Dear investors,
Autumn is often a time of rising markets. The last few months have demonstrated this. October and November enabled portfolios to realise their potential in small and medium-sized companies and digital currencies.
The markets are correcting their excess downside, whether in the SME segment, interest rates, digital currencies or the dollar.
As mentioned in previous reports, current positions are in line with this general recovery. Patience since last summer has paid off, obviously by betting on a Republican victory in the US elections.
December corrected some of the upside. Some traders preferred to take profits and liquidate their positions. This end-of-year phenomenon is not uncommon. It often lends strength to a market recovery in January. So I remain positive for the first quarter of 2025.
How the markets see the US elections
The Republican victory has generated a wave of optimism and hope in several areas. The most important are:
1. Lower taxes for businesses
2. Growing political influence for a faster cut in key interest rates
3. Revitalising the US economy through a protectionist policy (higher tariffs)
4. Financial and regulatory stimulus for new technologies and digital currencies
5. A reduction in geopolitical tensions in the Middle East and Ukraine.
Clearly, a full Republican victory (in the Senate, the House of Representatives and the White House) is creating high expectations, and subsequent disappointments over the measures taken could have a negative impact on the markets. We are, however, in a phase of positive expectations during this first quarter.
The small and medium-sized business segment
Against this optimistic backdrop, there are some figures worth considering. In particular, the value of large-cap markets. The risk premium on large caps is falling steadily relative to long-term US yields. Having peaked at 9% in recent years, it is now close to 3%. Large companies are therefore less attractive today than in the past. Market participants are well aware of this. Taking refuge in smaller caps has therefore become a way for fund managers and financial asset managers in general to create the next generation of returns over the coming months.
Some statistics from the distant past (1957) show that when key interest rates start to fall, the small and medium-sized companies segment rises by an average of 30% in the year that follows and outperforms large caps. Another statistic has shown since 1982 that when SMEs underperform large caps over a 3-year period, the latter catch up in 99% of cases over the next 3 years.
Major financial groups such as BlackRock, Vanguard, Goldman Sachs and others estimate that S&P500 companies (large caps) will only offer an average return of 4% over the next 10 years.Based on these considerations, it is therefore advisable to maintain current positions in portfolios.
US debt and long-term interest rates, the problem of financing the deficit
Long-term interest rates in the USA have been rising since September. Some are of the opinion that the causes lie in the fact that inflation will persist, while others point to the problem of financing the budget deficit and the increase in government debt.
I'm leaning more towards the latter. Indeed, the latest bond auctions by the US government have been badly received by investors, who are demanding higher yields.
The US federal government is well aware of the risks involved in increasing its debt to the financial markets. This is a ‘taboo’ subject, where any media blunder could cause panic and worsen the situation through a self-destructive effect.
The ‘non-media’ solution, once again, is the ‘monetarisation of the debt’, i.e. the repayment of loans by issuing new money printed by the State (the Central Bank). This solution is a programmed devaluation of the currency, i.e. the dollar, by dilution.
Another ‘unmentionable’ solution is emerging and is being advocated by certain politicians, namely the creation of monetary reserves in digital currency, in this case Bitcoin. This will require legislative changes within monetary institutions. The scarcity of BTC could lead to a significant increase in its value against the dollar. This would help to balance government finances.
That said, the increase in US debt should be taken seriously and could disrupt the markets if long-term rates were to rise further.
In Europe, the problem is similar, particularly in France, where we are seeing political problems with the Prime Minister's proposed budget. We also see a negative return of -1% for 2024 for euro-denominated sovereign debt over the medium term (8 years).
Digital currencies
The crypto market continues to grow and to be increasingly adopted by institutional investors. ETFs launched at the beginning of 2024 have reached USD 49 billion under management. This is a one-year record for the US stock market. Since then, other ETFs have been floated on other cryptocurrencies such as Ethereum. The US elections have provided a positive boost, because until now the powers that be have sought to contain the development of digital currencies by putting the brakes on certain companies through legal complaints and fines. The Republicans seem to be moving in the opposite direction. The blockchain economy and the various digital currency protocols could be promoted in order to further develop the crypto economy on American soil.
There is talk of governments creating Bitcoin reserves. To date, some small countries have decided to create reserves at national level. If the US were to pass legislation along these lines, it would create a major wave of adoption around the globe. BTC is limited in terms of supply, so any significant positive news can create a bullish panic.
Some of the ALTCOINS (all cryptocurrencies other than BTC) showed significant increases over the last quarter. The most sought-after ones feature innovative and economically profitable protocols.
In terms of cycles, while the crypto market is volatile and can correct significantly, the upward cycle is not over. It is highly likely that 2025 will be a year of strong rises. It is therefore worth maintaining current positions in digital currencies in your portfolios.
Conclusion
The risks remain linked to debt, which could lead to a rise in long-term interest rates in the USA. As for inflation, China is in deflation, Europe and Switzerland are showing signs of economic weakness and consumer prices are falling. That leaves the USA, which is showing a cautious approach to inflation that seems to me to be overdone. US interest rates are set to fall over the next few months. If we consider the annual cost of debt alone, which is approaching USD 1,000 billion, rates that are too high are therefore unsustainable in the longer term.
As far as SME equities are concerned, certain segments such as renewable energy and new technologies should perform positively in 2025. Stocks in portfolios that have fallen significantly due to rising interest rates since 2021 should recover their price declines during the course of this year.
Digital currencies continue to enjoy growing adoption, both through products such as ETFs and thanks to a more favourable political and monetary climate.
I wish you all a happy new year.
Yours sincerely
Steve Dubied,
Financial Analyst
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