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Shifting winds call for a tweak in investment strategy
3 min read – Global Chief Investment Office
Our 2024 investment strategy of ‘Sailing with the Wind’ has performed well in the first half of this year on the back of a strong equity market rally. However, keen investors will know that prevailing winds can change and it is crucial to adapt investment strategies accordingly.
Looking ahead to the second half of 2024, one big shift is the fact that major central banks have started to cut interest rates. The other one is the upcoming US Presidential election. Therefore, we believe it is time for investors to ‘Adapt to Shifting Winds’.
We expect the following:
• Equities to outperform bonds and cash. This will result in diversified strategies consisting of stocks, bonds, and alternative assets which may outperform strategies solely geared towards generating income.
• US equities are likely to outperform global markets.
• In Asia, Indian equities are likely to lead.
• Gold and Emerging Market bonds to offer diversified sources of return.
Policy inflection point a key positive for equities
Major central bank rate cuts, which started in Q2, are likely to extend into the second half of the year. Europe is the forerunner along this path. The central banks of Sweden, Switzerland and Canada and the European Central Bank have already cut rates as growth and inflation slow down. We believe the Fed has room to follow suit, albeit later in H2, as slowing rents and softening labour markets drive US inflation lower.For markets, this policy shift is significant as it creates the conditions for our soft-landing view to pan out. Pre-emptive rate cuts that sustain economic growth will help boost corporate earnings. These conditions should result in equities continuing to outperform bonds and cash in H2 2024.
US and Indian equities to lead
We believe that US equities will continue to outperform as compared to other major equity markets in H2. Strong US corporate earnings are a cornerstone of our view, given that expected earnings growth for the next 12 months has been revised higher since the start of the year. We expect gains to broaden beyond the Mega-cap technology and communication sector stocks by the end of this year.
US equity valuations are high and have been one key pushback against our positive view. However, we believe these are justified by a high return on equity (ROE). In our view, this suggests valuations are unlikely to be a barrier to further gains in an environment where markets remain focused on growth assets amid upcoming Fed rate cuts.
Fig. 1 High US and Indian equity market valuations arguably justified by high return on equity
12m forward Price/Book vs. return on equity
Source: FactSet, Standard Chartered
Nevertheless, despite strong gains in early 2024, equities may face short-term volatility due to low cash levels and the upcoming US elections.
Beyond the US, we have a Neutral view on most other major markets. We have upgraded Euro area equities from Underweight to Neutral. This is due to a revival in growth despite political uncertainties.
We also have a Neutral view on Japan. The positive factors such as share buybacks, shareholder-friendly reform, and higher nominal growth are offset by negative signals from our technical investment models. We are Underweight on UK equities amid low earnings expectations.
We are Overweight on Indian equities. The economic and earnings growth outlook stays positive and the completion of elections puts a key event risk behind us. Indian equity markets rank second highest, after the US, in terms of ROE. While valuations are challenging, we prefer large-cap equities which will help to mitigate this risk.
We have a Neutral view on Chinese equities. Positioning and valuations suggest the easy gains are now behind us as both metrics have moved away from excessively negative extremes. This now puts the onus on earnings growth, which is likely to require greater policy support.
Carry remains key
‘Carry’, or the yield, remains the key opportunity in bond and FX markets. It is, however, much harder to find value. This balance causes us to have a Neutral view on global bonds.
History reminds us that US dollar bond yields generally peak not far from when the Fed stops hiking rates and fall near or ahead of Fed rate cuts. While the magnitude of this decline varies depending on the size of rate cuts, history strongly argues for locking in today’s yield. Holding a benchmark allocation to bonds in a diversified portfolio is attractive compared to cash. We have a Neutral view between government and corporate bonds. While corporate bonds offer a slightly higher yield, their yield premiums over government bonds offer little value.
Emerging Market (EM) bonds offer both opportunity and risk. We are Overweight on EM USD-denominated government bonds due to the high yield and better value. This means they are likely to outperform global bonds. In contrast, we are Underweight on EM local currency bonds as we believe the yield does not compensate for taking on currency risk. Many major EMs are also unlikely to cut rates as deeply or rapidly as Developed Market (DM) central banks, limiting price gains in EM local currency bonds.
Gold a bright spark
Gold has been a top-performing asset class in the first half of this year. What we find most interesting is how the gold rally continues to be driven by a tight demand/supply balance rather than falling bond yields. We see room for this to continue given central bank demand is strong, while a likely decline in interest rates in the coming months turns more supportive for gold amid central bank rate cuts. While we continue to have a Neutral view on the asset class, H1 has been a lesson on why it is important to build and maintain a core holding in gold within diversified foundation portfolios.
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