Our previous column – ‘Don’t sell in May, don’t go away’ - was unusually tactical.
I’m quite relieved to report that all asset classes had positive monthly returns, led by equities, and that it continues into the first sessions of June so far. It however didn’t happen in a straight line: a rally of everything following the May FOMC, then two weeks of doubt and profit taking, and another wave of optimism in the recent days.
Dear readers, fasten your seatbelts: volatility is here to stay, and should most likely increase in the months to come. Let’s get into it.
Our base scenario for 2024, which we call ‘The Year of Answers’, is (boringly) unchanged. The global economy is gently decelerating, with a rebalancing between less US exceptionalism and more recovery elsewhere.
Inflation should continue to moderate, but it will be erratic and slow. But crucially, we strongly believe that central banks have a very limited leeway for action: whatever they say (and they speak a LOT), all Western central banks should start cutting rates without committing on future action.
Our investment implication views are also unchanged: we expect 2024 to provide reasonably positive returns, at the price of very high volatility from three sources - economic data, geopolitics, and politics. The good news is that markets respond to fundamental drivers instead of just inflation and central banks, which unlocks the benefits of diversification and selection.
As we approach the middle of the year, this scenario is so far unfolding. Growth is actually slightly stronger and inflation a bit stickier than we initially thought, but the big picture remains a soft-landing, with improved regional and sectoral balance.
Market expectations for Fed policy action are randomly gyrating, from 6 cuts in 2024 at some point to zero a few weeks ago, now pricing in two cuts which is also our own, steady forecast. The US job market is expected to cool down, and corporate profits are delivering.
Volatility is not going anywhere
As a result, our cautious, moderate and aggressive profile show positive year-to-date returns of +2 per cent, +5 per cent and +6 per cent, respectively, with full benefits of diversification as the negative performance from government bonds is offset by the positive returns from equities. What’s not to like?
Well, nothing, of course.
But it’s important, especially in good times, not to get carried away. First, +5 per cent in 6 months for a balanced portfolio is not insignificant. It’s strong, and you need a few starts to seriously align to expect the same in H2-2024.
We remain absolutely convinced that volatility will continue to be elevated, from the three sources we highlighted. Any economic data will continue to impact markets more than they used to in recent years.
The next one at the time of writing is the US monthly job report, where the consensus is for 185,000 job creations, but we can feel that markets expect a lower number to validate the recent rebound in bonds. July will see the Q2 corporate earnings, and potentially crucial policy decisions in China.
Geopolitics are extremely fluid, between what increasingly looks like a trade war between the West and China, and two theaters of armed conflicts involving superpowers with little hope for de-escalation.
A couple of election-linked jolts
Finally, markets care about elections, and they hate surprises, as illustrated by the sharp equity drops in South Africa and in India last week. The November US elections are extraordinarily open and extraordinarily important for the world. The major risk is not about the result itself: it is not having an uncontested result which could lead to a long period of uncertainty, with potentially serious trouble as the levels of mistrust and polarization are higher than ever.
Electoral heat usually hits markets at the end of the summer, but we note that this year, the first debate between the two probable leading candidates is scheduled unusually early, in late June. As both are unpopular, could there be some big change in case there is a clear losing candidate? A legal or health issue for one or the other?
Now, what to do. Volatility is part of investors’ life, and it’s simply all about preparation. Here is a simple checklist. First, don’t speculate.
If your horizon is less than a year, simply grab the risk-free yields from the money market and don’t even think about buying Nvidia.
Second, be diversified: economic weakness is bad for stocks and good for safe bonds, take advantage. Regional dynamics are decoupling, sectoral valuations are heterogeneous, that’s also good news.
Third, don’t hesitate to adjust your exposures tactically in a contrarian way, but never go all in: small, progressive moves are the way to go so that your portfolio structure stays sound, which preserves your emotional control as well. This is exactly what we do in terms of tactical allocation.
Finally, keep an eye on tail risks – we all pay a car insurance for low probability, high hassle risks after all, why not doing the same for your portfolio? A reasonable allocation to gold or even Swiss francs or Yen can’t hurt much, especially as we approach the heated US elections.
