What can we (and others) reliably predict for the coming year and what not?

Just in time for the Christmas season, numerous capital market outlooks for the year 2024 are being published. Unfortunately, many of the forecasts they contain only have a probability of occurrence corresponding to chance. We would like to show you which types of forecasts should be ignored and which can provide useful indications for the next 12 months.

An annual outlook usually begins with a forecast of economic development. As early as 1969, the Philadelphia branch of the US Federal Reserve began compiling the economic forecasts of economic researchers from universities, banks and other financial service providers and compiling them into a time series. Chart 1 shows the probability of a recession in the following 4 quarters as indicated by the forecasters. This has been particularly high since the 3rd quarter of 2022. For the 3rd quarter of 2022, we can already state that no recession has occurred (chart 2, point Sep. 2022), as in the other 10 cases of a particularly high recession probability (blue points to the right of the vertical red line). There is no correlation between the predicted probability of a recession occurring and its actual occurrence, as shown by the figure R² = 0.0178, which is close to zero. A useful correlation would only exist for values of 0.5 to 1, the maximum possible value.

The equity strategists, whose forecasts for the next year's share price performance have been determined by financial data provider Bloomberg in December of the previous year since 1999, are presumably still impressed by economic forecasts. When the economic forecasts in the fourth quarter of 2022 were more pessimistic than ever before (chart 1), the equity professionals predicted a negative performance of the US S&P 500 share index for the first time since 1999 (chart 3). Those who followed this forecast had to forego gains of over 20% (green bar in chart 3). Stock forecasts for one year work just as poorly as economic forecasts; the R² value for these is 0.004 (chart 4), which is also very close to zero.

Equity strategists' current forecasts for the S&P 500 for 2024 are again very cautious at +2.4%. You should not take these forecasts too seriously.

Even if economic researchers are unsuccessful with their forecasts, it is still worth asking why they have been conspicuously pessimistic for some time now, as they are not just reading coffee grounds, but look at a wide range of data to make their forecasts. Clear recession signals for the US economy come from the inverse yield curve, which has only sent a false signal once since 1953, namely in the mid-1960s (chart 5). Otherwise, all 10 US recessions since 1953 have been correctly predicted by this forecasting model. An inverse interest rate structure exists when short-term interest rates (here: the yield on 1-year government bonds) are higher than long-term interest rates (here: the yield on 10-year government bonds). It arises as a result of the central bank increasing short-term interest rates in order to cool down the economy and reduce the risk of inflation. This is because banks are reluctant to grant loans at high short-term interest rates, which lead to an inverse interest rate structure before recessions (chart 6), for which they only receive the comparatively low longer-term interest rates. In addition, banks know that an inverse interest rate structure increases the risk of recession and thus the threat of loan defaults. In fact, the volume of lending in the USA is already falling slightly (orange line in chart 6).

In the last 70 years, the unemployment rate has indicated US recessions with even greater reliability - there has not been a single false signal - when it has risen by more than 8% compared to the average of the last 12 monthly values, as in October 2023 (chart 7). US purchasing managers are also pessimistic (chart 8).

We can also look at the growth rate of the M2 money supply, which fell by 6% from its peak in April 2022 to October 2023. Previously, a decline in the US M2 money supply has only occurred four times since 1920: -8.3% in 1920-21, -35.8% in 1929-33, -2.5% in 1937-38 and -1% in 1948-49 - each time followed by a severe recession (source: Prof. Steve Hanke, Johns Hopkins University, in: The Macro Strategy Partners, 19.12.2023). The eurozone is also on the brink of a recession (chart 9), triggered by a sharp contraction in the money supply.

Foreign direct investment in China has also collapsed - it was negative for the first time in the third quarter of 2023 (chart 10). As a result, foreigners are no longer positive about the business prospects of the Chinese economy (for China's future problems, see the capital market outlooks of November 2021, which you can find here, and September 2022, which you can find here ). China will hardly be able to support either the American or the European economy.

It follows from the above that the US economy should have long been in the recession that economic researchers have been expecting since the late summer of 2022. However, they have probably not sufficiently taken the following factor into account. The US government has taken on USD 2,509 billion in new debt so far in 2023 and pumped the money into the economy. (Source: US central bank (St Louis Fed), Dec. 2023, U.S. National Debt Clock: Real Time (usdebtclock.org), 19.12.2023). This is likely to be close to the 5-year average of annual new debt as a percentage of national income, which is still 9% p.a., while the eurozone only allowed itself an average of 3% p.a. in the same period (chart 11).

Our interim conclusion on the economic outlook for 2024 assumes that the US government will not be able to maintain this massive debt policy for much longer and that a new government, which will be elected on November 5, 2024, will have to become more frugal and thus trigger the long-overdue recession. Economic researchers are therefore likely to be confirmed in their consistent pessimism this time. Hopes of a "soft landing" are misplaced, if only because the US central bank has always triggered a recession with the inverse interest rate structure it created in the mid-1960s, with just one exception (chart 5). This immediately forced the central bank to reverse course - interest rates had to be cut sharply (charts 12, 13).

