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Riding the equities wave

Wealth Insights: Riding the equities wave

Manpreet Gill Chief Investment Officer of Africa, Middle East and Europe

7 Mar 2024

Home > News > Wealth & retail banking > Wealth insights > Riding the equities wave

A friend of mine is a keen surfer. He often reminds me that catching the right wave, and riding it successfully, can mean the difference between a successful day out on the surf and one spent treading water near the shore. As is often the case, though, it takes time to develop the judgment and skill to pick the right wave and ride it well. Unexpected waves can still surprise even the most skilled surfers.

A strong start to 2024

The equities wave has been well worth riding thus far in 2024. Global equities have risen about 5% year-to-date, with our preferred markets, the US and Japan, leading the way.

Bonds, however, have had a more muted start to the year. Positive returns have been led by riskier and more ‘equity-like’ high yield bonds. High quality Investment Grade (IG) bonds have faced headwinds as markets have pushed back expectations of the first Fed rate cut to June as sticky inflation led Fed policymakers to signal delaying the start of policy easing. We, however, view this positively for high quality bonds as it brings the market’s assessment now in line with our own outlook for Fed rates.

Growth optimism or exuberance?

Should investors continue to ride the wave in equities? When it comes to US equities, optimists argue that the underlying earnings fundamentals remain strong, the labour market remains resilient and the Fed could cut rates pre-emptively to head-off a recession as inflation softens. Pessimists, however, argue that valuations are now lofty and that the concentration of the rally among the technology leaders (the ‘Magnificent Six’) is unusually narrow.

Insights from the technology sector can help. There is undoubtedly some merit to the view that earnings growth is strong – the US technology and communication services sectors rank among the top 3 sectors in terms of 2024 expected earnings growth. This follows a 70% y/y surge in earnings growth in Q4 23 for the so-called ‘Magnificent Six’ (Alphabet, Amazon, Apple, Meta, Microsoft and Nvidia). This is also likely why technology sector gains are no longer about falling bond yields – this relationship appears to have started breaking down from last year.

A second insight likely comes from investor positioning. Our own market diversity indicator continues to warn that US equities, and the technology sector, face a still-significant risk of a temporary consolidation. Fund manager surveys similarly show falling cash levels among institutional investors and rising consensus on US equity allocations.

On balance, we believe it makes sense to remain Overweight on US equities in foundation allocations, and maintain our Overweights to technology, communication services and healthcare sectors in opportunistic allocations. While the risk of a temporary pullback or consolidation are higher than usual, we believe the resilience in economic and earnings growth, supported by strong corporate margins, is likely sufficient for the current wave to extend further.

Japan and Asia

The standout gains in Japanese equity markets (and indeed in Indian equities within Asia) elicit a similar question – can the gains extend? In Japan, the jump in stock buybacks argues there is substance behind the optimism about improving corporate reforms. This, along with relatively fewer short-term positioning concerns, is why we retain our Overweight view.

Within Asia ex-Japan, though, the debate between India and China equities remains an intense one. The outlook for Indian equities is potentially similar to that for US markets – strong gains since Q4 2023, arguably justified by growth and earnings optimism, but now at high valuations. In contrast, Chinese equities offer unusually cheap valuations, but greater uncertainty about the growth outlook.

In China, markets continue to look towards policymakers for a catalyst. Measures thus far have not revived the equity market sentiment in a significant way, but the Hang Seng Index’s outperformance compared with global equities since its end-January suggests some investors believe policy support is approaching a critical level.

On balance, we believe a neutral allocation to both Indian and Chinese equities within Asia ex-Japan offers the best way to balance the risk and reward. For Indian equities, this ensures maintaining moderate exposure without taking excessive risk. For Chinese equities, a neutral allocation ensures exposure to what could be an unexpectedly rapid rebound, given the unusually bearish sentiment and positioning. Raising exposure to the market as momentum improves, or adding exposure to preferred equity sectors, can be additional ways to improve the risk/reward in Chinese equities.

Staying the course on bonds

Unlike equities, bonds have faced headwinds from rising yields as markets went through a repricing of the likely start of a potential Fed rate cutting cycle. Nevertheless, we expect growth and inflation to continue to slow in the coming quarters as the impact of past Fed rate hikes starts to bite. As the Fed starts cutting rates, high quality bonds are likely to offer an attractive risk/reward. Therefore, we believe the recent backup in yields offers a renewed opportunity to add exposure. This is particularly true relative to staying in cash. History shows us that USD cash returns failed to beat inflation in four of the past six decades, regardless of the starting yield level.

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