PERSPECTIVES
MARKET AND ALLOCATION
Our experts monthly overview
OUR CENTRAL SCENARIO
Deputy Chief Executive Officer,
Chief Investment Officer
OFI INVEST ASSET MANAGEMENT
Summer ended up being no walk in the park, with the phase of volatility that we ran into in early August. This phase appeared to flag that the markets would henceforth focus more on economic growth figures than on disinflation.
And, indeed, based on the latest inflation figures on both sides of the Atlantic, central banks appear to have won their anti-inflation battle, but will still have to remain alert. Jerome Powell came right out and said so at Jackson Hole. It will now be growth numbers, particularly US job figures, that will have the markets most concerned.
The US Federal Reserve will accordingly begin the rate-cut cycle that we mentioned in our pre-summer baseline scenario. In pricing in four 0.25% rate cuts, the market now seems to be overdoing it after having failed to price in rate cuts sufficiently prior to the summer.
The European Central Bank (ECB) is also likely to keep its monetary easing cycle at a gradual pace in the coming quarters.
In light of the path already traced by 10-year yields, we are lowering our rating from overweight to neutral on sovereign yields, where we now see little downside potential, based on the markets’ expectations of central banks action. We are also taking our profits in investment grade corporate bonds, following the shift in its spread component. And we are lowering our rating on high yield corporate bonds but remain positive, in light of the yields on offer.
The equity markets once again demonstrated their resilience after this summer’s swoon. On the one hand, concerns over the US economic slowdown are likely to lead to cuts in earnings forecasts against a backdrop of weaker momentum in artificial intelligence thematics. But, on the other hand, a cycle of Fed rate cuts is likely to reassure investors, although, then again, they may very well “buy the rumour, sell the fact”. Given year-to-date performances, which are on target with our forecasts for 2024, we reiterate our neutral stance, alongside convexity stances to exploit new likely bouts of volatility, such as occurred in August.
OUR VIEWS AS OF 05/09/2024
After already cutting its key rates in June, the European Central Bank (ECB) is now likely to be joined by the US Federal Reserve. Both central banks have flagged that they could lower their rates in September and then continue to adjust their monetary policy gradually. US bond yields receded sharply during the summer, with the 10-year yield falling as low as 3.76%. Market expectations and yields now look more on the mark than in late June. Against this backdrop, the bond markets got a big boost from interest rate shifts. We now think that the bond markets have now exhausted most of their upside potential for 2024, and we are accordingly moving to a neutral stance on sovereign yields and on investment grade corporate bonds. High yield and money-market remain more attractive in our view, as well as emerging market debt, which is likely to benefit from US rate cuts.
Despite very steep volatility in early August, global equity markets continue to rub up against their all-time highs, although it’s true that France continues to trade sideways. While we still recommend exploiting the sometimes exaggerated volatility to add to exposure on the dips, we reiterate our neutral stance on the equities asset class, as the markets have hit the full-year objectives that we had set (and even surpassed them in the case of the US). Although our baseline scenario remains bullish on equities, we are leaving our stance as is, due to geopolitical risks and possible future earnings forecasts downgrades. Geographically, the wide valuation gap between the US and Europe persists, but it’s true that it is in the US that growth is to be found, in both the economy and profits. We are sticking to our eastern bias on both Asia ex-China and Japan, the latter of which quickly rallied from its 5 August swoon and which, like the US, is being driven by the boom in artificial intelligence.
The hike in interest rates by the Bank of Japan (BoJ) made yen financing more costly and flagged a potential monetary tightening. This, in turn, triggered an unwinding of carry trade positions on a particularly imbalanced, short-yen market, amplified by the BoJ’s ultra-accommodating monetary policy. Since then, the market has become more balanced, which calls for some profit-taking on the yen, at least in the short term. The euro’s appreciation vs. the dollar this summer reflects fears over US growth and, hence, expectations of rapid Fed rate cuts. Barring a further worsening in the job market, a more gradual pace of rate cuts remains our scenario for the coming months, and we remain neutral on the dollar.
MACROECONOMIC VIEW
THE US JOB MARKET UNDER CLOSE WATCH
Head of Macroeconomic Research
and Strategy
OFI INVEST ASSET MANAGEMENT
US MACROECONOMIC FUNDAMENTALS REMAIN SOLID
Second-quarter economic growth was revised upward (3.0% annualised), tracking mainly an upward revision in household consumption. Monthly consumption data show that this favourable momentum spilled over into the third quarter. In July, total consumption once again rose faster than Americans’ total income. In other words, their savings rate fell once again, this time to below 3%, at 2.9% of disposable income. Meanwhile, as expected, the deflator underlying household consumption, which is the Fed’s benchmark inflation indicator, fell by 0.2% in July (2.6% year-onyear), i.e., at a pace compatible with the return of inflation to its 2% target in 2025.
THE JOB MARKET HAS INVESTORS ON HIGH ALERT
The dip in US net job creations and the increase in the unemployment rate raised fears of a sudden downturn in the economy this summer. Such fears are overdone, in our view. Since the start of the year, unemployment has been driven up by heavy inflows onto the job market, particularly from immigrant labour. As a result, the labour force participation rate in the 25-54-year age group is at a more than 20-year high, which is good news.
