At this point last year, everything was set for a recession amid the steepest policy rate increase in decades. However, three months into 2024, despite the investment landscape remaining complex and challenging, equity markets have continued to perform well as inflation expectations and the likelihood of a recession recedes. While we continue to believe that the outlook for the global economy and corporate profits is looking more optimistic and the threat of a deep global recession has ebbed, we are eager to highlight that those risks have not vanished. We are conscious that in some sectors, prices have moved ahead of where the outlook for sustainable company revenue and earnings suggests they should be.
We commented in our last market update that we were more optimistic about markets, primarily because central banks are priced to cut policy rates in 2024. Economic data is not showing many signs of slowing activity in the face of higher rates and recent data this quarter has alluded to more persistent inflation in some areas. At the turn of the year the projection for the number of rate cuts in 2024 was seven. This has already been reduced to three. Inflation risks still remain prevalent, primarily driven by pent-up demand, an economy that is still running close to full capacity, and the potential for further supply chain disruptions from the wars in Eastern Europe and The Middle East. Against this economic backdrop, we expect the Fed to remain patient before cutting rates.
Geopolitics will undoubtedly play a significant role in the global economy and financial markets in 2024. In an election year, the US is facing geopolitical tensions in Ukraine, Israel, and Taiwan. With the US going to the polls in November, it is likely that the political situation will become more paralysed in 2024, lowering the fiscal impulse and adding to both economic growth and heightened geopolitical uncertainty. These tensions are also helping to create a favourable cyclical environment for gold and with central bank demand continuing, potentially supported by a weaker dollar, gold has reached a record high this quarter. In commodities, the industrial metal and oil sectors also stand to benefit from the prospect of lower interest rates, driving a long overdue period of industry restocking. These sectors appear poised for renewed demand as the Federal Funds Rate and real yields are likely to decline just as the Chinese economy shows some tentative signs of improvement.
In the last quarter, US technology stocks were propelled to new all-time highs and as a result, the US equity market is at, or close to being at, the most concentrated it has been in the past 100 years. It is notable that the recent performance of stock prices has broadened into other large companies and sectors. The demand for manufacturing capacity, artificial intelligence and other applications will be important drivers of growth and productivity for the global economy, but it is reassuring that recent performance has not been solely driven by the narrow band of US technology stocks, namely the Magnificent 7 (Apple, Microsoft, Alphabet, Amazon, Nvidia, Meta and Tesla), some of which have been very mixed in the quarter.
In the US specifically, price and wage pressures have reduced even though the economy delivered strong economic growth. Despite some stock prices moving ahead of where the outlook for company earnings suggest they should be, this quarter we witnessed increased workforce participation helping to improve the supply of labour, in a period of falling inflation and without companies resorting to job cuts – a rare phenomenon. We remain confident that with US business and consumer confidence strong, employment and industrial manufacturing robust, the US economy will continue to display economic resilience. Furthermore, if the market accelerates its forecasts on the number of policy cuts in 2024, then the underperforming green transformation stocks across wind, solar, energy storage, electric vehicles and hydrogen could also see a short-term boost.
European equities, which are more sensitive to interest rates, have also been helped by natural gas prices that are lower than before the Russian invasion of Ukraine, the pick-up in global manufacturing activity and a recovery in bank lending growth. European healthcare companies such as Novo Nordisk and semiconductor companies like ASML have driven European markets to highs. Japan is also beating expectations, both in terms of economic activity, corporate profits growth and in financial markets where the TOPIX has recorded 30-year highs. We have debated whether the Bank of Japan (BoJ) will threaten the economic revival by further tightening policy and triggering yen strength and at the moment the BOJ is keeping its powder dry. Meanwhile, China continues to hold the emerging markets back as its measured policy response and property market challenges have left many global investors sitting on the sidelines.
In the UK, GDP is stagnant and inflation is declining at a slower pace than for other developed economies. Market expectations are for the Bank of England to begin lowering rates in the second half of the year, which will provide some relief, but we believe the impact of the substantial rise in 2-to-5-year fixed-rate mortgage interest rates is still to be fully felt by the UK consumer. In a year of elections galore, the Labour Party holds a strong lead according to recent public opinion polls, which have seen support for the Conservative party drop as low as 19%. The incumbent Conservative government has cut some taxes to boost its poll ratings, but as these are pushing in the opposite direction to monetary policy, the risk is that this could delay the BoE’s monetary easing.
In an environment of high fixed income yields, improving economic growth and sustained inflation, we remain confident and optimistic about good opportunities for investors within both fixed income securities and equities.
The value of securities and the income from them can fall as well as rise. Past performance should not be seen as an indicator of future returns. All views expressed are those of the author and should not be considered a recommendation or solicitation to buy or sell any products or securities.
