We’ve got a spring in our step, and it’s not just because of the warmer weather. The markets are buzzing with reasons to feel optimistic. Dive into our latest quarterly report, your shortcut to all the must-know information that’s keeping us on our toes.
Download PDF VersionIn 17th century America, English-born poet Anne Bradstreet wrote: “If we had no winter, the spring would not be so pleasant: if we did not sometimes taste of adversity, prosperity would not be so welcome."
While “prosperity” could be a stretch too far, Bradstreet may have been on to something. Admittedly the winter of 2023 may have been lacklustre, to say the least, but the first quarter ushered in increasingly positive sentiment, with significant risk of recession avoided around the world and investors buoyed by reassuringly resilient economic data.
JP Morgan’s Global Market Strategist, Vincent Juvyns, captured the motivators and mood, stating: “The US economy grew by more than expected during Q4 2023, while the composite Purchasing Managers’ Index (PMI) survey data remained firmly in expansionary territory, boosting investor sentiment. Macroeconomic data elsewhere around the world also showed encouraging signs, further supporting the prospect of a soft landing.”
Even the spectre of interest rates staying higher for longer failed to put a dampener on solid performance, with a 10% gain for S&P500 giving total returns a leg up to almost 30% over the past 12 months.
• Resilient economic data: Robust economic data was the order of the quarter, with the US economy confirmed to have grown more than expected during Q4 2023. Survey data from the composite PMI stayed firmly in expansionary territory, fuelling positive investor sentiment in the process.
• Strong returns for global equities: The MSCI ACWI gained 7.4% over the opening quarter. Developed market indices had a good first three months, driven by the solid performance of growth stocks, which returned 10.3%. Japan was the strongest performer, with the TOPIX rising 18.6% despite the start of monetary policy normalisation by the Bank of Japan. Meanwhile, in Europe, equities overall continued to lag behind the US and Japan but surprised on the upside at the end of the quarter – possibly driven by cheaper valuations relative to the US.
• Rate cuts draw nearer: On the back of 11 rate hikes, the Fed’s most aggressive rate-hiking campaign in four decades, the Bank again opted to hold rates steady at its end-of-March meeting as it awaits more positive data on inflation. The Federal Open Market Committee (FOMC) will have six more opportunities to cut interest rates this year, with Fed Chair Jerome Powell appearing to suggest in a recent speech that three rate cuts are still on the cards for this year: “The recent data do not, however, materially change the overall picture, which continues to be one of solid growth, a strong but rebalancing labor market, and inflation moving down toward 2% on a sometimes bubbly path.”
Declining inflation: The FOMC’s December forecasts predict that inflation, as measured by the personal consumption expenditures (PCE) index, will fall from 3.2% in 2023 to 2.4% in 2024, with a subsequent fall to 2.2% in 2025. The final phase of the war on inflation will be focused on the “sticky” elements such as core services. Meanwhile, price inflation, which changes gradually over time, could be slow to respond to monetary policy adjustments.
• Economic downturn: The number one risk for the global economy will be geopolitics, from the war in Ukraine and an escalation of trouble in the Middle East to elections in the US, Europe, and the UK. There is also the not-insignificant risk of what could happen in Taiwan. These political uncertainties could stop businesses and households from spending as they wait and see, leading to a year without momentum.
• European recession: Recessions are happening in Japan, the UK, Finland and Ireland, and negative GDP rates for Q4 2023 were also reported in Germany and Canada.
• Inflation improvement at a slower pace: While financial markets are still pricing in rate cuts later this year, there has been a shift in expectations to fewer cuts as the rate of inflation improvement slows and the labour market remains tight, weighing on market sentiment.
• Bond market corrections: The 10-year US bond has risen to 4.43% (as of 8 April) which is increasing the risk of a correction of maybe 5%-10% in US equities (it was 3.80% in January). If the 10-year US treasuries go to 4.60% - 4.70% then it will slow the economy down. Bond yields are increasing because everyone thought that rates would go down and therefore slow the economy, but the reverse is true.
