In this month’s Core Offerings, we briefly assess how H1 2024 has evolved relative to our expectations. It’s fair to say, despite challenging periods of sticky inflation and resilient growth, we arrived as planned at a mid-year rate-cutting cycle, though the sequence of the protagonists clearly changed. As we now set a course for H2, we have made some modest changes to a largely unaltered (and constructive) tactical position. After adding risk in early June—moving modestly overweight equities (though still with a preference for fixed income)—weakening US growth sees us take a more cautious tilt within fixed income, while moving overweight Japan relative to emerging markets to hedge political risks.
This month we also flag six key debates we believe investors need to be across as they traverse the back half of this year. More importantly, many of them are likely to ‘come to a head’ over coming months and may challenge our desire to tactically rotate from fixed income to equities, as interest rates are reduced and economies soft land. These include a mistake by central banks, reaccelerating inflation, political volatility, or recession risks.
“Our performance does not come from what we buy or sell. It comes from what we hold”
In one sense, and mostly through a macro lens, the first half of 2024 has not veered materially from expectations. There were moments when inflation reaccelerated, and at times growth appeared unwilling to slow in the face of at least moderately tight policy. Yet, on the whole, global growth has ebbed weaker (without collapsing), jobs markets have softened, and inflation has continued to grind lower, somewhat arduously, toward central bank targets. And as we highlighted in June’s Core Offerings, the ‘easing cycle has come into view’, with the European and Canadian central banks, among others, starting to trim rates. Forecasters are expecting the UK to join them this month or soon after.
For markets, this has not paralleled perfectly into our expectations around how asset classes have performed, albeit portfolios with a growth tilt should have delivered a strong 5-6% return uplift for H1 2024 (an annualised double-digit pace). Maintaining a constructive (underweight cash) position has been key to performance.
It’s fair to say, despite challenging periods of sticky inflation and resilient growth, we arrived as planned at a mid-year rate-cutting cycle. However, the sequence of the protagonists clearly changed…
…For markets, this has not paralleled perfectly into our expectations around how asset classes have performed, albeit portfolios with a growth tilt should have delivered a strong 5-6% return uplift for H1 2024.
As the second half of this year gets underway, we believe our central thesis remains ‘on track’ – we’re in a new phase of slower growth, moderating inflation, and a modest rate cutting cycle for at least the next six to 12 months. There have been twists and turns along the way, and there will likely be more ahead. But the fact that our outlook remains largely unchanged for now doesn’t make it wrong. Nor are we unaware to those potential risks and developments that could set us on a different path, such as renewed inflation risks, political volatility, or rising recession risks, which we discuss (among other risks) below.
“The breadth of global growth is improving from cycle lows, with encouraging signs from the PMI data. 80% of countries globally are seeing their composite growth proxy in expansion.”
But for now, data continue to broadly support expectations for a relatively mild global growth slowdown during 2024. Outside the US, many major economies have gone through various stages of a ‘traditional’ cyclical slowdown during 2023 and early 2024, sparked by tight monetary policy. Assuming central banks provide some modest (and for some, additional) policy relief by end 2024, this ‘softish’ landing for the world economy should give way to a patchy recovery through 2025. Indeed, as Société Générale (SG) notes, “the breadth of global growth is improving, with encouraging signs from the PMI data. 80% of countries globally are seeing their composite growth proxy in expansion”.
Moderate topline ‘world’ growth masks the divergence between ongoing resilience in US and Asia and recent recessions in the UK and Europe (as well as weak growth in Japan)…
After seemingly reaccelerating through early 2024, inflation has reclaimed its downward glidepath. Indeed, markets are now increasingly emboldened by renewed price disinflation in the US, with markets now fully anticipating a September rate cut. Still, the divergence in growth cycles (particularly US and Asia’s resilience versus recent recessions in Europe and the UK) is also playing out in policy timings. Policy easing now appears likely to be far more heterogenous, with a key differentiator being each country’s relative progress toward its inflation target. Progress, particularly for countries like Australia, which faces ‘stickier’ prices, will remain key to the pace and timing of any normalisation in rates. The US, initially seen as among the first to ease in 2024, now is sequenced behind others with lower inflation.
