Macroeconomic backdrop

The ‘higher for longer’ rate mantra and growing speculation that the US Federal Reserve would delay cutting interest rates until the end of 2024 undermined equity and bond returns in April. Fears that the Israel/Hamas conflict would spread to the wider region escalated, although the oil price was little changed by month end. China’s economy expanded by 5.3% year on year in the first quarter, a stronger than expected outcome. The data boosted hopes that the worst of China’s slowdown was now behind it, although the real estate sector continues to be a drag.

Market update

Having enjoyed uninterrupted gains since late October, equity markets finally exhibited some volatility during April. Sentiment was affected by monetary policy concerns linked to sticky US inflation, as well as higher geopolitical tensions. In most key markets, equities delivered negative returns over the period, while bond yields rose as prices fell. US equities were among the weakest performers. European and Japanese stocks also declined. In contrast, Chinese equities rebounded, helped by stronger than expected Q1 GDP growth and the authorities’ measures to restore confidence. Global bonds weakened as investors reassessed the scope for major central banks to cut rates. The US dollar appreciated against other major currencies over April, while the Japanese yen fell to a 34 year low. The gold price rose further. 

Our view

Previously we noted that demanding valuations and abundant positive sentiment were concerns in the near term, but that any meaningful correction would need to be driven by material negative macroeconomic events or a deteriorating earnings outlook. Our base case was that neither of these scenarios was likely, and this remains our view. Indeed, there is an increased risk of few, if any, interest cuts in the US this year, encapsulating the ’interest rates remaining higher for longer’ mantra. While tighter financial conditions will inevitably weigh on economic growth, our sense is that the recent sticky period of inflation should subside. Although delayed, the next rate move by the US Federal Reserve is still likely to be a cut, helping to provide a floor to any excessive market movements.

We retain our preference for equities on expectations that economic activity will remain resilient. Tighter financial conditions might have an impact on growth in developed markets, but improving corporate earnings will continue to support rising equity prices. Our market selections have broadened from the US and Japan and now include Europe. The European Central Bank is likely to be first major central bank to cut interest rates, and this should provide a positive tailwind in Europe. In this environment, the region’s defensive yield and income characteristics should be better rewarded in the months ahead.

Our increase in developed markets exposure is being offset by a reduction in emerging markets, where we have lower conviction.

Within fixed income, our preference is for eurozone government bonds. Growing uncertainty about US rate cuts suggests volatility may be more of a feature there relative to the eurozone, where we expect yields to be more range bound given a better inflationary backdrop. In contrast, we remain neutral elsewhere across fixed income and given the tight level of credits spreads, we see more attractive upside in equities.

To accommodate our positive selections on bonds and equities, we have very limited exposure to alternative assets or cash.