‘The Year of Answers’, as we had called 2024 in our annual global investment outlook, is living up to its name, with an avalanche of data points and events.
From economic releases to corporate earnings and central bank meetings, visibility has improved. This didn’t reduce volatility at all.
As we expected, it’s actually the opposite and it should unapologetically continue. Still, the fundamental picture remains constructive, excluding an external “tail risk shock” of course.
Let’s start with the economy.
Both global growth and inflation surprised to the upside in the first quarter, which resulted in a radical shift in market expectations for the trajectory of policy rates. This was a lot about US exceptionalism, growing above potential, with an unbreakable labour market and sticky inflation.
April, however, showed a different picture from the just released PMIs (Purchasing Managers Index), widely considered leading activity indicators.
- First, the US is decelerating. Both the ISM Manufacturing and Services are just below 50, which marks the threshold between expansion and contraction.
- Second, the US labour market is cooling, with ‘only’ 175,000 jobs being created in April, which compares to a median forecast of 240k, after 315k in March and 270k in February. Hourly earnings continue to gently rise, but the number of hours actually worked is trending lower. Inflation remains too high in the US, but we don’t see a ‘wage/price’ spiral.
Now, the most interesting is that while the US is decelerating, but not breaking, the rest of the world is clearly improving. The composite PMI measure (which combines manufacturing and services) is now 51.7 for the Eurozone, 54.1 for the UK, 52.3 for Japan, 52.8 for China: all in expansion, and all higher than in March.
India continues to fly (61.5), while the UAE and KSA remain extremely healthy. In summary, while global momentum is gradually slowing, the sources of growth are diversifying, leading to improved balance and robustness. This is positive news overall.
What are central banks up to next?
Now, let’s talk about the central banks. A cornerstone of our 2024 outlook is that they should have limited leeway for action, between the threat of inflation on one side, and the multiple risks of being too restrictive on the other – which could harm growth, question debt sustainability, and hurt voters’ feelings.
The monthly policy meeting from the Fed was a perfect illustration. As widely expected, rates were kept unchanged. However, the institution announced a material downshift in the pace of their monthly balance-sheet reduction (quantitative tightening).
Expanding the balance-sheet (quantitative easing) is an injection of liquidity that supports markets. Shrinking it has the opposite effect, so shrinking less is a net positive.
Finally, but crucially, the press conference from Chairman Powell was much more balanced than most analysts expected. He appeared patient, if not optimistic, on inflation, while highlighting the risks of staying too restrictive for too long.
End to the rate hikes?
A rate hike is ‘highly unlikely’: the worst case is to hold if inflation persists. But they will cut when it normalizes, as well as in case of a material weakening in employment. No surprise that between these statements and the following job report, US Treasury yields dropped by roughly -20 basis points across the curve, in two days.
This brings me to the third point: market action. We are gaining confidence in our view that with less space for central banks to act, fundamentals are the key driver for markets this year.
Q1 corporate results exceeded analysts' expectations by a wide margin, between 6-8 per cent at the earnings per share level so far. This justifies the asset class’s positive returns this year in the same way that negative bond performances are explained by faster growth and stickier inflation.
Look at MSCI China
This is fundamentally rational. It gets even more interesting: did you notice that the MSCI China now outperforms the US, Japan or even India this year (total return in US dollar)?
China was considered ‘uninvestable’ not that long ago by many. Why is it good news? Because it is also fundamentally rational, considering the valuation, expected growth and even higher risk.
Differentiation also happens at the single security level, even within the most hyped sectors. For example, the ‘Magnificent Seven’ are not acting like one anymore. The best of the seven outperforms the worst this year by 110 per cent - this difference was only 20 per cent in Q4.
Fundamentally driven markets are theoretically beautiful, but factually painful on short-term horizons: volatility is higher than when central banks liquidity is everything, and it may even spike further when we approach the US election heat.
But fundamentally driven markets unlock the benefits of diversification, selectivity, and analysis. The current backdrop is supportive for disciplined investors: diversified, patient, and selective. April showers are said to bring May flowers; we’re not sure about the timing, confident that the medium term should be fruitful.
