2024 Q3 Market Outlook: Losing some of the shine?

With many elections taking place around the world this year, the global economy is vulnerable to the threat of increased trade tariffs and geopolitical tensions. Given the significant increase in government deficits, debates around fiscal discipline are likely to dominate market focus.

On the other hand, global inflation progress continues to grab market attention. Although there has been significant improvement, the “last mile” in inflation is proving to be sticky. Most central banks have responded by raising their 2024 inflation projections.

When will the Fed begin to cut interest rates?

Recent data suggest that U.S. inflation may have returned to its more disinflationary trend. But without a sharp labor market slowdown, inflation will unlikely reach central bank targets until late 2025. We expect the first cut to come in September, followed by December – but it may take additional positive inflation readings to cement the timing. Although the timing of Fed rate cuts remain a difficult question to answer, weakness in recent consumer and labor market survey data in the U.S. suggests that the next policy move may be a cut.

When will central banks kick off rate cutting cycle?

Typically, central banks wait for the Fed to reduce rates before they move. However, given the Euro area’s lackluster growth backdrop and headline inflation having plunged sharply, the ECB (European Central Bank) had strong reason not to wait for the Fed. The next ECB rate reductions are likely in September and December. If the Fed delays the start of its easing cycle, the ECB’s next move may be equally delayed. The BoE (Bank of England) will likely begin rate cuts in August.

For the Bank of Japan (BoJ), a slow move towards hikes has weighed heavily on the Yen. With the Fed’s cutting cycle likely to be short and shallow, the BoJ may need to embrace tighter policy to avoid further yen weakness.

The timing of the first rate cut remains a question, how can we position our portfolio?

Equities not only offer exposure to important secular themes, such as AI and technology but may also harness the positive growth environment. Bonds may offer important income stability and a hedge against downside risk. Alternatives such as real assets may offer insulation in case inflation remains sticky or starts to trend higher again.

In equities, exposure to large-cap technology and AI means that the U.S. remains the favored region. Developed market outside U.S. have started to show more appeal, with valuations relatively less stretched, central bank paths somewhat more assured, and cyclical economic upturns underway. However, the sustainability of any outperformance is still in question given the limited nature of their economic recoveries. Small caps have seen occasional flickers of strength, yet their relatively high share of floating rate debt implies that small caps cannot stage a sustained recovery unless rate cuts materialize promptly and the economic growth backdrop strengthens.

Japan’s valuations are clearly flagging as expensive, but momentum in corporate governance reforms presents opportunities for unlocking value. Segments of the Latin America and Asia emerging markets are historically cheap and have strong fundamentals.

China’s growth has improved, it is being upheld almost solely by net exports. However, with the property sector showing no clear signs of bottoming and credit growth still weak, China’s recovery is unlikely to gain further traction.

In fixed income, despite the significant repricing in rate expectations so far in 2024, fixed income has continued to deliver positive performance, predominantly because the macro resilience narrative remains intact. More pertinently, the total yield today is markedly higher than a few years ago, and credit is likely offering important additional carry to U.S. treasuries. In an environment of solid economic growth and higher for longer rates, the short duration and cyclical exposure of high yield may be attractive.

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