…This divergence is also playing out in policy responses. Easing now appears far more heterogenous, with a key differentiator being each country’s relative progress toward its inflation target.
A focus on quality and tactical opportunism may prove more rewarding than relying solely on traditional asset class positioning. This might look like capturing higher fixed rate yields before rates fall, favouring small and mid-cap equities, where valuations are less stretched. Within alternatives, beyond private debt, the time to revisit commercial real estate may be emerging.
Our six-to-twelve month tactical positioning also continues to be influenced by a number of our ongoing key themes, including:
We have made a number of tactical changes at the sub-asset class level. These better reflect recent political developments, progress on inflation, as well as clearer signs that a moderate slowdown in US growth is underway.
Our tactical positioning has recently benefited from our decision to add risk from 1 June this year, reflecting our improved confidence that both lower inflation and modestly lower interest rates were imminent. We continue to favour staying underweight cash (-3%), with a preference for fixed income (+2%) relative to a modest overweight (+1%) in equities.
Looking beyond the short term, given our secular (medium-term) bias toward higher growth and higher inflation (which are imbued with political volatility and populism that fosters limited fiscal restraint) we recognise that as central banks trim rates over the next six months or so (and markets better price endpoints to the cycle), our preference for fixed income will likely wane in favour of adding further equity risk. This will, of course, also depend on risks of renewed inflation or a harder economic landing remaining at bay.
For now, this month, we have made a number of tactical changes at the sub-asset class level. These better reflect recent political developments, progress on inflation, as well as clearer signs that a moderate slowdown in US growth is underway. These changes, summarised here, are covered in more detail in the succeeding pages.
There is now a higher probability that former President Trump will win the November election. Heightened risk of trade wars afresh and new tension with China and Europe (among others) are likely to be US dollar positive.
1. Are central banks making the same mistake again? Central bank credibility suffered sizable damage in 2021 and 2022. They arguably kept policy too low for too long, as hoped-for ‘transitory’ inflation proved more persistent than first thought. Central banks embraced a clear deviation from past history. Rather than policy decisions made through a forward-looking lens, they shifted to a more ‘data dependant’ policy (one willing to ignore the ‘well understood’ lags of policy). In the US (and Australia), real policy rates have now been above ‘neutral’ for an extended period, unemployment is rising, and growth is slowing. Could central banks be making the same mistake again? By once again relying too heavily on ‘data dependence’, language that is again permeating the vernacular of central banks from Europe, the UK, Australia, and the US, are we already sowing the seeds of a sharper slowdown than is needed in 2025? This would support fixed income more and favour equities less than we currently expect for 2025.
Central bank credibility suffered significant damage in 2021 and 2022, arguably keeping policy too low for too long...
…could central banks be making the same mistake again? Are they, once again, relying too heavily on ‘data dependence’, language that is again permeating the vernacular of central banks from Europe, the UK, Australia, and the US?
2. When is bad data ‘bad’? As the following chart portrays, equities are in a ‘mood’. They regard bad macro data as good news, to the extent that it suggests future rate cuts and an easing of bond yields (amid political and fiscal uncertainty). Weaker-than-expected data has been leading equity markets higher, particularly small and mid-cap sectors that are likely to benefit from easier financial conditions that support activity. Yet, history reveals that this narrative can be fragile when valuations are not ‘cheap’. At some point, bad data can actually turn bad for equity earnings, leading markets to fret. Of course, given most central banks have ample ammunition to deploy, any sharper-than-expected downturn may be short-lived. This risk plays into our current desire to be only modestly overweight equities. It may also present opportunities for the nimble to tactically lean into equities (including the US) if markets correct.
Equities are in a ‘mood’. They regard bad macro data as good news, to the extent that it suggests future rate cuts and an easing of higher bond yields (amid political and fiscal uncertainty). Yet, history reveals that this narrative can be fragile when market valuations are not ‘cheap’.
