House View Q2 2024 - Turning the corner
Our view of global markets
All eyes are on the US…
- With the scene set for a historic cut in interest rates, US developments are more key than usual for global markets. Based on the latest data, we think the US economy is heading for a soft landing – the holy grail for central banks, where they dampen inflation without tipping the economy into recession.
- With a mild slowdown in sight, the most likely date for the US Federal Reserve (Fed) to cut interest rates is now July – a “pivot” that represents an official invitation to re-enter markets after the 2022 reset and should provide continued momentum to bonds and equities in the coming months.
- The question then is how rapidly – and by how much – the Fed cuts rates. On this score, markets expect much less than they did in late 2023. We have thought for some time that US rates will be only 75bps lower by the end of 2024 – at best. US labour market resilience may give the Fed pause for thought.
Chart of the quarter: Will the Fed “stick” the landing?
Our near-term cyclical model, which relies solely on high-frequency macro data, currently suggests only an 11% chance of a US downturn over the next six months.
Source: Proprietary recession model. Our cyclical macro model (PCA, probit) is based on 14 high-frequency cyclical macro indicators (business and consumer sentiment, labour market, housing, monetary, consumption, orders). Source: Allianz Global Investors Global Economics & Strategy, Bloomberg, Refinitiv (data as at 29 March 2024). Past performance does not predict future returns.
Position for selective opportunities amid bouts of volatility
- While investors are eyeing the Fed’s next move, markets are benefiting from a global economy showing more resilience than during previous periods of high interest rates, with signs that European and Chinese economies are also starting to bottom out.
- Healthy company earnings in countries including the US and Japan should support risk assets. Also: watch for the “wildcard” of artificial intelligence (AI) – any acceleration in implementation in the coming quarters could signal stronger productivity and lower inflation.
- There’s also the possibility that the Fed cuts rates less than the market expects if the US economy holds up better than anticipated (a “no landing” scenario). While good news for equities, this scenario could be challenging for government bond yields.
- Geopolitical risk has risen. To date, markets have done a good job of recalibrating for an environment of conflict and global tensions, particularly in a US election year. But the risk of a major “black swan” event should not be ignored.
- But the recent equity market rally signals that now is not a time for investors to sit on the sidelines. We do not think markets are overbought. There will likely be market volatility, but this can also present opportunities.
Consider the following:
- Equities: We take a constructive stance on the US where valuations are reasonable; China offers potentially attractive valuations and innovation potential.
- Japan: Improving corporate governance and the smooth normalisation of monetary policy support equity valuations.
- Technology: Some of the Magnificent Seven stocks are richly priced but the sector generally isn’t.
- Fixed income: Our preferred trade is curve steepeners in the US and Europe to benefit from rate cuts and the re-emergence of term premiums. In credit, on a risk-adjusted basis our preference is for investment grade.
See below for more details of our asset class convictions.
“With the prospect of the first US Federal Reserve rate cut in four years, we see a turning point ahead for the global economy, which should create new openings across asset classes. “
Asset class convictions
Asset class convictions: equities
Tech sector – still value for astute stock pickers
The well-documented rise of the Magnificent Seven tech stocks has left them looking richly priced. However, valuations for the sector overall are not excessive (see chart). As AI moves from building the “plumbing” to more applied benefits for software firms and others, we expect to see wider opportunities in the sector.
Overall tech valuations are not excessive
Cyclically-adjusted price-to-earnings ratio (CAPE) for US IT sector, Nasdaq
Source: LSEG Datastream, AllianzGI Economics & Strategy, 12 March 2024
We also expect geopolitical tensions to present opportunities in the tech sector. The divergence in standards between China and the rest of the world, and further breakdown of cooperation, could create investment opportunities. In our view, national security concerns and the wider use of AI are creating strong opportunities in the cyber security space.
