Recently, we hosted our latest market update for clients, where independent Investment Committee members George Boubouras, Tim Macready, and Quentin Stewart provided valuable market insights on the year to-date, the global economy, upcoming U.S. election and considerations for investors for the remainder of the year.
Given risk assets have been resilient through 2024, and the anticipated bond bounce has not yet materialised, what are your thoughts on what investors can expect for the second half of 2024?
It is possible that there will be moderation in equities, perhaps some sort of correction and a long-term slow decline in bond yields which would provide some appreciation to bond investors. The broad outlook of equity market valuations looks stretched, although there have certainly been some individual standout performers over the last few months. Our consistent message is to stay invested, invest for time, try not to anticipate what is going to happen, but keep your money working as hard as you can for as long as you can.
Moving to global macro and geopolitical issues, there are contradictory views with some predicting a market correction given the strong rally, particularly in the U.S. and yet others that see this rally continuing given solid company earnings and growth prospects. What are your thoughts?
This is all about appetite for risk and the right time to deploy cash was 18 months ago, yet so few people did. Trying to time markets is inherently difficult because it’s not about what you know, it’s not about what you think the future might hold, it’s about if you have the appetite to make those decisions at the right point in time. Very few people do as most don’t see when it’s the darkest hour before dawn or dawn coming. To earn a consistent return on capital stay invested for as long as you can, recognising there will be volatility.
With interest rates on cash now above inflation, we’re no longer going backwards in real terms or are we? A cash rate of 5.50% looks good until you can factor in inflation that’s still above target. The number of scenarios in which equities and bonds persistently fall is sufficiently low in that cash has some optionality value, but little beyond that. If you believe that equities are likely to hit some headwinds, the bond markets offer some protection. The European Central Bank (ECB) has started cutting rates, the Bank of England (BOE) is expected to cut rates as is the Federal Reserve in the U.S. We believe it’s a shallow rate cut cycle, which is positive for broad risk assets.
Trade wars – China vs. US?
China is countercyclical. It’s going through the worst property correction the world’s ever seen, and growth is slowing at an alarming rate. The Chinese Central bank did do a surprise interest rate cut recently, however this was not done to stimulate domestic demand, rather Beijing’s intention is to ensure that their production and export sector is positioned as the key supplier of renewables and their supply of energy is diversified. They’re building capacity, have excess capacity and are exporting to the world, at a level never seen before.
China is basically retooling its economy – moving their economy away from basic manufacturing to something much more sophisticated and that’s policy driven. When you have a central government with significant resources able to do that, in a coordinated way, it’s a different game to the one we play in the West.
Inflation has peaked…
Although it’ll be some time before we see inflation back within targets, particularly in US, China and Europe. At current levels its manageable however, there is still significant wage price inflationary pressure in the UK, and to some extent Europe, largely driven by what are effectively stagnant labour markets, where mobility is low, both in terms of people’s ability to physically move and their willingness to work. Whilst those circumstances remain, inflation remains a threat. Another point to consider is the nature and stubbornness of ‘core’ inflationary measures among major economies, which are problematic for policy so when rate cuts begin, they will be shallow.
Given the challenge now facing central banks is engineering a soft landing, what’s your view on fixed income?
Short-term it could go either way. Long-term, rates need to slowly come back to more normalised levels, so for investors looking for some level of stability, there is good yield available now, with reasonable duration and return.
At this stage of the cycle, credit quality is better, so it’s reasonable to assume that the rate cut cycle sometime next year is a shallow one. Central banks may not need to cut rates drastically as the economy has been expanding, earnings have been growing, albeit at a slower rate and therefore, companies can repay debt, so the quality of the credit has improved. This is a positive narrative for fixed income.
The AI revolution: Large cap growth stocks have been exhibiting bubble-like behaviour in recent months, should we be concerned?
The earnings coming from the tech sector, particularly NVIDIA are astonishing. Last quarter NVIDIA had $26 billion quarterly revenue, which is extraordinary. NVIDIA has also had huge margin growth – between 60-70% – as everyone’s been using the chips to scale up their business, with the largest purchasers being Meta, Amazon, and Microsoft.
There are some risks on the horizon as despite strong earnings from big tech, these are historical highs and margins have been high, so people are rightly questioning how far it can go from here and some rotation should be on the table.
Another way to look at it is that for $1billlion of new earnings for NVIDIA, all things being equal, with a 70% margin, and 45x multiple, that adds $31.5 billion to the market cap of that company. The point to reinforce is that there’s strong growth and strong earnings, yet how sustainable is this? The AI revolution will inevitably help other sectors: transport, education, healthcare etc., to be more efficient going forward, however we don’t believe growth can continue at this rate. NVIDIA is likely overvalued with some companies that could be beneficiaries as opposed to primary producers, perhaps undervalued relative to market.
What are your views on the US election, potentially Trump v2.0 and likely impact on markets?
The expectation is that Trump will win. Whilst Harris is polling better than expected, Trump has tended to win in hypothetical polls despite some out recently, indicating she may have a chance. That’s an optimistic bounce that’s unlikely to withstand the onslaught that’s coming at her from a Republican machine that has been prepared for this contingency with attack ads ready to go. One of her challenges is that she has little in legislative accomplishments to fall back on and stayed in the shadows making a Trump victory in November a significantly more likely the outcome.
As to what it means for markets, it’s likely that much of the disruption from Trump v2.0 is likely to be neutral to favourable for business, in the short-term, which is what markets are looking for. The prospect of tax cuts and decreased regulation, all the areas that Trump wants to jettison in terms of the public service, might have long-term implications for education and other things, but for business on a short-term outlook they are potentially, neutral to positive. We are not worried about November being a dislocation point. This election unlike the last four in the U.S., has been characterised as the defining election of the century, in terms of the national psyche, however, in terms of the economy it may not be. So don’t be distracted by the noise.
Given that global backdrop, what are your views on Australia and New Zealand?
Business should be hard because that’s what tight policy is, Central Banks are attempting some demand destruction, to lift the risk-free rate to the discount rate, so the companies that survive are going to be in even better shape going forward.
That said, aggregate earnings are still positive and there’s a lot of cash due to government stimulus, so that’s still underpinning the economy and putting pressure on the RBNZ and the RBA. The RBNZ will start the rate cuts earlier and it will be a shallower rate cutting cycle as a reward for getting on top of core inflation, which is the most important thing to do to protect the wealth of future generations. However, that fiscal stimulus is quite unique and that is why aggregate conditions and aggregate spending are holding up.
What are you optimistic about for the remainder of the year?
The Western world has gone through a tightening cycle like never before, to deliver a non-recession outcome for the first time since WW2, that is impressive. This is quite an achievement and that is largely why risk assets have rallied. The quality of companies that have survived the higher cost of capital environment have to be better. Excess bubbles in the cycle ahead will be there but not as much as when you have zero interest rates for 10+ years.
If you look at where the corporate world and the global economy sit today relative to the trajectory we were on several years ago conditions have significantly improved. For all the challenges that businesses face with high interest rates and decreased consumer sentiment, they have proven resilient, profits have been maintained with sectors particularly linked to AI having significant opportunities for further productivity improvements. This will bring about societal disruptions, as workforces need to adapt to the jobs of tomorrow rather than today, which whilst not without its challenges is positive for investors and economies.