Key tactical changes
- Neutral across equities: Rich valuations in the U.S., and underwhelming economic growth prospects limit the upside to equities
- Neutral across fixed income: We maintain a neutral position to fixed income as spreads remain tight especially in high-yield markets
- Modest overweight position to cash: We hold a modest amount of cash as we look for opportunities to deploy cash to both equities and fixed income
U.S. equity markets had a banner first half of 2024. The benchmark S&P 500 Index rose 4.4% in Q2 2024 for total gains of 15.3% for the first six months of the year. The tech-heavy Nasdaq Composite Index did even better, up 17.3% for the six-month period ending June 30, 2024. While investors’ enthusiasm about artificial intelligence has driven equities higher over the past 18 months, macroeconomic trends of gradual cooling in the U.S. job market alongside a slowdown in inflation have recently boosted markets even further. While the U.S. has continued to add jobs, the pace of jobs growth has slowed, and the unemployment rate has inched up to 4.1%. On the other hand, thanks to tight monetary policy from the U.S. Federal Reserve (the Fed), prices are showing a disinflationary trend. Markets now expect the Fed to cut interest rates twice before the end of 2024.
We think conditions are right for the Fed to initiate a rate cut within the next six months. Our research shows that the U.S. consumer price index (CPI) could start to capture the slowdown in shelter inflation over the next few months. We expect this to confirm the further disinflationary trend required for the Fed to cut borrowing costs. We also expect the U.S. consumer to come under more strain as pandemic-era savings dwindle, job growth shrinks and wage gains slow. This along with a lukewarm manufacturing sector in the U.S. could force the Fed to prioritize growth and jobs in the coming months.
We are concerned about economic growth prospects outside the U.S. Government spending has been an extra boost for U.S. growth, but an absence of such fiscal generosity in other economies is already showing. Many developed economies are wrestling with a more acute manufacturing slowdown than the U.S. Other sources of growth such as consumption and exports are also under pressure outside of the U.S. In response, major central banks such as the European Central Bank and the Bank of Canada have already initiated interest rate cuts to loosen monetary conditions.
Given these conditions and geopolitical risks, we are largely neutral to equities across regions. In the U.S., we are concerned about the concentration of gains in the technology sector, where a handful of stocks have largely driven market returns. We also worry about the rich valuations of U.S. equities relative to their profit outlook. On the other hand, we think the equity rally may broaden out to sectors that have mostly been stagnant for many quarters. We think a Fed rate cut may give a much-needed boost to these sectors. We also reduced our bets on emerging market equities as our data shows rising growth concerns. Within fixed income, we think core credit dominated by government issuers offer more value over risky credit such as high-yield that are trading at tighter spreads. We are modestly overweight cash as we look for opportunities to deploy in both equity and fixed income markets.