Focus on quality and volatility for entry points
The expectation of a soft landing is an obvious positive for the macro environment. Consumers will benefit from resilient economies and job markets while a disinflationary environment increases real purchasing power. But we expect volatility around the timing of potential rate cuts, and from elections, which may present opportunities. We will be focused on quality indicators, such as strong balance sheets and leadership, when evaluating companies across growth, value, and income styles.
We anticipate regional opportunities as the monetary policy cycle turns. US valuations are up but still reasonable in a global context of earnings growth and anticipated rate cuts. The normalisation of monetary policy and improving corporate governance, along with geopolitical tailwinds, support the case for Japanese equities. China appeals as the most under-owned market offering attractive valuations and innovation potential. Europe is also showing attractive valuations and some green shoots.
Asset class convictions: fixed income
Seek relative value in government bonds
Slow growth momentum, abating inflation risks, expected rate cuts, and more becalmed geopolitical risks appear positive for developed market government bonds.
We see increased scope for relative value as government bond markets decorrelate in response to diverging growth outlooks. Major government bond markets have moved in lockstep in recent years, but we expect this to change going forward given differences in debt fundamentals, the transmission of monetary policy, and fiscal support. In the US, for example, investment incentives under measures such as the Inflation Reduction Act seem to be underpinning economic activity significantly.
This gives us a preference for US Treasuries over other government bond markets, while core euro area are also beginning to look more attractive as more balanced growth and inflation risks should allow the European Central Bank to soften its policy stance.
We prefer to position portfolios to benefit from yield curve steepening, which can work as a longer duration proxy.
Maintain carry – and caution – in credit
Credit spreads – the premium offered by corporate bonds over sovereigns – appear relatively tight, but valuations are supported by solid fundamentals and we see no negative catalysts for credit in the short term.
On a risk-adjusted basis, our preference is for investment grade over high yield. But remaining invested for the carry offered by both investment grade and high yield corporate bonds appears advantageous, and we will look to hold select higher beta assets with high yields in both markets. There could be opportunities in areas such as subordinated bank bonds (for example Additional Tier 1s), and real estate, where risks look well priced and central bank rate cuts should support a market recovery.
That said, we maintain caution in credit given the slim spreads. We are wary of cyclical sectors in IG, and security selection remains paramount in HY given the risks presented by tighter financial conditions.
Asset class convictions: multi asset
Better governance benefits Japanese equities
Japanese equities combine a reasonable valuation with a supportive growth environment and decent momentum. Japanese companies – especially exporters – are geared towards growing their global footprint and harnessing long-term trends like robotics, automation and digitalisation. They are repairing their balance sheets as Japan’s economy emerges from a period of stagnating growth and deflation.
More shareholder focus, better governance, improved capital allocation and higher profitability are part of a transformation of Japan’s business landscape resulting in strong recent earnings. We see the recent all-time high for the Nikkei index as just the latest step on a sustained transformation journey – and a sign of greater investor interest in Japanese assets.
The recovery process should be supported by the Bank of Japan’s continued efforts to stimulate growth. While Japan recently exited negative interest rates (after 17 years), we expect monetary policy to be normalised only cautiously. Investors seem to have accepted this approach and the recent move was met with little market disruption.
Gold’s shine may last
Gold prices are surging – and have shown little sign of losing momentum. A weaker US dollar, purchases by central banks and strong appetite for physical gold from emerging market retail investors have underpinned its upward trajectory.
Amid geopolitical tensions and a rise in government debt and defence spending, demand for gold from emerging market central banks has increased for two reasons. First, it is an alternative to government bonds and the US dollar and, second, it supports de-dollarisation efforts in response to geopolitical risks. Central bank purchases should continue to support gold. In a multi asset portfolio, gold should outperform US Treasuries due to the surge in government debt. We maintain a positive stance on gold over the next 12 months.
In the short term, gold has surpassed the psychological threshold of USD 2,100/oz and short covering (buying back gold previously sold to close a short position) may accelerate the recent rally. Gold holdings among exchange traded funds remain relatively low, potentially serving as an additional catalyst for gold’s gains once positions align with the recent price rise.
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