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Our Chief Investment Officer’s 2024 Q1 Market Update

by | Apr 3, 2024

GSI's CIO Andrew Heath provides his market insights and highlights for the first fiscal quarter of 2024.

Market Highlights

The first quarter was a positive month for stock markets, with resilient economic data and relatively strong earnings reports contributing to solid gains. Markets were characterised by strong momentum and rising company valuations. It was most obvious in the US where the macro narrative supporting this was a perceived soft landing in the US, effectively a cyclical slowdown in economic growth that avoids recession.

Earnings season was relatively robust with many companies including the magnificent seven in the US, broadly met or exceeded expectations, contributing to a strong gain in the S&P 500. Economic data also proved resilient, with the US composite Purchasing Managers’ Index (PMI) suggesting activity continued to expand.

Equity markets also regained momentum helped by a little more clarity from central banks after several weeks of pushing back on near term expectations for interest rate cuts. Although the US has experienced a two month jump in inflation so far this year, it was clear from the US Federal Reserve (Fed), that they will start to cut very soon. Elsewhere, Europe is struggling to avoid stagflation and China is fighting a renewed round of deflation. Fundamentally the rate cutting cycle is underway. At the same time there were tentative signs of a broadening of the global cyclical recovery which in turn supported a broadening of equity market performance.

In the US, the Super Tuesday round of primaries delivered no significant surprises with Donald Trump and President Biden now near certainties to secure their respective parties’ nominations for the Presidential election on November 5th. Both candidates face significant fiscal challenges given the run up in debt in recent years, and more recently the increasing costs of servicing such high debt levels have come into focus given the return of interest rates to more normal levels. Trump also continues to face legal challenges, though these may get pushed out well after the election result in November.

The China Economic Work Conference took place in Beijing, with the highlight being the setting of a growth target of 5%, as expected. Premier Li Qiang pledged that China would remove restrictions for foreign investment in manufacturing while announcing issuance of ultra long government bonds worth $138bn of major projects. Premier Li acknowledged the need for further policy support announcing $138bn of spending on major projects. However, the long-awaited stimulus bazooka remains absent.

Central Banks Turn Dovish

The Federal Reserve sent a positive signal to financial markets in March by upgrading their growth forecasts despite the recent uptick in inflation. Many in the market were worried that higher inflation readings since the turn of the year would force the central bank to take one of the expected interest-rate cuts off the table. However, this was not the case and the central bank held firm. Futures markets and guidance from Fed officials has now converged, after a period of over-optimism by markets on the pace of interest rate cuts. It is the perfect outcome for financial markets, with the Fed relaxed about inflation, economic growth expected to pick up and monetary policy (interest rates) still on track to be cut soon.

The Bank of England also sent encouraging signals that interest rates are on the cusp of being lowered, even as they kept rates on hold for a fifth consecutive meeting in March. Governor Andrew Bailey noted that inflation does not need to get to target before interest rate cuts began. They just have to be convinced that inflation is going back to target. The UK also reported employment and inflation data, with unemployment picking up slightly, to 3.9%. Wage growth slowed to 5.6% in the three months to the end of January, a level the Bank of England remains uncomfortable with. The inflation data eased to 3.4% year on year in February, while core inflation fell to 4.5%.

The Bank of Japan ended almost eight years of negative interest rates, voting to increase interest rates effectively back to zero. This was the first interest rate hike in Japan since 2007. While the exit from negative rates is a significant turning point in policy, the emphasis from the Bank of Japan was that policy would remain accommodative for now given the current outlook for the economy and inflation. The policy shift was widely expected, not least given the first indications from the Shunto wage round pointed to wage settlements of 5.3%, the highest level since 1991. However, Japan still appears to be some way off an aggressive tightening cycle as we have witnessed in the UK, US and eurozone over recent years. With Japan only recently emerging from deflation, the Bank of Japan believes they have scope to keep policy loose for some time yet in the hope that inflation will settle over time around their 2% target.

Lower Inflation, Higher Growth?

Lower rates are good for markets if they do not reflect recessionary risks. When looking at some global data, it seems that rather than recession, the narrative might become more of a better-balanced global recovery. Data from the US, Europe, China, UK, and Japan suggest business confidence is bottoming (same message from Purchasing Managers’ surveys). Consumer confidence is picking up in the UK, Europe, and Japan. Asia export growth is strong. Global producer price inflation collapsed last year and remains very low which I take as good news that supply chains are operating more freely. All of this is feeding into upward revisions to global GDP growth forecasts.

The Bank of England and European Central Bank are closing in on their inflation targets, and rate cuts look possible mid-year. There is some concern that the Fed may send a more hawkish signal with the US facing stickier inflation. However, this inflation is against a backdrop of an economy that still appears in solid health with the lagged impact of the rate hikes we have seen in the past two years failing to significantly slow the economic momentum. Market expectations for rates have moved a lot since the start of the year but investors have grown comfortable with rates staying somewhat higher for longer because the economic momentum has continued which in turn translates into healthy corporate earnings. The positive signals from the central banks this week that cuts are coming are supportive for risk appetite and in the absence of data or news flow to disrupt this narrative, the path of least resistance for markets appears to be higher for now.

Reasons to be positive – The Year Ahead

We are possibly shifting into a new phase where the narrative might become a global recovery. A critical component of that is clearly easier monetary policies (lower interest rates). The rate cutting cycle has started but the timing and extent of global rate cuts will depend on what happens with inflation. On that, the trend towards lower inflation continues to be steady. While headline inflation has fallen significantly, core inflation and wages remain sticky, but the direction of travel is clear.

Apart from lower rates and more balanced global growth, the secular drivers of equity market performance remain automation, digitalisation, and the green transition. Markets are showing strong momentum, and mentions of bubbles are on the rise. Most risk assets are performing well. Yet there is no overwhelming sense of euphoria (away from Nvidia and selected AI-related stocks) or a sense that leverage is being ramped up to generate even stronger investment returns. Equity price earnings are high in the US but that is biased by the technology sector. Moreover, earnings growth expectations have started to tick higher again, perhaps encouraged by signs that the global manufacturing and trade cycle has bottomed out.

It is worth noting that there is still a lot of wealth held in cash. Cash rates have not come down so there is a psychological hurdle rate for investment in riskier asset classes to beat. That is understandable when there have been high levels of interest rate volatility and when global equity performance has been so concentrated, led by expensive US technology stocks and a single narrative around artificial intelligence. But growth is now broadening, and cash rates will naturally start to fall as interest rates fall.

There are clearly risks within markets, sticky inflation, geo-politics, high valuations to name a few. However, they are not material enough to reverse positive momentum in markets. There is no real recession, rates will probably come down in the second half of the year and companies continue to do well.

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