The actions have had a rollercoaster summer with wildly volatile views on the global economy and corporate earnings, as well as the likely path of interest rates. It is likely that the coming we will be sailing through rough waters for monthsnot least as investors face the start of a cycle of interest rate cuts by the Fed and the US elections in November.
Asset Allocation: Caution After Summer Rally
This is what you read in the comment “Global Markets: Financial Stocks Still Have Strength to Run”edited by the Strategy Unit of Pictet Asset Management, who explains that “both factors could cause a strong divergence in the performance of individual equity sectors. Overall, we remain neutral on bonds and equities. Bonds have rallied strongly over the summer in anticipation of significant central bank easing and there does not appear to be significant value in this asset class given the current level of yields”.
Our business cycle indicators – it reads – confirm that they are cautious, with our global growth forecasts revised down on a worsening outlook for China. Chinese data this summer has been disappointing, although the economy should continue to be supported by a recovery in consumption, particularly in the services sector. But the dire state of the real estate market continues to cast a shadow over the country’s growth prospects.
United States under the lens
In the United States, “the labor market is entering a less favorable phase, and further weakening is unlikely to be detrimental to growth. We expect the U.S. economy to grow below potential over the next four quarters, driven by slowing consumption and continued weakness in residential investments. Even though the odds of a recession are marginally higher, businesses and households are not overly indebted.” This, combined with the benefits from future interest rate cuts“should keep the slide low. At the same time, we expect inflation to remain at the US Federal Reserve’s target of 2% by the end of next year, although the road ahead will be bumpy. Both the expected increase in private sector lending and the underlying strength of the economy suggest that market expectations for eight-quarter point interest rate cuts between now and next summer are overly hawkish. As for the eurozone, it has recently seen growth close to potential, although this is largely driven by net exports rather than the strength of individual national economies. Meanwhile, rising goods prices are keeping inflation momentum well above the Federal Reserve’s target. European Central Bank, although this should ease in the coming months.”
Our liquidity indicators are marginally inclined towards looser monetary conditions globally. A net 33% of major developed and emerging market central banks are easing monetary policy, up from 26% last month. We will see an infusion of liquidity in the near term, as central banks, not least the Fed, wind down their quantitative tightening programs, a natural complement to interest rate cuts. Without significant further fiscal stimulus, central banks will seek to stimulate private credit growth to support economic expansion, and we expect the increase in credit to amplify the effects of monetary easing.
Regions and stock sectors
Our valuation indicators “show that shares remain very expensive, although marginally lower than a month ago, thanks to a premium forthe highest equity risk. We believe earnings expectations are too bullish and price in continued economic growth rather than a slowdown and weakening of pricing power, which we expect. Our technical indicators show sentiment around US equities is at elevated levels, with retail investors strongly bullish. S&P 500 futures positioning has come down from its highs but remains elevated. After US stock market volatility spiked earlier this month, it has fallen at its fastest pace ever, returning to its long-term trend.”
In this context, financial sector stocksor “they still have the strength to perform. Despite falling bond yields, the sector should benefit from a steeper yield curve, a dynamic that means net interest income for banks remains strong. Earnings should also be supported by strong loan growth, as central banks are easing their monetary policy in a supportive macroeconomic environment. Then there is the possibility that the US elections will help deregulate the banking sector. Fundamentals are also supportive, with valuations still cheap and very strong earnings momentum. According to Lipper Alpha Insight, financials posted the highest percentage earnings increase in the second quarter among the S&P 500 sectors. Add to that solid dividends and share buybacks, and we think there is enough reason to upgrade financials to overweight.”
We also observe with interest the active companies in communications services, buoyed by exposure to secular trends, such as advances in artificial intelligence. Indeed, one of the messages from the last earnings season was that tech capital expenditures are continuing, with companies viewing underinvestment as a greater risk than overinvestment. share buybacks above-average yields (with a net repurchase yield above 3% for the industry, compared to the market below 2%) provide additional momentum to the sector. However, we maintain some defensive positions to protect against potential market volatility, risks to economic growth, and uncertainty about future US politics ahead of the election. For us, this includes overweighting utilities, a sector that offers defensive characteristics and stable earnings at attractive valuations. These qualities will be evident if economic growth is slowed by consumer spending.
Among the regions, the our overweight in Switzerland, which is home to an unusually large number of quality companies with stable earnings, offers further protection against the possibility of weakening economic conditions. In addition, Swiss companies trade at attractive valuations given their superior profitability. We continue to see potential in Japanese stocks as well. The market shows the strongest earnings momentum among the regions in our model, and it is one of the few economies where we expect growth to accelerate significantly in 2025. We remain neutral on US equities. On the bright side, the recent gains in the S&P 500 have been increasingly broad-based, rather than driven by a handful of large-cap stocks. However, fundamentals are less supportive. We expect US economic growth to slow from 2.4% this year to 1.5% in 2025, and we also believe there is scope for disappointing earnings growth in the medium term. Our top-down model projects earnings growth of just 5.2% in 2025 in the world’s largest stock market, a third of the pace currently expected by bottom-up analysts, according to I/B/E/S.
Fixed Income and Currencies
The bond markets show that investors are now betting on US interest rates falling by as much as 200 basis points by the middle of next year. However, this scenario it is in contrast with our opinion that the US economy will have a soft landing and that price pressures will remain elevated for some time before inflation reaches its target.the 2% set by the Fed by the end of 2025. In this scenario, we downgrade U.S. Treasuries to neutral. The benchmark 10-year yield is about 30 basis points below our year-end fair value estimate of 4%. Bond yields relative to nominal GDP growth are no longer all that attractive, having fallen again after hitting levels above zero for the first time in over a decade. That said, inflation-protected Treasuries (TIPS) remain a good store of value and their valuations appear more attractive, especially given the persistent inflation risks over the medium term. We also remain neutral on credit. While yields are still attractive, we see limited scope for spreads to tighten given the slowdown in economic growth. We remain underweight in Swiss government bonds, which remain one of the most expensive fixed income asset classes in our model and offer a low yield of just 0.5%.
With regard to the currencies, “We upgraded the Swiss franc to neutral. As major global central banks begin to ease monetary policy, which will narrow the gap between global and Swiss interest rates, the currency should start to attract inflows from the unwinding of carry trades. We remain neutral on the yen. While the Japanese currency may benefit from gradual interest rate hikes by the Bank of Japan (BOJ) in the long term, the positions have been long for too long (global investors are long the currency for the first time since 2021). Furthermore, in the short term, we believe the BOJ will adopt a cautious stance following the recent volatility and strength of the yen, given that the dollar, which is trading below the mid-point, is likely to be in a weak position. 140 yen, would start to damage the profitability ofof Japanese companies and increasing imported inflation.”
