Investors should not take outsized risks even as global economy gives off good signals

‘The Year of Answers’ is the title of our annual Global Investment Outlook, and the first quarter of 2024 is starting to provide clarity on the big questions of 2023 (which we had called ‘The Year of Unpredictability’).

Those big questions, with regards to macro-economic items, are obviously the relative trajectories of growth and inflation, and the reaction function of central banks.

Bottom-line, the first answers are mostly positive. Beyond the good news, markets appreciate visibility itself and so far show a refreshingly fundamental behavior. We are thus reasonably constructive for the months to come.

Starting with economic activity, global growth is unambiguously resilient. The pace of its deceleration is reasonable – it is slowing down very slowly. Importantly, it’s also about quality: the sources of global growth are broadening.

The US consumer is not the only economic superhero anymore, not because it’s alarmingly deteriorating, but because the rest of the world is improving, as shown by the just released flash PMI indicators for March. The composite PMI for the Eurozone improved to 49.9, better than forecast and close to the expansion level (50 is the neutral point).

The same measure is at 52.9 for the UK, 52.3 in Japan, and a spectacular 61.3 in India. In the US, the PMI Services decelerated but remained in expansion at 51.7, while the manufacturing gauge accelerated to 52.5.

Soft landing mode for global economy

The US job market is not materially weakening, business confidence and even home sales are well-oriented.

Meanwhile, public support continues to build up in China, with ambitious targets for this year – China is usually serious about reaching targets. Bottom-line, while the global economy slows in 2024, it is an extremely smooth ‘soft-landing’.

Better-than-expected growth raises of course the second key question: inflation. Again, we have better clarity: the pace of disinflation is slowing, if not stalling. Apart from China, core inflation is higher than the magic 2 per cent number pursued by most central banks: 2.8 per cent for the US core PCE, but also core CPI at 3.1 per cent for the Eurozone, 3.4 per cent for the UK, and 2.8 per cent in Japan.

Worryingly, these numbers don’t seem to be heading much lower, but what matters most for markets is not the level in itself. It’s the trend, which is not alarming and crucially how central banks react.

This is the third question, where visibility also improves, aligned with our 2024 theme of less leeway for monetary policymakers, leading to less domination on financial markets.

End of negative interest rates

Indeed, the tone has changed. Last week, the Bank of Japan ended their negative interest rates and most of their unconventional policy tools, but clearly stated that they want a vigorous economy and a persistent inflation. Markets loved it. In the US, the Fed revised higher their 2024 projections for both growth and inflation, but did not change their rate projections, an unchanged 75 basis points of cumulative easing this year (from three cuts).

Chairman Powell confirmed a more relaxed stance, downplaying the recent absence of disinflation and adding that they would adapt to any unexpected deterioration in the labor market. Last week, on Thursday, the Bank of England left their rates and guidance unchanged, but the minutes revealed a clear step closer to cutting rates.

Finally, the Swiss National Bank was the first in the West to actually cut rates. No doubt, Western central banks are much less scared of inflation and their next move is to start a gradual easing.

The rate cuts are coming

There are several investment implications. For the short-term, it’s positive.

Better than expected growth supports earnings (already turbo-charged by the prospects of AI). Visibility on monetary policy is good for the fixed income asset class as well: we should pretty much get orderly 25 basis points cuts every quarter from June from major Western central banks.

So, bond returns should be close to their coupons while stocks should evolve in line with their earnings. This is why, last week, we actually put more cash at work. We slightly increased our allocation to equities and remain overweight on money market funds, with their unparalleled risk-adjusted returns for the months to come, and on quality bonds of reasonable duration, for their safety and comfortable yields.

Now, don’t get me wrong. We are constructive with improved visibility for the coming months.

But the volatility of 2024 is certainly not suppressed, at all. First, we don’t know what lies ahead: central bankers may be wrong and inflation could make a come-back. Additionally, geopolitical developments remain extremely fluid and the heat of US elections will become intense at some point.

2024 will continue to bring answers, but also new questions and more volatility in the second part of the year, potentially from the summer. This is why we are more invested but not taking outsized risks.

We also remain cautious on duration, waiting for a better entry point on the longer end of the yield curve. More than anything else, 2024 is about the benefits of diversification, which is the case so far with very differentiated behavior between bonds and stocks, as well as between regions and sectors.

This is good for well-built multi asset portfolios. Enjoy visibility, but never ever go ‘all in’…