Monthly house view | September 2024

Macroeconomy

Global purchasing manager indexes (PMI) for manufacturing in advanced economies continued to point to declines in business activity. Services activity has held up better, but may not remain unaffected by the decline in manufacturing. A slowing jobs market will contribute to a downturn in household spending and lead to a slowdown in the US economy. We expect three 25 bps rate cuts from the Fed between September and the end of 2024, with four more in 2025. But the Fed’s reaction to the slowdown in the labour market will need monitoring. While our base case is that the downturn in jobs will be manageable, downside risks are growing. The euro area economy surprised to the upside in H1 and real income growth could continue to support domestic demand. But manufacturing remains a weakness, particularly in Germany. Our forecast is still for 0.8% annual GDP growth in the euro area this year, but risks are tilted to the downside. We believe the ECB will cut rates by 25 bps this month and again in December, bringing the deposit rate down to 3.25%. In Switzerland, the decline in annual consumer inflation to just over 1% opens the way for another Swiss National Bank (SNB) rate cut in September. As long inflation expectations remain subdued, the SNB could be tempted to lower rates further to deal with renewed Swiss franc strength.

Asset classes

Developed-market equities. After a long winning streak, the risk-reward profile of equities is looking increasingly unappealing. Sluggishness in Europe and China and a downturn in the US (although not necessarily a recession) mean challenging macro conditions for stocks while rate cuts have already been priced in. In the circumstances, forecasts for earnings look (too) optimistic—yet valuations remain near the top of their historic range. We have moved from neutral to underweight positions in US and euro area equities and from an overweight to neutral position in Japanese equities. Q2 earnings figures from US and, to a lesser extent, from European companies, were generally good, but there was negative guidance from some consumer discretionary companies. Guidance from high-profile industrial companies was also sometimes weak. Meanwhile, tech stocks have lagged as returns from tech-related companies’ huge AI investments has bubbled up to the surface as an issue for investors.

Fixed income. Growing sensitivity to poor economic data together with upcoming rate cuts amid a slowdown in inflation expectations have been boosting the appeal of government bonds, with a steep fall in bond yields this quarter. Government bonds also proved their worth in defending portfolios at the height of the short-lived equity sell-off at the start of August. Given that the balance of risks has shifted to more aggressive rate cuts from central banks, we have revised lower our year-end forecasts for 10-year government bond yields (except in Japan) and moved from a neutral to an overweight position in US Treasuries. Attractive yield pick-up means corporate bonds have enjoyed a good run year to date. Yields on the main US high-yield bond index average over 7% while the default rate remains low. While we do not ignore the risks stemming from economic downturn, Fed rate cuts should provide breathing room for corporate bond issuers. The improved quality of the US high-yield universe and our belief that the US economy will manage to skirt inflation has therefore persuaded us to move from an underweight to tactically neutral position in US high-yield bonds.

Currencies, commodities, commercial real estate. The yen has experienced a turnaround since July. Dollar weakness and Bank of Japan policy tightening contributed to an unwinding of short yen trades that reinforced the Japanese currency. Given the narrowing of bond spreads as the Fed moves to cut rates, we expect the yen to remain well supported. Oil prices have declined in Q3 as demand momentum droops. Our year-end forecast for Brent oil is USD72 per barrel. Prices for other commodities, notably copper, have also been coming off the boil –in large part because of persistent sluggishness in the Chinese economy. This situation may endure unless we have decisive economic stimulus from the Chinese authorities. Commercial real estate continues to be in the eye of the storm and foreclosures in the US reached a decade-high in Q2. But this could mark a bottom, especially as interest rates come down. Low vacancy rates in a number of European cities mean average rents continue to rise for the right properties in the right location.

Asian markets. We expect economic momentum in China to pick up sufficiently to meet the authorities 5% GDP growth target for this year. But the recovery remains uneven, with a rebound in infrastructure (thanks to government stimulus), but household spending is still languishing and there is no real stabilisation yet in real estate prices. The Bank of Japan remains intent on continuing to normalise its monetary policies as market conditions allow. Our base case is for the next rate hike in Japan to come in January 2025. There were signs of a decline in export momentum in July in countries like South Korea and Taiwan as well as China. Depending on how the global economy evolves, we believe there is scope for Asian central banks to cut rates in the coming months. We believe Fed rate cuts would brighten the outlook for Asian (ex Japan) stocks, with equities in South Korea and ASEAN markets the most sensitive to monetary easing and US dollar weakening. We maintain our positive structural outlook on India. We view Asian credits as a good diversifier for portfolios and note they proved more resilient than their US counterparts during the brief upsurge in volatility at the start of August. Asian currencies rallied to their highest level in seven months in August. The Malaysian ringgit was in the vanguard of currency appreciation whereas the Korean won has been among the weaker performers.

Asset-class views and positioning

Despite the onset of rate easing, economic challenges, political uncertainties and exaggerated earnings forecasts have pushed us to an underweight stance on stocks in general. Less aggressive valuations and the out-sized boost they receive from lower bond yields mean we are less downbeat on global small caps. We have a nuanced, company-specific view of the tech sector. While the debate over the monetisation of AI continues, we observe that abundant free cash flow enables Big Tech companies to pursue their investments. But a tailing-off of the growth in AI investments is liable to dent revenue growth for big AI chip companies. We maintain our active, bottom-up approach to the tech sector. The move to overweight US Treasuries has shifted our stance on fixed income as a whole to overweight. But we were already overweight emerging-market sovereign bonds in local currencies, which continue to offer attractive risk-adjusted returns and should benefit from USD weakness. We have moved to a tactically neutral stance on US high-yield bonds, which we view as an alternative to US equities and sit higher in the capital structure. We maintain our medium-term bullish outlook on gold.

Three investment themes

Take on more duration. The attractiveness of cash is declining as overnight rates decline. We believe that short-term bonds are a viable alternative. We also see renewed steepening of the yield curve as a good entry point into longer-duration bonds. The decent coupon offered by bonds provide a cushion against further bouts of financial-market volatility, with our preference going to US Treasuries of up to five years duration.

Focus on politics. This year is marked by a series of important elections around the world against the backdrop of high or rising public debt burdens. In these circumstances, country selection is of utmost importance. Our preference goes to countries with healthy fiscal dynamics. Increased volatility stemming from fiscal issues can be played through option strategies and currencies.

Move up the capital structure. Given that earnings targets for equities look over-ambitious, we suggest looking selectively at credits at the top of the high-yield ratings scale. The overall quality of the US high-yield universe has been improving, default rates remain low and credits stand higher in companies’ capital structure than equities, meaning investors have a higher claim on a company’s assets and earnings than with equities.