Macroeconomy
Recent business surveys suggest that the slump in global manufacturing might be bottoming out, although the figures remain more robust for emerging economies than for advanced ones. However, the vulnerability of some supply chains means the improvements need to be confirmed. Data released so far this year in the US have been generally more robust than expected, meaning our 0.8% growth forecast for this year faces upside risk. But with growth, labour market gains and inflation all set to slow, we expect the Fed to lower the fed funds rate by a total of 125 bps this year, starting in June. The European economy remains sluggish, especially the big German economy. Our baseline scenario is for the ECB to start its rate-cutting campaign in June, although there is a risk that easing comes earlier. With manufacturing also feeble in Switzerland, we expect the Swiss National Bank to begin lowering rates in June as well, with domestic inflation making an earlier move unlikely. We see a moderate, albeit uneven recovery unfolding in China. Despite recently stepped-up policy support, sentiment remains weak, with more stimulus still needed to bolster household demand and stabilise the property sector. Growth and inflation are moderating in Japan, but we still expect the Bank of Japan to progress cautiously toward ending yield-curve control and negative interest rates. Our base case is for a move in the second half of this year, but the end to ultra-loose monetary policies could come earlier.
Asset classes
Equities. The Q4 23 reporting season has been providing generally positive surprises in terms of revenues and income for S&P 500 companies, while pre-announcements for Q1 24 are in line with historic trends. Yet we are not fully convinced that earnings news fully justify the high valuations placed on some ‘Big Tech’ names and therefore remain cautious about the US market overall. We remain neutral on the Japanese and European stock markets alike, with valuations in the latter more reasonable than in the US. Although they may find it harder to outperform the broader market than before, we are generally more upbeat on European banks than US ones. As for other sectors, we believe the prospect of interest-rate cuts should help housing and home-related stocks in the US and note that energy companies continue to pay attractive dividends and buy back their shares. In Asia, we believe the real economy needs further policy boosts before we see a sustainable rebound in China’s stock markets. Reforms designed to heighten interest in the Korean stock market may bear fruits, but we are cautious ASEAN markets in the near term and neutral on the Indian market in the light of rich valuations.
Fixed income. We have lately turned tactically more cautious on US and core European government bonds, believing that markets had become over-optimistic in their timing of the first rate cuts by central banks. Indeed, the late-2023 bond rally fizzled out in the first weeks of 2024 as central banks, notably the Federal Reserve, pushed back on the idea of early rate cuts. However, we still believe in the diversification benefits of core government bonds and await for a favourable opportunity to consider extending duration again. On the corporate side, we remain cautious on noninvestment-grade bonds in light of the rising volume of debt that needs to be rolled over at higher rates. While prudent overall, we remain more sanguine about investment-grade bonds, especially in Europe, where we still see room for spread tightening.
Commodities, currencies. It is difficult to discern any clear trend in oil prices. Production has been increasing in non-OPEC countries like Canada and Brazil, forcing OPEC to step in to support the market. Prices will undoubtedly fluctuate before then, but with the conflict in the Middle East so far having only a limited impact, we are sticking with our year-end forecast for Brent oil of USD80 per barrel. The US dollar has rebounded in recent weeks as the Fed has pushed back against early rate cuts. But with markets still pricing in more rate cuts this year than the Fed itself, we belief that US dollar strength may have further to go in the short term.
Asset-class views and positioning
We retain our highly selective approach to equities. We remain underweight the large-cap US equity market, where performance has become dependent on a handful of tech-related companies with high valuations. Elsewhere, our interest in Japanese stocks remains supported by corporate governance reforms and a weak yen, while we believe cash returns from European stocks will outstrip returns from their US peers this year. We also believe small-cap indices could improve their relative performance as interest-rate cuts approach. While we have become tactically cautious on US and core euro area government bonds, we still believe intheir potential, especially as their positive correlation with equities recedes. Investors will need to show exceptional agility this year, but with base rates set to come down, there is room for a selective approach to private assets, which continue to offer uncorrelated returns over the long term.
Three investment themes
Arbitrage between fixed and floating rates. We believe that the prospect of interest rate cuts will provide opportunities to arbitrage between fixed- and floating-rate debt. The fortunes of companies and corporates that have suffered the most from rate rises over the past two years should improve and we could see a broadening out of equity market performance.
Favour companies engaging in buy-backs. We continue to favour companies with plentiful liquidity and capable of paying down their debts and returning money to shareholders in the form of buybacks and dividends in a sustainable way.
Capitalise on AI’s promise. We are optimistic about the scope for generative AI to improve productivity and open new avenues of growth. In particular, we believe that GenAI will contribute to innovation in areas like healthcare as well as other data-intensive sectors. In tech, our focus is on companies able to monetise proprietary (as opposed to open-source) intellectual property.
