As you all know, the eventfulness of 2023 extends to WHVP and the world as a whole. We were – once again - faced with several unexpected events.
After a war broke out in Europe in 2022, another one was added to the global stage in the Middle East. Most would have guessed Taiwan if you asked someone where the next war broke out a year ago. The quote “It is difficult to make predictions, especially about the future” was confirmed again. However, that was not the only unexpected development. We also find ourselves in the most extended pre-recession period in history. At the beginning of 2022, investors were waiting for a recession to hit. While we have various more minor, local recessions (e.g., Germany), the United States has avoided one. In the meantime, the voices proclaiming a soft landing became louder. Whether we will see a soft landing or a recession, mild or hard, we cannot know for sure. Even Brian Wesbury, an economist with multiple decades of experience in macroeconomic forecasting, recently said in an article that “the past few years have been the most difficult time to forecast in our careers. The US economy has never gone through COVID lockdowns before, plus a reopening, along with such massive peacetime fiscal and monetary stimulus.” The spending was immense, and there is much more to come. Who will pay this cost, and especially when will settlement time come?
The Sky is the Limit
While 2022 was a year with considerable losses in almost all asset classes, the indices started to turn in the last quarter of 2022. The expectation was a bear market rally, ending sometime in the first or second quarter of 2023. Instead, we experienced another breathtaking rally, at least in the US. However, it was not the economy that was so well off. It was mainly the magnificent seven driving the indices into heavenly spheres, leaving the people wondering why they were struggling to pay the bills while markets were doing great. However, a gaze into the constituents representing the indices showed that the economy could be doing better. Accordingly, during the third quarter, we saw the markets returning on a much broader scale as they were pushed up before.
Nevertheless, another quote says, “Hope is the last to die.” Accordingly, investors became more optimistic again due to easing inflation and ongoing low unemployment. That led to the rally we have seen in the last two months of 2023.
The chart below shows the S&P 500, the Nasdaq, and the Dow Jones Industrial Index YTD and how the markets have performed in 2023 and particularly, over the last two months.
However, with that in hindsight, what should we expect from 2024? We believe 2024 will be another challenging year with a good outcome. The reason is that economic figures are starting to darken, and investors see this as a good sign. With easing inflation figures, central banks can react to weakening economies by loosening interest rates. The question will then be whether the central bankers respond soon enough or whether economies’ downturns will accelerate into a worse environment. Not often was it the case that central bankers could create a soft landing, but neither was it impossible.
Furthermore, many uncertainties could still affect the markets in 2024. The support of Ukraine is put more into question; the conflict in Gaza has the potential to escalate into a regional war, including not only the countries around Israel but also the US, which is already on the spot with their marine. The potential war emerging from China’s ambition to integrate Taiwan is still on the table. Furthermore, about 64 elections are coming up in 2024 around the globe (including Taiwan).
Amidst all these uncertainties, it is essential not to lose faith and get frustrated. The macroeconomic environment is one part to consider; however, no matter how bad things get, good companies are always worth an investment. Therefore, the uncertainty leading to volatility represents an opportunity to invest in such companies at reasonable prices.
How Fix is Fixed Income
When speaking about fixed income, people often mean bonds, debts given out by corporations and governments to finally pay back and, on the way, pay interest to the debt holders to compensate them for several risks and the lack of liquidity. However, why do these organizations take on credit from investors instead of banks? One reason is that it is cheaper than it would be with banks. With still higher interest rates and the potential that banks and investors will not be willing to reduce their requested compensation (interest) by the same pace as the central banks, the question will remain on how many companies can refinance their debt. We have bankruptcies increasing in 2023. Several articles from various news portals and government websites show the increase in bankruptcies on a broader scale. Accordingly, United States Courts published on October 26, 2023, that “bankruptcy filings are up 13 percent, and business bankruptcies rose nearly 30 percent, in the twelve months ending September 30, 2023.” Furthermore, they say, “This continues a moderate rebound after more than a decade of sharply dropping totals.” Expectations are that this increase in bankruptcies will continue to rise within 2024 with stricter credit terms.
Furthermore, we were just informed on Dec. 28 that US jobless claims rose again. What does that mean? After governments allowed their economies to reopen, a lack of products and employees boosted the inflation figures. Therefore, management stayed calm and tried to prevent employee losses during the last year. However, if consumer sentiment starts to drop and the products and services are not in demand anymore, at some time, the management has to decrease their workforce to reduce overhead costs. This is what starts to happen now. Suppose the workforce reduction needs to be improved to generate enough free cash flow to cover the remaining costs, including the interest payments of their outstanding debt. In that case, the issues will start to spread across the economies.
Accordingly, it is of the essence to make sure that whenever you add bonds to your portfolio, make sure that the cash flow not only covers the interest payments but also ensures the repayment of the so-called face value (this is the amount of debt initially taken on by the organization).
The Swiss Franc, the Place to be
We find ourselves in a very similar situation as was the case a year ago. The US dollar stayed relatively strong against the Swiss franc during the year to lose it all again. With clients that joined before the last quarter, we could benefit from this development. But what do we have to expect from the US dollar within 2024? The strength of the US dollar was not only against the Swiss Franc but also against the EUR, the GBP, AUD, and, first and foremost, the Japanese yen. However, with the chances rising that the Fed will be at the forefront of easing interest rates in 2024, the interest rate benefit will start to vanish. This will especially be the case with the Japanese yen, where the Bank of Japan (BoJ) is expected to leave behind the negative interest rate environment. Yes… You heard correctly. The BoJ still works with negative interest rates.
However, as mentioned above, the expectations are one thing, and the reality could be another. It would not surprise us if investors were too confident about a decrease in interest rates in the US. The Fed is expected to execute the first interest rate cut as early as March. However, if the Fed takes more time and starts cutting in June instead, markets would be negatively surprised, increasing the value of the USD.
Furthermore, especially with the latest volatility, the USD lost quite a bit, ending the year negative against most currencies (see graph above). This could again lead to a countermovement, resulting in a stronger USD. Such a countermovement would allow you and us to diversify into other currencies at more reasonable levels. The ongoing high volatility in the Forex market might trigger central banks to intervene to stabilize the exchange rates. Especially for the US as a net importer (the US imports more goods than it exports), a weak currency can easily lead to another boost in inflation since products in other currencies become more expensive.
The Golden 20ies
Over the last five years, gold and silver have performed about 60 percent and 57 percent, respectively. Also, this year, gold could satisfy investors with a performance of about 13 percent. Silver could have been more convincing, with a performance of about 1.4 percent. However, it is interesting to see that palladium, which was the star in 2021 and 2022, lost more than two-thirds of its height, about USD 3,000 an ounce. That shows the difference between value-focused, investment-focused, and industry-focused precious metals.
Additionally, platinum has not been able to break out upwards, either. With a recession in mind, platinum and palladium could take another hit before recovering. In the case of a soft landing and global economic growth, these two metals have quite some potential upwards. However, considering the cost of palladium over the last couple of years, we prefer platinum. On one side, it serves as a substitute for palladium in catalytic converters. Conversely, platinum is counted as one of the critical minerals needed for the green transition and energy independence.
For gold, we think prices below USD 1,900 per ounce are doable and offer an opportunity to buy. Currently, the risk of a setback is too high for us.
However, as we have seen over and over again, as well as mentioned, it is good to have expectations, but what the future will bring is not for us to know today. Therefore, I want to close this edition of the Swiss View in memory of Charlie Munger († November 28, 2023):
Acknowledging what you don’t know is the dawning of wisdom.