3. How much will (US) politics really matter? 2024 was always going to be the year of ‘national’ elections, with over 64 across the world and more than half of humanity fronting a ballot box. By now, many have come and gone, and most have landed on the less consequential side of the ledger. The US election still lies ahead and will demand attention—not least because of the market tension between the potential for a newly-elected Trump to spur markets via stimulus versus disruption in global trade, including far-reaching tariffs. According to BCA Research, “investors are overstating the degree to which bond yields will rise under a Trump presidency. [While] a further weakening in growth will help Trump in the polls, it will also put downward pressure on bond yields. Moreover, a second Trump administration might produce a lot less fiscal stimulus than widely believed”. Who, if anyone, has the balance of power in the US Congress will be key to policy freedom, with the outcome a key focus for markets.
4. Is China accepting ‘mediocre’ near-term growth? Confronted with slowing growth, reflecting both structural and cyclical headwinds, China’s authorities have resisted the temptation to support growth through significant leverage. China’s debt expansion over past decades has weighed on investors’ perceptions of financial stability. Post the recent third plenum (which many view as lacking stimulus) policy appears focused on “long-term development plans and various structural reforms”, according to UBS. These decisions come in the wake of disappointing sequential Q2 growth, which halved form around 6% to 3%. It is possible that China is ‘saving’ its stimulus to support the economy through any post-US election imposts announced. However, it may also be the case that China is trapped in a balance sheet bubble that it can’t get out of. Alternatively, it may now be more accepting that a consumer-led growth story will take longer to write. Either way, there is a risk for the world (and Australia) that China may be a less significant growth driver over the next few years.
5. Could services inflation remain elevated, short-circuiting policy easing? Ongoing tight monetary policy appears to have belatedly reversed high services price inflation earlier in the year (likely helped by rising unemployment). But while services inflation has typically trended above central bank’s 2-3% inflation targets (averaging nearer 3%, balanced by weaker goods inflation), more recently, global services inflation appears to be settling closer to 4%. Absent further easing (as we expect), this could create some angst for central banks and limit the pace and extent of future policy easing.
6. Will Australia’s stickier inflation drive a recession? Real economic activity has slowed significantly in early 2024, and is likely to have remained well below trend into mid-year, led by a flat consumer, weaker housing activity, and softer external conditions, including in China. However, the outlook is conflated by a range of other indicators that suggest aspects of the economy remain robust, including the jobs market, house price growth and the demand for services. The latter may be contributing to inflation remaining pegged at 4% mid-year, while it has fallen closer to 2% in many other key economies. Likely contributing to this is much more stimulatory fiscal policy than expected from mid-year—across both federal and state governments. Fiscal largesse isn’t free, and appears to be making the task of reducing inflation more difficult. Further inflation upside could see rate hikes back in the frame. While consumer spending has not collapsed, and the jobs market remains firm, late-cycle hikes could shunt the economy on to a much weaker path than expected. This could challenge even a relatively attractively priced equity market.
Fiscal largesse isn’t free, and appears to be making the task of reducing inflation more difficult in Australia. Further inflation upside could see rate hikes back in the frame. While consumer spending has not collapsed, and the jobs market remains firm, late-cycle hikes could shunt the economy on to a much weaker path than expected.
We maintain a broadly constructive macro view and expect further moderation in global growth and inflation, as well as a modest global rate-cutting cycle. We have made changes to our tactical positioning to reflect the shifting balance of risks sparked by recent transatlantic political volatility. We have closed our global government bond underweight and high yield credit overweight, moved underweight emerging market equities, and overweight Japanese equities. We have also increased foreign currency exposure. We maintain a nimble stance with our tactical positioning, given evolving macro and political risks.
Can policymakers stick the landing? After a fast and steep hiking cycle, central bankers now need to calibrate policy to lower inflation without triggering a recession. There are political and geo-political risks, and the secular inflation outlook is volatile.
Politics takes centre stage in 2024: After the geo-political shocks of the past two years, politics will be a key market driver this year. More than 64 ‘national’ elections are taking place in 2024, headlined by the US in November.
Diverging cycles: The US economy is resilient, but momentum may be peaking, while Europe may be bottoming, and China faces key cyclical and structural challenges. How these macro dynamics play out will be a key driver for markets this year.
Fortune favours the flexible: With ongoing volatility and uncertainty, we believe it pays to be diversified, nimble, and flexible over the year ahead. Investors will benefit from prudently managing liquidity and investing with high quality active managers.
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