Chase de Vere House View

Q2 2024 Update

As we enter the second quarter, we see a bright outlook with interest rate cuts likely in the summer months from key central banks and recession risk fading with global economic data surprising to the upside. Global manufacturing has entered a period of growth with 3 consecutive months of expansion and new orders rising at their fastest rate for nearly 2 years. The improvement is broad based with growth across the UK, US and Chinese manufacturing sectors. We have also seen Taiwanese and South Korean exports rise at 19% and 9% respectively year-on-year suggesting momentum in global trade is building.

The UK economy accelerated in January and February, recovering most of the lost ground from the technical recession in the latter part of 2023, and recent data indicates activity has continued to recover in March with the Purchasing Manager Indices (PMIs) reaching a nine-month high. The Chinese economy surprised to the upside achieving an annualised growth rate of +5.3% in Q1 and the Peoples Bank of China (PBoC) continues to expand stimulus aggressively with increasing liquidity to the banking system to the tune of c.$300bn over the last 7 months. It will take time for this stimulus to feed through to the economy but is another level of support to global growth.

The downtrend in global inflation continues, notably in the UK and EU. In the US, shelter-related inflation (rent and owners-equivalent rent) is slowing but is proving stickier than expected and has been contributing roughly 60% to headline US Consumer Price Index (CPI). It is a notoriously lagged inflation measure, and we expect slowing wage growth, benign house price growth, and declining live rental price agreements to continue to push shelter-related inflation lower. One of the most significant developments that has largely passed unnoticed is the US ISM services price index dropped to a 4-year low in March, and augurs well for the direction of inflation in the US.

March was the fifth month in a row that the number of central banks, globally, cutting interest rates exceeded those that hiked. The Swiss National Bank (SNB) became the first major developed country central bank to cut rates, indicating to us that we are on the cusp of an easing cycle across the developed world. Markets are now only pricing in between 1 and 2 interest rate cuts in the US, which equates to 0.25-0.5%, and given the sharp repricing from six cuts, we believe the pendulum could easily swing back the other way again. Notably, the US Federal Reserves (Fed) preferred inflation measure – Core PCE – is coming down on a yearly basis, supporting a swing back to at least 3 cuts as telegraphed by the Fed. We expect the European Central Bank (ECB) and Bank of England (BoE) to start lowering rates in June/ July, delivering a total of c.0.75% of cuts each in 2024.

We see a number of positive drivers for investors, but our complex world also demands careful attention to risks, including a busy election calendar and elevated geopolitical risk. Politics and geopolitical affairs will dominate proceedings in the second half of this year, notably the UK and US elections.

Economic Outlook – Key Points

  • Global manufacturing cycle is now in expansion, with future growth likely. After 18 months of contraction, the global manufacturing cycle has grown for 3 consecutive months at the start of the year. New orders and new orders-to-inventories suggest continued positive momentum in the coming quarters. Export data from smaller open economies in Asia and Europe such as Sweden, Taiwan, Singapore, and South Korea, suggest global trade is rising.
  • Improving confidence supports growth in the short-term. The closely followed ZEW Economic Sentiment Index for Europe continues to rise and has increased for nine consecutive months. Improving confidence levels supports future economic activity.
  • Lower inflation supports the consumer. EU and UK headline inflation is set to hit the 2% target this year, and US inflation will ease over the course of the year but will experience brief up swings, supporting consumption. For example, real disposable incomes across the UK have risen for 10 consecutive months.
  • Shifting to an easier monetary policy. Central banks last raised rates in June-September last year, indicating that peak rates are in, and despite uncertainty around timing the next move is for cuts. There is also a strong indication the core developed market Central banks will end or slow their Quantitative Tightening (QT) programmes, such an action would increase liquidity in the economy, easing monetary conditions.
  • Chinese growth is improving and stimulus increasing in 2024. There are many direct and indirect benefits of better growth in China, which can’t be understated. The Chinese Service PMI has risen for four straight months, the manufacturing sector has just returned to expansion and economic growth surprised to the upside in Q1. We expect more stimulus to be announced over 2024.
  • Fiscal spending set to increase further across globe in the run up to elections. Biden’s pursuit of re-election as well as other leaders across the world in 2024 will lead to further government spending to win over voters and juice the economy. Incumbent governments typically lose when their respective economy is weak.

Market Outlook – Key Points

Global equities have started the year in a positive fashion following a sharp rally at the end of 2023 because the likelihood of recession has receded. The “pivot” to easing from central banks represents an opportunity for investors to put cash to work and should provide continued momentum in global equity markets.

In 2023 an unusually small number of stocks, the so-called ‘Magnificent 7’, contributed over 80% of the gains of the entire US equity market, however in contrast this year returns have been less concentrated and more broadly spread. The performance of the Magnificent 7 – Apple, Microsoft, Alphabet, Amazon, Nvidia, Meta and Tesla – has been mixed so far this year with Tesla, Apple and Alphabet all underperforming. If we look back through history, we see that it is unusual for the largest companies in the world to remain that way for extended periods of time.

