- Cycle and Scenario:
- Improving growth momentum, despite the resilience of inflation, means the macro backdrop is still relatively favourable for risk assets, with valuations still a major concern, but we do not think that the US economy is overheating. Asymmetries between regions and sectors are set to rise.
- Looser financial conditions and ample liquidity remain in place, which partially explains the recent rerating of risk assets.
- Our global asset cycle framework indicates that we are moving out of the downturn phase and re-entering an improving cyclical phase. However, a more in-depth analysis suggests that without lower rates this expansion will be extremely cyclical, and the global economy will re-enter a slowdown.
- Disinflation remains bumpy and the risks for the Fed have fundamentally shifted and thus it will not be in a hurry to further ease financial conditions. Rising geopolitical tensions – see recent Iran/Israel hostilities – could further slow the disinflation process. We still expect no more than two cuts this year and see an increased likelihood of a no-cut scenario.
- While US inflation is accelerating, this is not as evident elsewhere in the world, suggesting other major central banks could cut rates first. The USD will remain strong until the Fed starts easing. A more worrisome development would be if the Fed increases rates while other parts of the world are easing policy.
- Higher-for-longer rates contribute to an increasingly idiosyncratic risk. But the looming maturity wall for corporate borrowing has been pushed further into the future thanks to healthy investor appetite for fresh debt at tight spreads. This means a more balanced approach between equity and fixed income.
- Equities:
- After the strong 1Q performance, upside potential looks limited. We expect healthy corrections in 2Q, although no dramatic sell-off, as buybacks and a lack of new issuance will contribute to keep ERP low. But US equity valuations are stretched at levels not seen since the dotcom era.
- We stick to Neutral, with a preference for Europe vs. the US on valuation grounds. Within EMs we now favour Asia over LatAm on valuation grounds and healthier EPS perspectives.
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- Rotation from growth to quality value should continue, favouring Energy, Financials, Industrials and Health Care. These sectors can also ‘afford’ to maintain their ambitious buyback plans on the back of a strong cash flow revenue generation.
- US IT: turning more cautious as valuation is very stretched – particularly in those hyped AI names. It is not in bubble territory yet but is moving towards it.
- Fixed income and FX:
- DM Credit: Positive—although US IG corporate spreads are tight, yields still look attractive. Fundamentals are firm, demand is strong, and the pace of new issue supply is set to slow. US spreads will be generally range-bound between +85 and +115 bp through to the end of the year. The risk in global portfolios leans towards euro spreads given their wider levels.
- DM Rates: no significant yield decrease in the short term. We still think duration is attractive with US 10Y yields in the 4.5-4.75% range in the medium term, despite short-term volatility. We are not changing our long-term rates or inflation forecasts and maintain our year-end 2024 10Y US Treasury forecast of 4.25%.
- Constructive on EM hard currency against a backdrop of moderating growth and inflation. Given its high carry, EM debt looks attractive on a relative basis versus comparable asset classes, and a mild spread tightening and/or declining core yields could raise total returns into the double digits. Local market performance may be challenged unless the Fed begins cutting rates.
- FX: fundamental tailwinds will keep the USD strong despite its overvaluation, while more divergence in the interest rate cycle will increase the downward pressure on EM currencies.
- Investment Ideas:
(i) European Gems and US jewels: Europe and US names with strong fundamentals and which have lagged behind their benchmark indexes after recent sharp rises;
(ii) Defence technology trends and innovation: leveraging from the increasing tensions globally;
(iii) All that glitters is gold: smart strategies to capture the current strong gold momentum;
(iv) Credit: Jewels in Non-Financial-Corporate Credit in Europe and the US.