As we edge into the second quarter, the near-term backdrop looks more supportive for risk-taking and upbeat market sentiment may well persist as long as inflation continues to fall.
Across developed market economies, inflation has been declining from the highs seen during the pandemic and appears poised to reach close to 2% this year. This scenario would lay the foundations for many central banks to start reducing policy rates. Indeed, the Federal Reserve’s revised forecasts released in March still signal three quarter-point rate cuts this year, despite both inflation and growth forecasts being revised upwards.
In the first quarter, the emergence of a “Goldilocks” economic environment (one that is neither too hot, nor too cold) has pushed many markets higher, with benchmark U.S. equity indices touching new heights. Several factors underpinned the soft-landing narrative and fuelled positive investor sentiment. Previous monetary tightening led to a moderate softening in demand, releasing tight labour market pressures, while inflation levels saw a hefty drop from their peak.
Meanwhile, the prospect of the end of Fed tightening and upcoming interest rate cuts joined forces to ease financial conditions significantly, propelling asset prices higher and generating a huge wealth effect - underpinning consumer spending. As a result, investors are broadly confident that a recession is off the agenda – at least in the near term.
Eurozone economic activity indicators outstripped expectations in the first quarter. Core inflation edged closer to the ECB’s 2% target, with Germany (2.3%), France (2.4%), Italy (1.3%) and Spain (3.2%) already having reported their national inflation rates.
The ECB is expected to cut interest rates soon, for two main reasons. Firstly, with Germany anticipating spending to a constitutionally permitted size and France attempting to chip away at its huge budget deficit, fiscal policy can only get tighter – and this will further weaken the economy. Secondly, the gap between the ECB’s current 4% interest rate and the 2% target rate is significant and achieving it will take more quarter-percentage point cuts than the ECB has remaining meetings this year.
Meanwhile, the resurgence in bank lending looks set to see positive economic momentum sustained over the next coming quarter. Economic growth is likely to slacken off later in the year as the delayed effect of ECB tightening makes itself felt, but the risk of a more entrenched downturn seems to be fading. Indeed, if the Bank follows through on its hint of rate cuts in June, easier monetary policy should help stave off the impact of a slowdown. And while European indexes do not count on the AI-themed stocks that have fuelled the S&P500, they are cheap relative to the U.S, and they stand to benefit if earnings can outpace the muted market consensus of just 2.8% earnings-per-share (EPS) growth this year so far.
The outlook for the UK economy continues to look challenging.
GDP growth continues to stagnate, and inflation is falling at a slower pace than in other developed economies. If the Bank of England does start cutting rates in the third quarter, as widely expected, there may be some relief on the horizon, but the full pinch of the hefty increase in two-to-five-year fixed-rate mortgage interest rates has yet to be fully felt. Recent public opinion polls indicate that the opposition Labour Party has built up a strong lead over the incumbent Conservatives, with an election likely before this year is out. The government has cut some taxes in an effort to increase its poll ratings, but as these are pushing in the opposite direction to monetary policy, this move risks delaying the Bank of England’s monetary easing.
During the first quarter, weakness in China’s property market continued to put the brakes on performance. Conversely, Asia-Pacific economies outside of China itself still look resilient.
Robust domestic demand looks set to buoy the growth of markets such as India, Indonesia, Malaysia, and the Philippines, while the continued easing of inflation should save the region’s central banks from tightening monetary policy again. That said, higher-for-longer US interest rates are still exerting pressure, making it unlikely that we will see any significant policy rate cuts over the next six months.
In the developed markets, equities have sustained their solid performance as the chance of recession recedes, with the US putting in a particularly strong showing. This stands in direct contrast to the first 10 months of 2023, when an unusually small cohort of stocks fed the gains of the entire US index, and most underperformed.
In the first quarter, a growing number of global companies are contributing to rising markets. Indeed, the performance of the ‘Magnificent Seven’ technology behemoths (Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla) has been much closer to that of other large firms, as have the returns of smaller and medium-sized companies.
