Horizon Q2│2024 - Multi-asset strategy

First quarter: easier financial conditions support the economy

The significant easing of financial conditions by the capital markets in November / December 2023 (such as lower interest rates and risk premiums) have given the US economy in particular new momentum. US bank lending standards have also been eased considerably and, despite quantitative tightening, net liquidity in the US has been supportive due to the reduction in the reverse repo facility. Since the beginning of the year, however, economic surprises have also turned positive in the eurozone, China and Japan. By contrast, US inflation is proving to be more persistent. As a result, the interest rate cuts priced in by the markets at the end of the year have been more than halved. Bond yields rose again, with 10-year Bund and US Treasury yields up by more than 40 basis points – 10-year US real yields climbed to 2%. As a result, many bond segments have been negative since the beginning of the year. The US dollar strengthened slightly. However, economic optimism dominated in equities and oil – the markets are pricing in positive earnings and economic developments in the long term, which would be consistent with higher real yields.

Economic recovery carries risk of higher rates for longer

Consensus forecasts for global economic growth in 2024 have been rising since the beginning of the year, led by the US. In February, the global manufacturing PMI rose above the critical 50 level for the first time since August 2022. A global economic recovery is taking shape. Against this backdrop, and with US growth above potential, a resurgence in inflation remains a key risk for markets. Short-term inflation dynamics have already picked up somewhat recently. This could weigh on the economy and equity markets again, like the phase from end-July to end-October 2023. At that time, however, the Fed had raised interest rates again, which is now unlikely given that the current federal funds rate is significantly higher in real terms, even with more persistent inflation. However, a renewed rise in US 10-year real yields to 2.5% would likely necessitate further rate hikes – unless this reflects solid growth prospects, in which case it should not be a major problem for equity markets.

Rate cuts despite economic recovery = stable bond yields

If inflation continues to fall for the time being, as our economists' baseline scenario suggests, central banks are likely to start cutting interest rates in June, despite the emerging economic recovery. However, long-term bond yields are unlikely to fall by much. With structurally higher inflation and rising government debt, the risk premium for holding long-term bonds, the “term premium”, should normalise somewhat and the yield curve should steepen again. Longer term, we see limited scope for interest rate cuts without a recession. In addition to structural factors such as demographics, the energy transition, reorganisation of supply chains and the arms race, a Trump presidency with potentially higher tariffs, a return to lower immigration, further inflationary pressures from de-globalisation and a strong fiscal expansion should not be overlooked. Also in view of the high US budget deficit, we believe a high proportion of real assets and inflation protection in portfolios remains important.

Moderate equity potential with greater market breadth

The improved economic outlook has not yet been reflected in significant upward revisions to earnings estimates. As a result, the gains have been almost entirely the result of rising valuations, particularly in the case of US equities. Without upward revisions to earnings expectations, further upside is likely to be limited, even if interest rates are lowered. However, profit margins are under pressure from wage growth and interest rates. Strong productivity growth (e.g. through AI, shorter supply chains, automation, sufficient energy) is therefore essential.

Contrary to our expectations, market breadth has remained low so far this year. Equity-weighted indices have underperformed market-cap-weighted indices (bottom chart). AI euphoria has once again boosted a few large companies, and interest rate sensitivity is evident beneath the surface. However, if the picture of imminent first rate cuts solidifies despite signs of economic recovery, market breadth should increase and (European) small caps and commodity prices should recover. In the US, the relative performance of the equally weighted index that we allocated to via an ETF in March has stabilised recently.

Sentiment and positioning increase market vulnerability

The synchronisation between equities and bonds has diminished significantly, bond volatility has fallen and equity volatility is low. Systematic investors have therefore continued to build equity positions and are now highly positioned. Investor sentiment is bullish. In addition, according to surveys and analysis, cash ratios of US mutual funds are below average. Equity markets are therefore more vulnerable to a correction. However, in the absence of a trigger, the typically positive seasonality in April and the prospect of interest rate cuts in June could see equities continue to rise, driven by laggards that are likely to outperform as we move into the summer. Equally weighted indices and small caps are likely to catch up. However, setbacks are likely in the third quarter at the latest, during the typically weak summer and in the run-up to the US elections. Given the many risks, this argues for a broad, balanced positioning. Our expectation of steeper yield curves and little change in long-term yields argues against an increased duration positioning. If the economy recovers, high-quality corporate bonds will remain attractive despite lower risk premiums. Given the strength of the US economy and a possible Trump victory, the US dollar is unlikely to weaken much for the time being.