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perspectives 04/2024

Article written on 7 October 2024

by Luca Carrozzo

Imagine the following scenario: the top decision makers at a central bank are sitting around the boardroom table in their suits wondering whether to press the magic interest rate button to stimulate the economy. The question they are asking themselves is something like this: “Should we be giving the economy a cup of regular coffee, or does it need a double espresso?” And when benchmark interest rates come down, hopes rise that companies and consumers will soon be spending happily once again and gross domestic product will go up.

But while the central bank is still reaching for its old familiar tools, in the corner lurks a silent helper with an entirely new form of magic: artificial intelligence (AI). These machines don’t need caffeine, work tirelessly and may soon see to it that companies and the economy enjoy the support of data-driven intelligence as well as cuts in interest rates. The trend towards digital is unambiguous: in 1985 an S&P500 company needed eight employees to generate sales of one million dollars, but today it can hit the same level with just two. AI is clearly going to help our economy overcome the current unfavourable demographic trends.

The idea that AI and business will be working hand in hand in future may completely change how monetary policy decisions are taken. Maybe one day robots will chair central banks and drive monetary policy – we don’t know. But until that time, we human investors have the thrilling task of enjoying rate cuts, being invested the right way and hoping at the same time that the economy finds its way back onto the growth track.

Our readers have no need to worry, though; human intelligence will still be able to justify its existence, even in an increasingly digitalised world. So the way the economy performs in future is likely to be a wonderful mixture of human chaos and (hopefully) a good dash of humour.

Luca Carrozzo

CIO

Economic prospects

The economy performed well in the second quarter, growing by 0.5% after adjusting for sporting events. This was supported by chemical and pharmaceutical exports, but the rest of the industrial sector was weak. Internal demand was modest but steady. At the global level, the economy began to pick up speed recently. The eurozone was at the opposite end of the spectrum with a slightly declining trend which, taken together with the appreciating franc, looks set to dampen Swiss exports. Gross domestic product is forecast to remain below average this year at 1.2% and to be 1.6% next year.

Monetary policy will have to remain sensitive

Inflation in Switzerland has fallen more sharply than expected recently. Because it is also declining in Switzerland’s key trading partners, however, they are importing less. The renewed appreciation of the franc is also helping to keep a lid on inflation. The entire Swiss yield curve has moved down this year. Further rises in the reference interest rate for mortgages are therefore unlikely, so the greater impact rents have been having on the consumer price index in the recent past should prove a temporary effect. Average inflation is expected to be 1.1% this year, and to fall again in 2025. Domestic electricity prices will decline by an average of 10% over the coming year and the historically strong Swiss franc may mean the SNB has to face the challenge of steeper falls in inflation than desired despite the rate cuts already seen.

Markets

All systems go for the stock market

After consolidating in the third quarter, there are now promising signs that equity markets will enjoy a year-end rally in the final quarter. Rates will come down further in Europe and the USA, the weak economy will at least stabilise, the uncertainty concerning the US presidential election will be over and corporate earnings will be rising once more. All this will push up equity prices. Investors should therefore exploit any weakness to add to their quality holdings: it’s all systems go for the stock market

Swiss equities

The overall Swiss equity market as measured by the SPI was almost unchanged over the third quarter, but there were some hefty swings at the level of individual stocks. Nestlé lost around 8% on weak half-year figures, preventing a better overall performance. Market sentiment on the two index heavyweights Roche and Nestlé is far too negative, so there is considerable upside potential. Among blue chips, we also like Partners Group; preferred second-liners include Bachem, Adecco and Georg Fischer.

European equities

The ECB cut rates by 0.25% but did not provide any outlook on where they will go from here. We expect money to flow into equity markets and positive market performance in anticipation of further rate cuts over the coming months. Our focus is on cyclicals, interest rate-sensitive stocks and quality companies. Paying attention to sector and country-specific risk is important when investing in Europe. We recommend Allianz, ASML and Schneider Electric. (wan)

US equities

Fed rate cuts are driving the US equity market to new record highs. They will continue to be a factor over the months ahead too. The members of the Federal Open Markets Committee, which decides on interest rate policy, expect the rate to be 3.4% by the end of 2025, implying a further five or six reductions. There is also the US presidential election, which has been supportive for markets in the past. We expect markets to go up and are recommending Salesforce, Nike and Microsoft. (amm)

Bonds

Bond markets rose significantly in the third quarter as inflation headed down and raised the prospect of further rate cuts by the central banks. The US Federal Reserve changed direction in the third quarter. There was some movement in credit risk spreads in early August on economic concerns, but they remain at a moderate level by historical standards. In the current environment, given that yield curves are still flat and in some cases even still inverted, we feel solid borrowers in the 1-5 year range continue to offer the most attractive risk/reward profile. (muc)