For this final update of the year, we take a look at the risks from a global macro perspective, a more detailed evaluation at the currency and equity situation in Asia, and finish with some thoughts on possible entry points for self-made and serious equity investors.
Risks and caution in 2024
Will 2024 offer a favorable environment for risky assets?
For Oaktree, the environment may continue to be very different from what it was, and a return to a pre-pandemic world with interest rates close to zero is unlikely. DBS, for its part, believes that US rates will peak as economic data on growth and inflation point to a slowdown. This lowering of interest rates could encourage investment in equities despite high prices, following the disappointment caused by the declines in 2022, and then a widespread recovery in 2023.
It is of course tempting to assume that 2024 will be a more favorable year for risk assets, and a soft landing for the US economy remains the base scenario, given the absence of structural imbalances (at household and corporate level, but not at state level). Historically (1989, 2000 and 2007), however, major monetary easing cycles have heralded recessions. Even a “soft landing” will not prevent risky assets from experiencing substantial volatility. Other fundamental elements need to be taken into account when assessing investment risks in 2024:
- The yield gap, which is the difference between the earnings yield on equities and the yield on 10-year US Treasury bonds, turned negative in October 2023, according to bank research. This means that one is no longer directly remunerated for taking a risk on equities (as opposed to holding bonds). However, investors are still willing to accept such a low return on risk, probably due to the historical attractiveness of US equities, which is unlikely to be repeated.
- Asian currencies could start 2024 with some volatility, as China doubles down on its threats ahead of Taiwan’s presidential and parliamentary elections in January. In China, after three years of deleveraging, a slight rebound is on the horizon for the Chinese real estate sector, but not yet normalization. Unfinished houses, local government debts and geopolitical risks are still risks.
More anecdotally, we note:
- Oaktree reports that a large number of real estate debts will mature between 2024 and 2025 in Europe, and that refinancing difficulties could offer attractive investment opportunities for outside buyers.
- Investors such as Jim Rogers see very limited returns in most asset classes. We suggest avoiding too much gold and commodities for their lack of coupon or dividend payout.
- Some observers even see a risk of global war, where Latin America would seem less exposed and an option in the event of conflict spreading, as Marc Faber advocates. However, the probability seems low, and Latin America is covered by the EM index, even if only by a small proportion.
Equity markets in consideration of currencies for 2024 in Asia
Banking turmoil on both sides of the Atlantic, combined with market volatility, has apparently shifted the center of gravity of global wealth to Asia.
Compared with the recent high returns on US equities (particularly in the technology sector), the performance of Japan and non-Japan Asia has been mediocre, in particular due to the weakness of foreign exchange markets, notably China and, to a lesser extent, South-East Asia.
Investors largely took on board the negative developments concerning China, as evidenced by downgraded valuations and signs of a rebound thanks to measures announced by the government to solve domestic problems. Thus, the strong underperformance of Chinese equities relative to global equities and emerging market equities should reverse for the following reasons:
- Valuation: Chinese equities currently trade at a price/earnings ratio of 1.2, which represents a sharp discount to global and emerging equities, which trade at 2.7 and 1.7 respectively.
- Earnings: Chinese companies are expected to deliver attractive forward earnings growth of 15% in 2024.
- The peak of US rates
CNY depreciation pressures are also likely to reverse, as markets come to accept the PBOC’s desire to stabilize the CNY.
For Japan, in the longer term, the question arises as to the country’s ability to meet expectations related to automation and AI and overcome its lost decades. The yen should eventually recover from the extreme weakness of 2023, as we expect yield differentials between the US and Japan to narrow in 2024.
Compared to their global counterparts, Asia ex-Japan companies should record more attractive earnings growth, in excess of 20% and 15% in 2024 and 2025 respectively. This is a clear turnaround from the previous year, and a factor enabling the Asia ex-Japan to reverse the mediocre results recorded over the past two years.
Overall, the confluence of low valuations, record high US interest rates and double-digit earnings growth bodes well for Asia ex-Japan. In 2024, growth should be stable across the region, with policy tightening in China and a reduction in the discount of Asia ex-Japan equities to global equities.
Practical options based on expectations and valuation of equities and currencies
The lower price/earnings ratio and higher expected growth, particularly for earnings, despite higher political risk, argue in favor of investing in Asia over the next quarter, despite low international investor confidence in the region. The overvalued Swiss franc, low currency valuations and limited upside in Japan and Asia ex-Japan could provide a good entry point. For the latter, EM ETFs from Vanguard (with a higher allocation to Chinese equities) and iShares may be an acceptable substitute at a reasonable cost to avoid a proliferation of different ETFs.
Sources:
- Oaktree, The Roundup: Top Takeaways from Oaktree’s Quarterly Letters, December 2023 Edition, 14.12.2023
- DBS, CIO Insights 1Q24: Shifting Currents
- Q4 2023 interviews by M. Faber, J. Rogers
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