Letter to Investors
Christian Nolting, the Global CIO, notes that markets remain focused on monetary policy. The dominant view is that central banks are close to peaking in their tightening cycles, which will allow a policy pivot. However, inflation remains uncomfortably high in many economies and fears of potential stagflation persist.
Nolting believes expectations of an imminent sharp change in economic or policy direction are misplaced. Central banks will be cautious even if tightening peaks, as still buoyant labor markets and lingering inflation make steering economies to a soft landing difficult. China is trying to engineer a recovery in growth.
Monetary policy actions will not be perfectly synchronized. The US is still on track for gradual rate cuts in 2024, while the ECB’s last hike was likely in September 2022 although rate cuts may be delayed in Europe due to sticky core inflation. Japan could see small hikes in 2023 to return rates to positive territory.
Portfolio management will require subtle changes rather than dramatic shifts. Fixed income yields are unlikely to slide much given inflation pressures, while credit spreads should not widen sharply given solid corporate fundamentals. Equities should also ride out slowdowns reasonably well as earnings resume growing.
Nolting remains confident central banks can manage ongoing policy realignments. The base case is a soft recession/anaemic growth followed by a moderate recovery in developed markets, and an eventual modest recovery in China from Q4 2023. Against this backdrop, investment strategy will require careful management.
Risks to Monitor
Geopolitical risks include additional US restrictions on China and the Middle East for semiconductors that hurt Western exporters. China may circumvent some sanctions due to domestic chip advances.
The expanded BRICS grouping will boost the political and trading clout of emerging markets. Upcoming Taiwanese elections could impact US-China-Taiwan relations.
Ending the Russia-Ukraine grain export deal and India restricting rice exports are driving up food prices exacerbated by climate events. Droughts are curtailing hydro power and boosting fossil fuel consumption. OPEC+ output cuts also raise energy prices.
Central bank tightening is slowing growth in some developed economies. Sticky core inflation may keep rates higher for longer. Asian and European corporate default rates increased and may climb further as refinancing conditions deteriorate.
US Treasury supply dynamics could add volatility as the composition of debt issuance changes. Idiosyncratic fiscal risks threaten some emerging market sovereigns.
Macroeconomic and Asset Class Update
Macroeconomic forecasts show growth slowing in 2023 before a moderate rebound in 2024. Inflation should also moderate but remain above targets. Central banks are still dealing with sticky inflation and a weak global economy, keeping rates higher for longer.
Government bond yields are expected to change modestly. US Treasuries may hold near current levels as the economy recovers. The Bund yield curve may normalize as the ECB remains hawkish on inflation. Italian spreads could widen on budget risks.
Corporate credit fundamentals remain sound despite economic deceleration, supporting modest spread tightening for investment grade bonds. High yield default rates may rise from low pandemic levels but not sharply given strong fundamentals. Emerging market credit spreads may trade sideways.
Developed market equities should ride out slowdowns as earnings resume growing, led by technology. Limited upside is expected for overvalued US stocks. Modest European gains could see valuation discounts shrink. Japanese stocks have further upside due to nominal growth and cash holdings.
Emerging markets underperformed in 2023 but some economies like Mexico posted strong gains. Sentiment in Chinese stocks depressed amid stalled recovery hopes. EM Asia ex-China may outperform on dynamic growth. Latam looks attractive on valuation and dividends.
Commodity prices face uncertainty from global growth. Oil and energy prices rose on OPEC+ cuts and supply concerns entering northern winter. Copper may receive support from electric vehicles and renewables. Gold demand may rise from recession risk hedging.
Currencies could see the EUR pare losses versus the USD as growth dynamics change. The JPY and GBP may gain against the USD on improved outlooks for Japan and UK. The CNY could strengthen slightly on stimulus hopes.
Real estate avoided major headwinds in most regions and segments. Prices may have bottomed as hiking cycles end and economies avoid severe recessions. Residential and logistics properties remain top picks. Retail should outperform offices but lag residential and industrial. China’s recovery stalled housing sector recovery hopes.
Update on Long-Term Investment Themes
The report discusses three long-term themes: resource transition to properly manage global resources and reduce consumption/encourage recycling; population support to provide for a growing population; and next-phase technology to develop key technologies helping address the first two challenges.
Specific areas discussed include land resources like minerals, agriculture and water; the energy transition involving renewable energy sources, electrification, and potential new sources like green hydrogen; the blue economy focusing on ocean sustainability; infrastructure now encompassing social equity and the green transition; artificial intelligence and its potential impacts; smart mobility and more efficient transportation solutions; the economic power of millennials and Gen Z; cybersecurity risks from geopolitical tensions and AI; healthcare/medtech advances from technology and scientific breakthroughs.
The report includes tables forecasting macroeconomic indicators, bond yields and spreads, equity indexes, commodities, and currencies through September 2024 based on Deutsche Bank’s base case views. Forecasts show modest economic growth recovery, inflation moderating but remaining above targets, bond yields changing modestly, credit spreads tightening, developed market equities gaining around 10%, emerging markets outperforming, and commodities like oil and gold supported by supply factors.
In summary, the report discusses ongoing monetary policy realignments and expectations for a soft economic landing. Central banks are seen keeping rates higher for longer given sticky inflation. Portfolios will require careful management through expected subtle rather than dramatic changes in investment conditions. Long-term structural trends around resource management, population support and new technologies also warrant ongoing attention from investors.