Monthly house view | October 2024

Macroeconomy

Global purchasing manager indexes (PMI) for manufacturing continue to point to declines in business activity, led by a downturn in new orders. It is still too early to say whether generalised rate easing and large-scale Chinese stimulus will managed to turn things around on this front. In the US, the state of the labour market is seen as replacing inflation as the Fed’s primary concern. Faced with a gradual weakening of job market dynamics and relatively benign inflation metrics, our base case is the Fed could cut rates by 75 bps more before the end of this year (but it could be less, depending on jobs data) and by a further 100 bps in H1 25. In view of recent inflation numbers, which came in below expectations, as well as indications that business activity and the labour market are weakening, we now believe the ECB will announce a further 25 bp cut to the deposit rate this month, followed by another in December. As in the US, we believe the ECB will opt for a further 100 bps in rate cuts in H1 25, bringing the deposit rate down to 2% in June 2025. The Bank of England has been comparatively prudent about cutting rates, but we still expect two additional 25 bp rate cuts by the end of this year. Prospects of a tough ‘Autumn Budget’ have started to undermine consumer confidence, but business sentiment in the UK remains comparatively strong.

Asset classes

Developed-market equities. We continue to believe that equities’ risk-return profile does not make them look particularly attractive at present. Some important leading economic indicators continue to point to downside risks, there is much geopolitical uncertainty and equity valuations and earnings expectations are high. Sector wise, we are looking for valuations in the healthcare and consumer staples sectors to catch up on the broader market. We are also keeping a close eye on the mounting challenges facing automakers (we prefer North America-focused companies to their European peers) and the energy sector (we prefer integrated energy companies that show excellent capital spending discipline).

Fixed income. Bonds rallied in September thanks to Fed rate cuts and the prospect of more to come. Yield-curve inversion in US Treasuries finally disappeared, with longer-term yields finally climbing back above shorter-term ones. As policy rates sink, cash has become steadily less attractive compared even to short-term bonds. We have a differentiated view of the attractiveness of longer-dated bonds, as we think there is less room for further compression of US long-term yields than for their European equivalents. We remain overweight government bonds in general, believing they will continue to protect portfolios in the current disinflationary environment. Corporate bonds have also been rallying as a result of Fed easing, with renewed tightening of yield spreads on noninvestment-grade credits, particularly in the US. Given current economic conditions, we believe credit spreads could remain in a relatively tight trading range for a while. While energy-sector issuers have been struggling because of sagging oil prices, we remain comfortable with our neutral stance on US high-yield bonds overall.

Currencies, commodities, private equity. The combination of Fed rate cuts and a Bank of Japan intent on ‘normalising’ its monetary policy has resulted int the yen making big gains against the USD. The prospect of further tightening of monetary policy in Japan could continue to support the yen, although the narrowing of the US-Japan interest rate spread has already been discounted by markets. In commodities, an end to curbs on oil production by major producers like Saudi Arabia could lead to a fight for market share that seriously impacts the oil price and makes some shale oil production in US unviable. But more immediately, the alarming situation in the Middle East complicates the near-term outlook for oil prices. With the pace of innovation accelerating to meet rising (and changing) healthcare needs, we believe we are in a golden age for healthcare private equity, with a focused on unlisted companies showing high potential (85% of healthcare companies are unquoted, according to our estimates).

Asian markets. The major stimulus we saw in China in late September (and the promise of more to come) has led to a rapid turnaround in sentiment towards Chinese assets. Chinese equities have rallied strongly in response to the measures, but whether gains can be sustained will depend on the scope of the promised fiscal stimulus and its effectiveness in restoring confidence in the Chinese economy. In Japan, our baseline case is that the Bank of Japan will be happy to wait until the start of next year before hiking rates again. The advent of Fed easing could pave the way for central banks elsewhere in Asia to cut rates, following on the heels of Bank Indonesia, which surprisingly reduced policy rates in September. ASEAN equity markets have responded positively to the Fed rate cuts and Chinese stimulus, and could continue to do so in the short term given attractive valuations and improving earnings outlooks. We also think that Asian investment-grade credits continue to offer attractive risk-adjusted rewards. We maintain a neutral stance on Chinese investment-grade credits in USD, with a clear preference for market leaders in areas such as ecommerce. The renminbi has been rallying and could have further short-term upside if we have meaningful fiscal stimulus.

Asset-class views and positioning

We have modified our asset-class stance to underweight on cash to take account of the drop in overnight rates and see short-term bonds as more attractive. However, we have a nuanced view of the outlook for government bonds. While we are happy to switch from cash to short-term US Treasuries, we believe the potential for further yield compression on longer-term Treasuriese could be limited. We have therefore moved from an overweight to neutral stance on the US Treasury market overall. We see more potential for long-term yields to rally in the euro area, including in periphery countries. We have therefore moved from a neutral to overweight position on these bonds and from an underweight to neutral position on Swiss government bonds. We continue to view better-quality high-yield bonds as an attractive alternative to equities, where we see limited further upside potential, despite the drop in policy rates.

Three investment themes

Move from cash to short duration. The attractiveness of cash is declining as overnight rates decline. We believe that short-term bonds are a viable alternative. While we like US Treasuries of up to five years duration, we believe that longer-dated euro area bonds are more attractive than their US equivalents.

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.