Alpinum Investment Management AG Q2 2024 Investment Letter

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“Muddling through”…..to be continued…..

The global financial markets continued their positive trend, carrying forward the momentum from the strong rally experienced in 2023. US large-cap growth stocks (+10.3%), notably in technology and communication services, maintained strong performance after leading the market in 2023 with over 40% gains. Optimism was fuelled by the US Federal Reserve’s signal of a shift towards monetary easing in response to disinflationary trends, enhancing financial conditions. Major economies, including the US, continued late-cycle expansion, with China easing policies to stimulate growth.

Chart 1: Softer economic growth, but no shock wave

Source: Alpinum Investment Management

Inflation, hovering around 3%, remained a focus, down from the 2022 peak of 9%. Concerns persisted about inflation exceeding the Fed’s 2% target without further economic deterioration. US consumers remained robust, supported by real wage gains and strong balance sheets. Business capital expenditures increased, indicating a potential recovery in productivity growth. Challenges surfaced, notably the market’s vulnerability to overly optimistic expectations of significant Fed rate cuts. Despite the Fed signalling a low urgency for rate cuts unless a recession occurred, the disparity between sentiment surveys, economic resilience, inflation trends and market expectations created complexity for investors.

United States

In Q1 2024, the financial landscape was characterized by a surge in market optimism, driving the S&P 500 to unprecedented heights, fuelled by expectations of a “soft landing”. This optimism was underpinned by a string of robust economic indicators, notably a strong February job report, which saw the addition of 275k jobs and maintained wage growth alongside a marginal increase of the unemployment rate to 3.9%. The fourth quarter GDP growth of 3.2% surpassed consensus expectations, further bolstering market sentiment. However, the market sentiment waned due to the Federal Reserve’s hawkish stance on interest rates during their January 31 meeting. The Fed’s resistance to dovish rate cut expectations, coupled with their explicit mention of an unlikely rate cut in March, unsettled risk markets and triggered a reversal in core government bonds.

Chart 2: Interest rates and equity multiples move in lockstep

Source: Alpinum Investment Management

Amidst this backdrop, earnings season provided a glimmer of positivity, with the majority of the “magnificent seven” companies reporting results that either met or exceeded expectations. This contributed to a notable 9.1% gain in the S&P 500 in Q1 2024. Economic resilience was further evidenced by the US composite PMI indicating continued expansion in February. However, the economic landscape in March presented a more mixed picture. While US Core PCE inflation met expectations with a 1.0% m/m increase in personal income, slowing nominal personal spending and persistent price pressures created uncertainty. The US ISM Manufacturing PMI disappointed, indicating challenges in domestic demand, while the ISM Services PMI suggested a slowing service sector. Despite a resilient job market, uncertainties loomed regarding the US election outcome and President Biden’s approval ratings, potentially impacting investor sentiment moving forward.

Europe

European markets experienced diverse performances. In January, the MSCI Europe ex-UK Index recorded a positive return of 2.1%, while the FTSE All-Share in the UK declined by 1.3%. The European Central Bank (‘ECB’) maintained rates during its January meeting and emphasized its commitment to data dependency. Positive signs emerged with the composite purchasing managers’ index (‘PMI’) reaching its highest level since July, suggesting potential bottoming out of activity in the manufacturing sector. However, concerns arose with the UK witnessing mixed economic indicators, including a sharp decline in retail sales despite an increase in consumer confidence. In February, European stock markets faced challenges, with MSCI Europe ex-UK rising 2.8% compared to 4.3% for the MSCI World Index. The UK continued to underperform, exacerbated by a fourth-quarter GDP print indicating a technical recession. Furthermore, earnings data from UK companies disappointed analysts, leading to downgraded profit growth estimates for 2024. Despite signs of resilience in wage growth, UK Gilts faced losses, and government bonds across the eurozone also experienced declines.

Chart 3: ECB implied policy rates (March ‘24 vs December ‘23)

Source: Alpinum Investment Management

The European Central Bank maintained a cautious stance, preferring to wait for further evidence of economic stabilization before considering rate cuts. Although signs of a slowdown in wage growth emerged, the ECB awaited confirmation through additional data, delaying potential policy adjustments until June. While Germany faced economic challenges amidst eurozone resilience, expectations of a potential rate cut by the ECB in June remained prevalent. The ECB’s decision-making would depend on evolving economic indicators, particularly wage growth trends, with June seen as a probable timeline for policy adjustments.

China and emerging markets (‘EM’)

In China, the domestic economy faced challenges with disappointing retail sales and further deterioration in housing activity. Despite fourth quarter GDP growth meeting expectations at 5.2% year-on-year, it remained historically weak. Although the People’s Bank of China (‘PBOC’) announced stimulus measures, they fell short of market expectations, contributing to the weak performance of the MSCI Asia ex-Japan Index and the MSCI Emerging Markets Index, which both declined by 5.5% and 4.7% respectively in January. Chinese policymakers surprised with a significant easing for the troubled property market, notably cutting the 5-year loan prime rate (‘LPR’) by 25bps to 3.95%. Deflationary pressures persisted in China’s economy, marked by declining producer and consumer prices, as well as falling house prices, which could overshadow the impact of policy easing on economic recovery.

Chart 4: 1-year spread of Japanese vs Chinese equities

Source: Alpinum Investment Management

China’s equity markets had hit five-year lows during the quarter. Still, activity data over the Lunar New Year holiday period showed improvement, and the Chinese government responded with supportive interventions, leading to an 11.8% gain in the MSCI China Index from its lowest point. Despite the policy-driven rebound in Chinese stocks, the macroeconomic backdrop remained challenging, suggesting limitations to further upside potential. Throughout the quarter, the Nikkei 225 Index in Japan displayed remarkable resilience, registering a notable surge of 21.8%, building upon its robust performance in the preceding year. Following its ascent to levels unseen in three decades, the Bank of Japan ended its negative interest rate policy in March, by increasing interest rates for the first time in 17 years, raising them by 10 basis points. This move shifted the range of the short-term policy rate above zero to 0.0-0.1%. This shift marks an exit from deflation, possibly revitalizing Japan’s economy.

Investment conclusions

We operate in an environment of low economic growth and high capital costs, but with no imminent recession. This is leading to greater dispersion between companies and sectors, while the path of least resistance for risky assets is still up. Structural inflation persists post-COVID, with cyclical inflation resurging alongside old disinflationary forces. While the US experiences low growth, the EU stagnates and China targets a 5% GDP. Despite geopolitical tensions, inflation, and conflicts, recession is averted. Interest rates normalize cautiously, with constructive credit exposure. Elevated equity multiples prompt value exploration beyond the US, warranting vigilance for potential economic shocks.

Chart 5: Attractive US bank loans yields (8-10%)

Source: Alpinum Investment Management

Bonds: Global monetary policy tightening has concluded, but banks’ credit restrictions pose challenges for corporations. Default rates rise, yet certain credit opportunities offer appealing pricing. We maintain a neutral stance on IG bonds, with a favourable outlook on US Treasuries. Overweight positions are favoured in Scandinavian short-term HY, European loans and structured credit. Duration remains neutral for portfolio diversification.

Equities: Equity valuations seem reasonable considering low rates and modest growth, but potential gains are constrained, especially for US stocks.

We maintain our positive bias towards risk assets overall. Specifically, we have slightly overweighted equity positions in our balanced portfolios. Regarding credit, we anticipate an uptick in default rates, leading to slightly elevated levels, while we view current credit spreads as reasonably valued in general.