Investment Outlook - Market Update
The first half of the year delivered strong equity market returns and notably against an economic background that was very different to that forecast by the consensus of economists for 2024. In hindsight, it was a six-month period where all news was interpreted as seemingly ‘good news’ for markets, the key beneficiaries being the concentrated Magnificent 7 group of US technology names. Irrespective of the economic scenarios that emerged—be it more or less than expected inflation, economic growth or importantly interest rate expectations, these stocks attracted investors and generally left the rest of the market behind.
Looking to the second half of 2024, inflation and growth have indeed proven to be stronger than expected, and the consensus has rapidly repriced downwards expectations to 2+ US rate cuts now, for 2024 with a strong consensus that the economy will land softly with no recession. Our narrative of ‘regime change’ has been consistent over recent years being one where investors will have to adjust to a world of stickier inflation and a higher and more normal level for interest rates and bond yields than experienced over previous years. That reality has now dawned.
Somewhat ironically with equity markets continuing to deliver strong returns and hit new highs, we are asked more and more about risks such as recession or especially geopolitical. This at a time when the strong economic consensus is for a soft landing in the all-important US economy. To rationalise the market performance year-to-date, one could conclude therefore that much of investor money has been parked in the Magnificent 7 US names, while these risks are reflected in the poorer performance of the rest of the market reflecting people’s worries.
In terms of outlook, the strong consensus conviction is for a soft economic landing, lower inflation and interest rate cuts. On the basis that such events do occur as the year progresses this strongly suggests to us an environment that emerges with a strong market rotation away from the expensive mega-cap technology names towards more attractive value and small-mid capitalisation stocks across market indices globally. This is also consistent with the beginnings of the next economic cycle.
At an aggregate market level this may not see material upward moves at the overall market index level, but certainly one that rewards strong active stock picking. We remain mindful that political risks abound, the US Presidential election looming particularly so, but market wise the result is likely largely priced in at this point.
Asset class outlook:
Equities
As in 2023, the market returns YTD in 2024 have generally exceeded earnings growth, and as a result, market valuations are now at an aggregate level trading above historic averages and cannot be described as cheap. The market however is split between “have’s and have-not’s” with the re-rating being predominantly driven by the AI driven technology names. Fundamentals including earnings growth do matter and as we progress through 2024, we do expect the broadening of earnings growth across the market to be reflected in stock price performance.
While the strong consensus is for a soft landing and a positive catalyst for rotation, we would also at this point argue that should a mild recession occur that valuations are such that for much of the stock-market that once a hard landing is avoided it should be a catalyst for a rotation and broadening of performance across the market, an environment that should suit good stock picking.
At a regional level we continue to note that the North American equity market in aggregate looks the most expensive compared to other global markets. In contrast, European and the strongly out of favour Emerging Market equity markets look much more attractively valued.
Bonds
Bonds as an asset class have experienced two difficult back-to-back years of performance during 2022 & 2023 and have struggled again so far during 2024. This is not a surprise to us who have argued that a new regime change was consistent with higher and for longer bond yields and interest rates. Noting that the aggressive central bank rate rising environment is now behind us with the outlook more favourable as we look to the second half of the year expecting rate cuts next across the world including Europe and the US. That said, we aren’t particularly bullish on the outlook for lower bond yields, arguing more that they are now at fair value rather than cheap. The prospects of a Republican victory in the US election combined with a reasonable chance of a ‘red sweep’ would be negative for US bond markets.
Risk wise, we continue to monitor corporate bond markets for any signs of distress at a company or indeed sectoral level. We watch spreads that to date have shown very little if any signs of stress.
Disclaimers:
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