Investing in the only constant: change
Take a closer look at themes or mega-trends that will shape our future world.
One basic rule of investing is to not attempt to buy oversold markets in a downtrend, and not to sell overbought markets in a primary bull cycle. We see no signals indicating a rising risk of recession in the US, and our hypothesis remains we are still in economic expansionary mode.
This suggests the current level of the S&P 500 index does not represent the peak of the bull cycle that began in October 2022. That said, a bull market needs to catch its breath from time to time to be sustainable, and we believe that a correction is not only likely at this point, but would in fact be healthy.
Ironically, in the absence of rising recession risks, the main risk factor markets face is an overly strong US economy. So far, positive macroeconomic surprises in the US have contributed to reducing expectations of interest rate cuts by the Federal Reserve. In this context, it is important to remember the reasons leading the Fed to cut rates matter more than the actual number of reductions.
Contrast this dynamic with the development last month when the People’s Bank of China cut its five-year benchmark rate by 25 basis points. China is in the midst of a private sector balance sheet recession, and lowering interest rates does not work in such circumstances.
Nevertheless, at current index levels, a tactical rebound in Chinese equities is possible and perhaps even likely despite that the fundamental economic problems are yet to be resolved. On this aspect, our view remains unchanged that the Chinese economy is in a prolonged stagnation phase before a sustainable recovery.
THEMATIC INVESTMENTS
Speaking of change, thematic investments have moved more into focus in recent years, establishing themselves as an independent investment strategy. They are often referred to as investments in mega-trends, which are demographic and economic structural developments, as well as social and technological ones that enduringly change the world around us.
Some of these trends start small and may eventually become so powerful they are neither stoppable nor reversible. Julius Baer Next Generation (NG) Research aims to translate these mega-trends into tangible investment themes, namely energy transition, feeding the world, digital disruption, shifting lifestyles, future cities, arising Asia, as well as inequality — all of which can be broken further into sub-themes.
In 2023, artificial intelligence (AI) dominated the headlines, not only in the news, but also in terms of investment performance.
Meanwhile, most other sub-themes struggled: genomics and digital health are still suffering from a post-pandemic hangover, while the fast-paced energy transition is counterintuitively causing more headwinds than tailwinds for the clean energy segment amid increasing competition in the industry.
This illustrates that thematic investing, despite its focus on long-term structural trends, is also exposed to short-term cyclical swings.
Beyond this current cyclical soft patch, we retain our convictions about the structural trends underpinning NG investment themes. Most valuation metrics are down into the bottom half of their multi-year ranges, and we believe 2024 should offer opportunities to lock in these attractive valuations in some of the most preferred themes:
■ Cloud computing and AI: The structural demand for AI solutions is stronger than ever and the cyclical backdrop is supportive as well, with demand outpacing supply. Valuations are appropriate, considering the theme’s superior growth outlook.
■ Future mobility: Competition among car companies has intensified and raw material costs have come down. Sentiment has deteriorated much more than justified amid still-sound growth in electric vehicle sales in the world’s key markets.
■ Future cities: Buildings in Europe are ageing rapidly, with 75% no longer energy-efficient. We see a sound fundamental backdrop for the building technology and efficiency segment.
■ Extended longevity: The ageing population presents investment opportunities related to the rise of chronic diseases and changing consumer preferences for improving one’s longevity and healthspan.
More recently, we upgraded the automation and robotics sub-theme within digital disruption as we see the start of a new manufacturing cycle on the horizon.
ECONOMIC INDICATORS
On the economic front, the Japan Machine Tool Orders Index, a key leading indicator, troughed in the fourth quarter of 2023 and is now improving, with momentum in positive territory.
This is an important signal for the manufacturing sector, as the Japanese index is well-correlated with global industrial production.
Other leading indicators including manufacturing purchasing managers indices (PMI), new orders, and the Fed’s business outlook and forecasts for capital expenditure all confirming we have passed the trough of the cycle.
That said, the improved outlook is not without uncertainties, and we see risks in relation to China, where demand remains weak, competition is high, and certain manufacturing segments look oversupplied.
In our opinion, the recovery is bound to be backloaded and might start in the second half of 2024.
As the stock market tends to price in changes to the economic environment well in advance, we believe the time to invest is now rather than later, and recommend investors build positions through thematic indices, exchange-traded funds or direct stock ownership.
Keep in mind that thematic investing, despite its focus on long-term structural trends, is also exposed to short-term cyclical swings.