A unique environment

• Markets are also looking ahead this year.

• In a soft landing, corporate profits come under much less pressure.

• Interest rate cuts, lower inflation and a growing global economy.

• The perfect environment for equities

• Corporate profits still rising.

• Accent on equities, at the expense of bonds

In financial markets, macroeconomic developments are often interrelated. As a result, the economic environment can quickly be identified with a typical scenario, such as a depression, recession or cyclical recovery. In the current market, however, there are so many extremes that do not fit together at all. For example, inflation is higher than it was in the early 1980s, which is when interest rates in the capital markets reached a historic peak. Today, despite high inflation, interest rates in capital markets are still historically low. This is not due to the efforts of central banks, because on the contrary, for the first time in 40 years, they have raised interest rates sharply in a short period of time. According to the market, that has already been more than enough, because the U.S. and German yield curves have not been as inverse as they are now in many decades. That is usually a good predictor of a recession, but just the most predicted recession ever is not coming for now. That's even though monetary tightening has already caused a banking crisis.

Given all these developments, it may be a miracle that stock markets are higher this year. However, markets do not discount the current environment, but mainly future developments. Current variables are especially apt to explain last year's stock price declines, but not this year's positive stock price development. Nevertheless, markets are also looking ahead this year, especially to developments in artificial intelligence. Apart from a few large tech companies, stock markets are not doing very well at all this year. Fortunately, there is increasing visibility of a uniquely positive scenario and that is the scenario of a soft landing of the economy. Never before in history has an economy made a soft landing from such a high level of inflation? A soft landing in this case means that central banks' inflation targets are met, without those same central banks having to push the economy into recession to do so. Now it seems that this has become the baseline scenario for both Europe and the United States.

A soft landing means that corporate profits come under much less pressure than in the case of a recession. Corporate profits have benefited greatly from rising inflation. Moreover, a successful soft landing means that central banks can now control inflation without triggering a recession. This will allow the risk premium associated with the development of inflation and the economic cycle to decrease markedly. Lower risk premiums mean higher valuations. That valuation can also go up if interest rates were to fall again, for example, because inflation targets have been reached.

After a soft landing, there will come a time when central bankers will cut interest rates. Probably the central banks of several emerging countries will cut interest rates even before the U.S. Federal Reserve. Those banks had started fighting inflation early and therefore can stop earlier. The Federal Reserve will probably pause for another year, then possibly cut interest rates early next year. The ECB will follow the Fed with some delay. The prospect of interest rate cuts, lower inflation and a still-growing global economy is very reminiscent of the scenario in the second half of the 1990s. Then, after a soft landing in 1995 - albeit from a much lower inflation level - a scenario often referred to today as the fairy tale of Goldilocks followed. In that fairy tale, everything was perfect, not too hot and not too cold, not too hard and not too soft. The world economy was navigating between the fire of inflation and the ice of deflation. This is the perfect environment for stocks because in such a scenario profits rise, but not interest rates. Further parallels can be drawn with the late 1990s. Then there were also several crises such as the Asia crisis and the Russia/LTCM crisis. Those kept central banks' policy interest rates low. This time, the banking crisis is easy to solve also a reduction in policy interest rates. In the late 1990s, the development of the (mobile) Internet created hype that sent stock prices soaring. This time, artificial intelligence is the big game-changer. The advantage of such predictions with an unknown but meaningful outcome in the distant future is that they excite the imagination of investors. In that respect, the risks are more on the upside.

The difference with the late 1990s is that the influence of Asian economies is much greater than it was then. For example, the Chinese economy grew fifteen-fold over that time, while the Italian economy, for example, did not grow over the same period. China is now by far the largest economy in the world on a purchasing power parity basis, and historically the Chinese stock market is cheap. The same goes for Japan where, after two lost decades and ten years of Abenomics, the stock market will be able to break through the highs of the late 1980s in the not-too-distant future. Whereas Asia was still causing instability in the second half of the 1990s, Asia now has a much more stabilizing role, helped in part by a delayed but steady reopening post-Corona.

Not surprisingly, a bad stock market year in 2022 was followed by a good stock market year in 2023. Corporate profits are still rising. Further increases in profits are also expected for this year and next. Ultimately, the stock market follows the underlying earnings trend. Nevertheless, many investors are extremely cautious and see many bears on the road. As a result, the soft landing scenario is hardly discounted in share prices. In this context, it is justified to focus on equities and invest in private markets at the expense of bonds in the portfolio.