Meanwhile, macroeconomic data from elsewhere in the world also proved resilient, with investors cheered by the ever-likelier prospect of the much-vaunted “soft landing”.
Against this encouraging backdrop, global equities posted robust returns, with the MSCI ACWI up 7.4% during the first three months of this year. At the same time, volatility stayed low, with the VIX Index hovering around an average of 14 for the quarter. Investopedia states that, “As a rule of thumb, VIX values greater than 30 are generally linked to large volatility resulting from increased uncertainty, risk, and investors' fear. VIX values below 20 generally correspond to stable, stress-free periods in the markets.”
Fixed income investors had a rough ride in the first quarter, facing negative returns on the back of challenges including resilient economic activity, stickier inflation, and some light backpedalling from the US Federal Reserve on its dovish tone in December.
The shift in the macro backdrop was also borne out in market expectations for interest rate cuts, where the implied number of US rate cuts for 2024 fell from six to seven cuts at the end of 2023 to a maximum of three rate cuts in total, beginning in the summer. As the prospect of aggressive rate cuts receded, the yield of the Bloomberg Global Aggregate Index rose by 28 basis points over the quarter, leading to negative returns of -2.1%. Meanwhile, strategies that favoured corporate bonds and other credit investments fared better on the strength of the economy.
In the credit space, high yield trumped investment grade thanks to its lower sensitivity to interest rates and more favourable financial conditions. US and European high-yield indices generated returns of 1.5% and 1.6%, respectively, while the Global Investment Grade Index rounded off the quarter with -0.8%. Meanwhile, emerging market debt rose 1.4% over the quarter, as high real yields outweighed the effect of an increasing US dollar strength on the asset class.
The US dollar, as measured by the Bloomberg Dollar Spot Index, got off to a strong start this year, undergoing a significant rebound in the first quarter and outstripping performance in the previous three quarters.
During the quarter, the prospect of the first globally synchronised easing of monetary policy (barring Japan) since 2008 proved a hot topic for investors. The Bank of Canada has been signalling it is “ready to go” for some time, with the European Central Bank and the Bank of England unlikely to be too far behind. A shallow revival in the global economy, along with falling inflationary pressures, look set to give the world’s most important central banks the impetus they need to kick off the rate-cutting process from around the middle of the year, and this should extend the economic recovery in the months ahead.
As the second quarter gets underway, the Fed appears to be clinging less tightly to its 2% medium-term inflation target. While there is no official word that the target has been abandoned, the tone of recent communications may suggest a readiness to ease monetary policy even with inflation closer to 3%.
In its quarterly investment outlook, BlackRock talks about the importance of focusing on three main investment themes: managing macro risk, steering portfolio outcomes and harnessing megatrends. Against this backdrop, BlackRock adopted a tactical overweight to US stocks early in the year, playing on the artificial intelligence (AI) theme as more sectors beyond tech adopt AI and as market sentiment is boosted by Fed messaging and falling inflation. The firm also increased its overweight stance on Japan, driven by robust corporate earnings and a recovery in wages and inflation. On the fixed income front, BlackRock is maintaining its selective stance, trimming its overweight to inflation-linked bonds and continuing to invest in private markets.
In the words of the firm’s strategists: “We believe investors would benefit from a more active approach to their portfolios. This is not a time to switch on the investing autopilot; it’s a time to take the controls. It’s important to be deliberate in taking portfolio risk, in our view.”
All things considered, it has been an encouraging start to the year, although stock market gains have once again been concentrated in the large-cap growth space as equity market valuations continue to rise.
This trend may continue to be supported by the resilience of the global economy, and the prospect of rate cuts in the second half of the year could continue to support this trend, but some markets appear increasingly priced for perfection and may therefore be vulnerable to profit-taking.
As always, economic, environmental, and geopolitical risks could generate volatility in the months to come, so maintaining a well-diversified portfolio may prove more important than ever.
CEO
