services (7x), household appliances (8x), diversified insurance (9x), oil and gas refineries and distributors (10x), broadcasting and streaming (10x), energy exploration (10x).

9. Reshoring, energy transition, and industrial policy will continue to create plenty of new jobs

The boom in the construction of new factories is creating record-high employment in the US construction industry. In 2023, more new production facilities were built than ever before in a single year. And reindustrialization is being seen far beyond the US. Construction of new factories is also booming in many other countries. They want to benefit from the shift in global supply chains. This trend is moving more slowly in Europe, and is of little relevance to Switzerland due to the country’s high wage costs. Overall, infrastructure expansion in the megatrends of energy, climate, mobility, security, and supply chains is likely to remain an increasingly important driver for the economy.

10. Real estate and construction boosted by monetary easing

While the demand for residential property remains strong, real estate prices and the construction industry proved sensitive to the interest rate reversal. That said, the fall in capital market yields and policy rates should be helpful in 2024. Residential property prices and building activity are picking up again in both the US and Europe. There are also signs that spring is in the air when it comes to the demand for construction materials, furnishings, and similar goods.

11. There may not be an increase in geopolitical risks

Global conflicts should not trigger a recession. On the contrary, the war between Russia and Ukraine has accelerated investment in the energy transition, supply chains, and security across the globe. Investors are currently preoccupied by geopolitical risks, and no-one can predict how things will pan out this year. But as things stand for various major powers, the scope to take action is limited. China is grappling with a real estate crisis, presidential elections are being held in the US this year, and moderate oil prices are trimming the income of Russia and other oil-producing nations. These restrictions could freeze the status quo in numerous conflicts, at least temporarily.

12. What does the historical perspective tell us?

Since data were first compiled for the S&P 500 in 1928, years with gains in excess of 20 per cent have been followed by a lower performance averaging 6 per cent. Negative periods frequently coincided with recessions. If years in which there was a recession are excluded, the average performance in the subsequent years climbs to +10 per cent. The main scenario is unlikely to feature a recession in 2024. In combination with the above considerations, this confirms the assessment that, despite the rally at the end of 2023, attractive opportunities are still available for 2024. The year is likely to be positive for balanced portfolios. Equities, bonds, and real estate could benefit.

The following applies to investors: Strategy check and diversification

The Credit Suisse House View positions itself with confidence, but not with blind euphoria. A good year in 2023 is no reason to get carried away. The principle of “Prepare, don’t predict” is reflected in our day-to-day quest for optimal diversification. What may look simple with hindsight is a challenging and time-consuming undertaking. This is what wealth management is all about. Ultimately, the three most important recommendations for investors in January 2024 are as follows:

1. Stay invested in private and listed assets, without forgetting diversification.
2. Review your investment strategy. It is personal to you. Much like a good suit, it should be inspected from time to time to make sure it still fits. When circumstances change, your strategy should be adapted accordingly.
3. Cash is better suited to spending than saving. Even though inflation is falling, the loss of purchasing power suffered by cash is a high price to pay for supposed security.