Outlook remains positive for global growth

At True Potential, we work with world-class fund managers across the full spectrum of asset classes and markets. We use their insights to inform our own outlook on global markets and economies. Here, we set out the key themes that we believe are driving markets at the moment.

• Economic activity is broadening beyond the US, with growth surprises remaining positive in the UK, Europe and Japan. The UK has the strongest momentum, but surprises turned (net) negative for the US in April. Manufacturing data continues to indicate a cyclical upswing, driven by emerging markets.
• In the equity markets, valuations and earnings outlooks reflect buoyant optimism. Profit margins continue to expand in the US, Europe, Japan and emerging markets, and have stopped contracting in the UK. Notably, US large-cap margins are expanding while those of small-cap companies are not.
• There are continued signs of disinflation (a deceleration in the rate of price increases) in slowing wage growth in the US and Europe and in other supply-side measures, such as shortening global delivery times. Wage growth may just be lagging consumer inflation, however. Although we see disinflation as a significant possibility, our base case is reflation, with the US core and headline inflation at 3-4%. This is in light of expected base effects and the current strength of services inflation.
• With inflation still above 3%, it will be difficult for the US Federal Reserve to cut rates. Outside the US, lower inflation is unlikely to lead to significantly lower sovereign bond yields given US fiscal dominance.
• That said, rate cuts (first in the Eurozone and then in the UK) and the reduced risk of US rate hikes have positive implications for bond returns and support the equity cycle. We continue to favour equities and high-yield bonds.

Around the world

In this section, we set out our views on the world’s main equity markets. We remain positive on the outlook for global growth and continue to prefer equities over bonds. In this, we are encouraged by the global purchasing managers’ index (PMI), which remains at an expansionary level (above 50) and has shown the strongest output gains for almost two years, with a notable acceleration in May. But we are mindful of the risks of reflation, and we note that equity valuations are looking increasingly full, especially in the US and Japan.

United States

Many US stocks continue to look richly valued. After steady share-price gains in the first quarter, a dip in April was offset by renewed gains in May. The constituents of the S&P 500 index are now in the 90th percentile of their historical valuation range. Although US economic growth decelerated significantly in the first quarter, forward-looking data improved in May, with the composite US PMI showing that economic output has hit a 25-month high.

The US core Consumer Price Index (CPI) fell slightly in April to 3.6%, down from 3.8% in March. Nevertheless, the core CPI has now been above 3% for 10 months. This reinforces our view that we are moving into a reflationary regime. Under this regime, real GDP averages 2% and the core CPI averages 2–4%. Over the next 12 months, we expect core CPI to remain in the lower half of that range. Markets have acknowledged this development, revising the number of rate cuts expected for 2024 (from six at the end of 2023 to between one and three at present) and pushing out the timing of the first cut to September. Given the uncertainty over the timing of cuts, we continue to favour high-quality, strongly cash-generative equities.

We continue to see the potential for a liquidity impulse (a sudden injection of money into the market) ahead of November’s presidential elections. The Treasury General Account ($770 billion) is currently in surplus of the $750 billion average that the Treasury seeks to maintain, so there is room for this to occur. This would provide support for US equities.

The main risks to our outlook would be if earnings growth were to remain narrowly concentrated in the ‘Magnificent Seven’ (Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla) and if housing costs were to rise in the wake of a liquidity impulse.

Rest of the world

Improving economic data around the world continues to challenge the notion of US exceptionalism. Other countries are showing signs of improving economic health and quiescent inflation. Both the Eurozone and the UK are likely to be able to cut interest rates before the US.

In Europe, economic data remains positive. In April, the Eurozone and UK economic surprise indices continued to build on their strong performance in the first quarter. Although there was a slight uptick in German consumer inflation, UK inflation fell to its lowest level since July 2021. In contrast to the stubbornly high CPI in the US, the German CPI has fallen 4 percentage points over the past 12 months (from 6.4% to 2.4%) while the UK CPI has fallen 6.4 percentage points (from 8.7% to 2.3%). We think that this gives the European Central Bank scope to lower interest rates in the summer. The market currently expects four cuts this year.

In the UK, Rishi Sunak, the prime minister, announced that a general election would be held on 4 July – much earlier than expected. The move was especially surprising as the ruling Conservative Party is currently far behind the Labour Party in the opinion polls. Election campaigning is now in full swing.

Meanwhile, the Bank of England is expected to begin cutting rates later this year. A plurality of market participants expects three cuts in 2024, with the first cut to come in August. We agree that the ‘sticky’ inflation components – wages, shelter, and service costs – will encourage the Monetary Policy Committee to hold rates until the late summer. Our preference is still to be underweight UK equities and overweight gilts.

In China, we continue to see little evidence of a sufficient growth impulse or ability to stimulate demand and combat credit challenges in the property sector. The equity market has responded well to recently imposed limits on short selling, however.

In True Potential’s view, we have become somewhat more cautious on Japan. The Japanese equity market has been boosted by the Bank of Japan’s reintroduction of monetary tightening after a 17-year hiatus, as well as by strong earnings growth and a weak yen. As in the US, however, the very strong performance of the equity market has left many stocks looking fully valued.

Summary

We are multi-asset investors who take a long-term view on the world’s markets. Given fuller valuations, we have grown more cautious on the US and Japan in the equity markets. Although we continue to favour UK gilts in the bond markets, we see attractions in inflation-linked securities and corporate credit, especially high yield. We remain alert to opportunities across the full span of markets and are committed to global diversification across our portfolios.

All data sourced from Bloomberg L.P. (30/05/2024)