Emerging market (EM) equities have underperformed over the last 12 months, led lower by China. However, Chinese authorities have stabilised the economy, and macro indicators have strengthened for the seventh month in a row in China, providing support to investor confidence in Chinese equities as well as the broader EM equity space. We expect to see solid corporate earnings growth globally, but we expect earnings growth in Asia and EM to be nearly double that of the Developed Markets (DM) markets.

Global equities trade above long-term average valuations at a multiple of 17.6x expected earnings, however it is skewed by the US equity market which is on 21.2x. Once we decompose the global index into regions there is significant disparity and opportunity. The US trades at a significant premium of 56% to the rest of the world. Even if we exclude the US Technology sector, the US market trades on 18.6x which is still high relative to history. On all measures we observe the US to be trading at elevated levels, and we are not alone with this view. In a recent Bank of America report, they stated the S&P 500 is expensive on 19 of 20 core valuation metrics and is trading at in the 95th percentile when measured on a price to trailing earnings ratio (based on data back to 1900). The most attractive markets on a valuation basis are the UK on 11.3x and EM on 12.3x, where there are also visible improvements on the macroeconomic front.

Markets respond more to the rate of change and that is why we focus on areas of improvement, not areas of well-known, well-telegraphed strength where investors are already positioned. Given the improving outlook for economic growth and what is priced into markets, we believe the prospects of small and midcap companies is particularly attractive, as well as value stocks and value markets, notably UK, EM, Japan, and Europe. It is worth remembering that over the long term, smallcaps and value stocks have proven to outperform due to superior growth and lower valuations, respectively.

Bonds tend to do well after rates peak. High yield bonds have performed well over the last 18 months, and credit spreads are now tight and do not sufficiently compensate for a potential pickup in defaults or credit events, supporting our preference for investment grade bonds. Promisingly, there was a significant refinancing round in Q1, the highest since 2021, which was well absorbed by the global bond market given the higher interest rate companies now need to pay investors. Government bonds continue to look appealing. There is an asymmetry in the potential returns for government bonds, notably UK gilts, which makes them a low-cost way of hedging against equity market volatility as well as providing a predictable source of income. The UK inflation rate is on a downward trend. Energy price deflation should be cut at least 1.5% from headline CPI, and food price inflation is set to drop to zero, bringing overall inflation to less than 2% by summer if not earlier. Consequently, UK interest rates are likely to fall by 0.5%-0.75%, and bond returns should accelerate.

We are confident that 2024 will be another positive year for markets and portfolios. Investors have ample cash with money market funds surpassing $9 trillion globally in early 2024. Falling rates, improving growth and confidence should pull some of that cash into equity and bond markets, where rewards are higher. Market conditions are supportive for risk assets, particularly if we have a combination of interest rate cuts and moderate but improving growth, which is looking increasingly likely.

Key Risks to Outlook

  1. Interest rate pricing risk – easing interest rates supports economies and markets, and therefore is a big risk to markets if rate cuts are not delivered. If the economy grows strongly and inflation continues to fall, the market will be content with no cuts. All other scenarios are likely to be negative.
  2. Inflation second wave risk – after a sharp period of disinflation to more normal levels over 2023, the risk of rising inflation has now increased. US inflation has bounced to 3.5% however we believe it will be temporary. Inflation is still in a “settling down” phase post pandemic, and it will not be a straight line. Dominant structural factors of demographics, debt and innovation remain disinflationary.
  3. Recession risk – highly predictive recession indicators such as the shape of the government bond yield curve and tightening bank lending standards, have suggested for some time that recession is imminent which you can’t completely ignore. However, the multi speed, desynchronised global economy that has appeared post pandemic and the potential stimulus that can now be provided via interest rate cuts does reduce the risk of a meaningful recession.
  4. Geopolitical risk – The Middle East is an obvious risk; however, it has been for decades and there are many levers for the West to pull to calm the situation. US adversaries may opportunistically aim to make geopolitical statements in an US election year to influence proceedings. The Israel Palestine conflict has morphed into an Israel-Iran conflict and sadly the people of Gaza are the pawns in the geopolitical chess match. The oil price is the biggest concern but any disruption to Iranian oil production or transportation can be substituted by Saudi oil. The Ukraine war remains an economic risk via commodity markets. The war sadly seems to be grinding on but without any major escalation as both sides await the outcome of the US election. The US holds significant sway in all global geopolitical affairs and the upcoming US election will be pivotal to the future direction of these conflicts.

Important information

The value of your investment and any income from it can go down as well as up and you may not get back the full amount you invested.

Past performance is not a reliable indicator of future performance.

Investing in shares should be regarded as a long-term investment and should fit in with your overall attitude to risk and financial circumstances.

Information was obtained from proprietary and non-proprietary sources deemed reliable by Chase de Vere.

Where the qualified Investment Manager has expressed views and opinions, they are based on current market conditions and their professional judgement and are subject to change.

The information contained within this update is for guidance only and does not constitute advice which should be sought before taking any action or inaction.

Prices were correct at the time of writing.

  • Share