Overview
Is this the post-pandemic normalisation we were waiting for?
Economic activity has held up this year as labour markets and consumer demand find a healthier balance. That shift towards equilibrium has partially soothed markets’ primary concern: that economies - and inflation - were proving too resilient to central bank tightening measures.
These improving fundamentals have shaped our thinking around three main themes heading into Q3.
The first is that now is a good time to take equity risk.
The second is China. It’s unwise to take your eye off the world’s second largest economy, even if investors have withdrawn from its shores for now. Policymakers appear more willing to support the economy, helping to establish a period of ‘controlled stabilisation’.
Finally, we’re thinking tactically. As economies diverge and new prospects open up, investors will want to make use of their active armouries.
Soft landing, risk on
The story of 2024 so far has been one of solid economic fundamentals. Signals suggest that the US still leads the pack, but Europe and the UK appear to be turning a corner, while continued stabilisation in China should mitigate its drag on the global economy.
Sticky inflation continues to temper expectations, however. This time last quarter, we were concerned that a stubbornly tight labour market might force the US Federal Reserve to keep rates higher for longer, which would eventually slow 2024’s positive momentum.
Labour market reports for June looked hotter than the Fed would like, but softening inflation in May adds to our growing confidence that price rises won’t reaccelerate from here. The range of outcomes when it comes to the magnitude of potential rate cuts by the Fed have narrowed significantly since the start of the year. We think that the bar for the cutting cycle to start remains high but recent progress on the inflation front has been encouraging.
A soft landing is the most likely outcome - and that’s a good thing for global growth and investors who are willing to take on additional equity risk.
Controlled stabilisation in China
We continue to believe that 2024 will be a period of 'controlled stabilisation' for China.
Policymakers are attempting to reduce the dominance of the property sector and rebalance the economy towards higher-end manufacturing and consumption.
It has taken some time for investors to adapt to this change - especially following the anaemic comeback of the economy after the pandemic turned appetite away from China - but sentiment has begun to re-establish, if at low levels. China’s economy is normalising as demand for goods and services gradually improves.
Policy shifts are starting to bear fruit in certain corners of China’s economy. The most obvious is manufacturing, supported by a resurgence in overseas demand. There are some upbeat signals from consumption too, led by the rebound in holiday travel.
This stabilisation is good news for China. It also bodes well for other economies in the region and for investors, who will be breathing a sigh of relief over the retreat in negative sentiment that pervaded the country in the first half of the year.
Time to be tactical
Solid fundamentals and a strengthening China mean we are adding risk to our portfolios. But doing so requires a nose for nuance: we expect divergence between regions and sectors is likely to be high in Q3, which means being tactical with that risk.
One point of divergence is monetary policy across developed markets. The eurozone has cut rates ahead of the US, as we expected. While this lays some groundwork for Europe to build on the positive momentum it’s established over recent months, the risk of a devaluing euro means that the European Central Bank’s (ECB) easing path from here is closely tied to the Fed’s. We think it’s unlikely the ECB will cut much further without the Fed following suit.
Conditions look ripe for US and Japanese equities to continue their strong run. Robust growth and healthy earnings in the former, coupled with structural tailwinds and corporate reforms in the latter, go some way to justifying rising valuations in these regions. But they don’t go all the way - in the US in particular, we’re looking beyond frothier parts of the market to uncover value. Mid-caps offer strong long-term growth potential at a reasonable price, and they should also prove resilient to higher rates.
On a sectoral basis, it’s hard to look beyond the earnings momentum of technology companies, and we also like the positive earnings revisions of US and European financials.
We like convertible bonds, which can benefit from any continued momentum in equities and can offer some protection if credit spreads don’t widen substantially. It’s a segment of the market that’s becoming increasingly populated by higher quality issuers, including some from attractive growth sectors like technology.
It’s finding seams in the market like these which could lift portfolio performance this quarter. The global economy now marches to a positive beat, but diverging policy will breed differentiating performance across assets.
You can find out more about our outlook for this quarter - and beyond - in this deck.