These reductions in money market interest rates are already expected on the capital market. Chart 14 shows that the yield on 2-year US government bonds has already fallen significantly for many years, several months before a downward turn in money market interest rates (red circles in chart 14). One possible reason for this is that the leading indicator for the US inflation rate pointing far into the future, the change in the money supply (chart 15), indicates a further significant fall in inflation.

It looks the same in the eurozone. First the yield on 2-year German government bonds falls at the end of a prolonged upward trend in money market rates and then the ECB begins to cut interest rates (chart 16). The justification for a turnaround in interest rates in the eurozone will come from the inflation rate, which had been driven up by rising energy prices and is now being pushed down again by their sharp decline (chart 17).

In our capital market outlook from October 2023, which you can find here, we correctly predicted the fall in long-term interest rates and the rise in share prices that has occurred in recent weeks (see charts 18 and 19). All major stock markets have been heavily dependent on interest rate movements again for several years. Falling interest rates drive share prices upwards and vice versa. The exception is the rise in US share prices from May to July 2023, which took place against the backdrop of rising interest rates.  

Investors suddenly became enthusiastic about the potential impact of artificial intelligence on the profits of large technology companies (AI bubble in chart 18). As a result, the US stock market has been driven into a strong overvaluation (chart 20, red circle) and earnings expectations have fallen to 0% p.a. by 2033 (chart 21).

This overvaluation is not only important for long-term earnings expectations. If only a single stock market is heavily overvalued, e.g. the USA in Dec. 2021, Japan in Dec. 1989 (chart 22), Switzerland in Feb. 1998 or the UK in Sept. 1987, this overvaluation is reduced by rapid, sharp price falls (chart 23). At present, only US equities are too expensive. If, on the other hand, all stock markets are overpriced at the same time, as for example in the 3 months from December 1999 to March 2000, a phase of high losses lasting several years followed (chart 23).

Chart 24 shows that the valuation of US equities is only 18% lower than in December 1999, while Swiss equities (chart 25), which are significantly better in terms of earnings performance, are 44% cheaper and German equities are even 60% cheaper than at the turn of the millennium, although their earnings performance since the end of 1999 has hardly been worse than that of US companies (chart 25).

Compared with the current yields on 10-year government bonds (blue bars in chart 26), the expected return on equities for the next 10 years is only lower than that of bonds in the USA at 0% p.a.; in all other equity markets, the reverse is true - equities have a high annual risk premium of at least 6% p.a. (gray bars in chart 26).

In December 1999, the conditions prevailing on all equity markets were the same as in the USA today: Government bonds had (mostly significantly) higher expected returns than government bonds (chart 27, gray bars pointing downwards). In 2009, most equity markets had indeed suffered heavy losses, with only Swiss equities performing slightly positively, which was also in line with the forecast (chart 28).

To summarize, we can make the following statements about the prospects for the stock markets in 2024:

• US equities are very unattractive both in comparison to the other equity markets of the industrialized countries and in comparison to US government bonds. US equities are also currently very expensive compared to their valuation over the last 50 years
• All other equity markets are very attractive compared to the respective government bonds and have normal or low valuations relative to their own history
• The probability of a "soft landing" for the US economy is low following the sharp interest rate hikes by the US central bank because, with one exception, sharp interest rate hikes in the US have always led to a recession
• The US economy also faces a high risk that the enormous government deficits of recent years will be reduced next year or the year after next at the latest. This entails a high risk of recession
• In a recession, which is also likely to occur in a moderate form in Europe, interest rates will fall more sharply than is currently expected. However, as all equity markets have been moving in the opposite direction to interest rate changes for several years, interest rate cuts are a considerable support for all equity markets, especially the attractively valued markets outside the US. This could even be sufficient for a positive performance of US equities until the end of 2024. Interest rate cuts plus attractive valuations should ensure another positive performance in all other equity markets

We expect the following for the other asset classes:

• In principle, the same applies to private equity as to equities. The prospects for private equity in the US are significantly better than for the US equity market because US private equity funds often have a significant focus on stable growth companies in the healthcare or consumer sectors. These are sectors in which US equities are not overpriced either. In addition, the performance of private equity funds is significantly better than that of equities in times of falling share prices (charts 29, 30)

• Gold will benefit from interest rate cuts, as this reduces the disadvantage of gold not generating interest income
• Residential real estate in Germany is benefiting from the mortgage rate cuts of around 100 basis points that have already occurred in recent weeks. Added to this is the decline in new construction activity and the high level of immigration as well as significantly rising real wages in Germany
• Bonds have become much less attractive in recent weeks as yields have fallen by over 100 basis points

You can also download the capital market outlook here.