After a terrible year on the capital markets in 2022, in which even bonds suffered price losses hand in hand with equities, 2023 saw a brilliant upturn. On the one hand, falling inflation reduced expectations of an even longer-lasting phase of high interest rates and raised hopes that central banks would soon start cutting interest rates. Secondly, the economy proved to be more robust than feared at the beginning of the previous year. All of this was recognised by a number of major stock market indices at the end of 2023 with annual or all-time highs. But can things continue in this vein?
In the first half of the year in particular, the market's expectations regarding interest rate cuts will probably continue to set the tone. With inflation rates falling faster than expected in many cases, market participants were quick to speculate that the central banks' "higher-for-longer" narrative would soon come to an end - which has led to the market pricing in interest rate cuts of around 150 basis points for the US and the eurozone over the course of 2024. We believe that this is too aggressive. We are currently only expecting key interest rate cuts totalling 75 basis points from the Fed and 50 basis points from the ECB in 2024, which will also start later than the market is anticipating. Nevertheless, we believe that the changed interest rate environment will have a positive overall impact on the equity markets. Six months ago, people were still talking about possible further interest rate hikes, but now discussions about the timing and extent of interest rate cuts are setting the pace.
Corporate earnings expectations are an equally supportive factor. After three consecutive years of record profits, the current consensus view is that corporate profits in the S&P 500 are likely to rise by just under 11% this year, while those of the Euro STOXX 50 are expected to increase by a good 3%. The expected dividend yields look even more favourable, at well over 3% in some of the most important European indices and even over 5% in the ATX.
Given the high index levels and the overall very good earnings situation, the question of valuation levels naturally arises. A clear distinction must be made here between the USA and Europe. For example, the expected price/earnings ratio of the S&P 500 for 2024 as a whole is currently 20 and therefore significantly above the long-term average of 15. In Europe, the DAX, for example, is significantly more favourable with a P/E ratio of around 11.5. Moreover, the valuation of the DAX is currently even below its own long-term average of 13. However, we do not see this factor as a strong support factor for the European markets, but merely as an opportunity for valuation growth. In the USA, on the other hand, we see a certain upside cap for the broad market due to the relatively high valuations. The bond markets also continue to have a "burdening" effect, as their relatively high yields - around 4% for 10-year US government bonds, for example - are once again competing with the equity market in terms of relative attractiveness, which we have not seen for a long time.
Overall, however, we remain clearly optimistic in our assessment of the future development of the equity markets. The soft landing scenario, which is increasingly materialising in the US in particular, interest rate cuts that will begin sooner or later and solid earnings growth at an aggregate level should provide the indices with a foundation for further rises at the end of the year. In the short term, however, there are still various risks, such as one or two disappointing economic data points or the need for a further normalisation of (overly) overheated interest rate cut fantasies in the market, which could weigh on global equity indices in the meantime. We expect above-average potential for the ATX in the current year. This results on the one hand from the sector composition, which has a high weighting of energy stocks in the ATX, which should benefit from the higher oil prices we expect, and on the other hand from a favourable valuation, which includes the opportunity for valuation increases.
Author:
Helge Rechberger
Senior Equity Market Analyst
Raiffeisen Research / Raiffeisen Bank International
11 January 2024
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Note
Wiener Börse AG would explicitly like to point out that the data and calculations given in this report are historic values, which do not permit any conclusions as regards future developments or value stability. Price fluctuations and loss of capital are possible in securities trading. The contribution is the personal opinion of the analyst and does not constitute a financial analysis or a recommendation for investment by the exchange operating company, Wiener Börse AG.