An increase in temporary layoffs, which are customary in the US in certain industries during summer, came on top of this. The data do not appear to suggest a worrisome increase in layoffs, which lessens the likelihood of a a recessive feedback loop between higher unemployment and lower household consumption.
“IT’S TIME FOR POLICY TO ADJUST”(1) (JEROME POWELL AT JACKSON HOLE)
At Jackson Hole, Jerome Powell flagged the start of key rate cuts at the next Fed meeting, in September. Most of all, he stated that a greater slowdown in the job market was neither necessary, nor desirable to lead inflation to its target. This suggests a clear rebalancing in the Fed’s reaction function. Barring an additional worsening in the job market, our baseline scenario remains a gradual pace of 25 basis point (bp) reductions. Otherwise, the Fed will not hesitate to trigger reductions that are greater in their pace and/or extent. Job statistics will be under the microscope, and now that the job market is closer to equilibrium, the Fed believes that the risks between inflation and the job market are henceforth balanced out.
FUNDAMENTALS ARE STILL TENTATIVE IN THE EURO ZONE
Economic surveys have laid bare an extraordinary divergence between an expanding services sector and a manufacturing sector that has still not hit bottom, as well as between countries – ranging from fast-growing Spain to stagnating Germany, with France and Italy between those two.
Meanwhile, household savings intentions are still close to their 30-year highs, which is consistent with tentative consumption, which has risen less on the year to date than might have been hope, given that wages have gradually caught up with inflation.
EURO INFLATION RECEDES BUT IS STILL GIVING HAWKS PAUSE
Inflation in euro zone receded sharply, to 2.2% year-on-year in August (after 2.6% in July), thanks to favourable base effects in energy. Core inflation decreased very slightly, to 2.8% yearon- year (after 2.9% in July), driven by ongoing disinflation in manufactured goods, which is no doubt close to bottoming out. Inflation in services moved back above 4% year-on-year, driven by the impact of the Olympic Games in France. But, on top of this temporary factor, inflation in services is also persistent outside France. In Germany, for example, it has not fallen for several months, nor in Italy, something that ECB hawks will no doubt mention in arguing for spaced out rate cuts after the September policy meeting. The markets are pricing in between two and three rate cuts by yearend, which seems less overdone than in the case of the US (as of early September).
INTEREST RATES
ALL BETS ARE OFF…
Co-CIO, Mutual Funds
OFI INVEST ASSET MANAGEMENT
Bond markets performed well during the past two months, thus backing the scenario of a soft landing of the US economy. With a reassuring inflation trajectory and moderating US growth and job figures, the US Federal Reserve now says it is willing to lower its key rates and make its monetary policy less restrictive.
US BOND YIELDS HAVE ADJUSTED CONSIDERABLY OVER THE PAST TWO MONTHS
The spike in volatility this summer on the financial markets helped adjust the US yield curve. On top of the Japanese market shock in early August, yields were driven mainly by US job figures – which were not as good as expected. During this phase, the 10-year US yield fell by 50 basis points (bps), from 4.40% to 3.90%, while the 2-year yield dropped by almost 85 bps.
This pronounced steepening made the US yield curve almost flat and no longer inverted. This is an important signal. As we had already mentioned, an inversion of the yield curve is usually a good leading indicator of an upcoming recession. So, a recession is not in the baseline scenario, especially as the Fed is expected to begin lowering its key rates gradually in September, which will support the economy. Market expectations have accordingly shifted from two 25bp rate cuts by yearend to about four. In our view, in late June the market had not been pricing in enough rate cuts. Expectations now look reasonable, although three rate cuts could be enough, depending on what the job figures look like.
In the euro zone, there was less amplitude in rate shifts. We had seen the Bund at 2.50% at the end of June, and here we find it, in late August, at 2.30%. Nevertheless, the yield curve has also steepened greatly in Europe. Between two and three rate cuts by the European Central Bank (ECB) are now being priced in for 2024, which we feel looks right.
As we had overweighted rates in early summer, we were able to take advantage of these shifts to reduce our portfolios’ duration and take some profits.
THE EUROPEAN CREDIT MARKET HAD A NICE SUMMER
Against this backdrop, the credit markets in particular got a boost from interest-rate trends. In July, risk premiums on corporate bonds narrowed in a highly conducive environment. As August began, falling yields, driven by US job figures and yen/ Nikkei stress, were good news for the credit market. Despite a phase of widening, credit spreads ultimately narrowed on the period, with the iTraxx Crossover, for example, tightening from 320 bps at end-June to 288 at end- August.
Investment grade and high yield credit markets thus performed very well, at, respectively, +2.0% and +2.6% since the end of June, raising their year-to-date return to almost 6%. However, carry on these markets fell, respectively, to 3.5% and 6.25%. This is still historically attractive, but we are nonetheless lowering our weighting of the asset class to closer to neutrality in investment grade in particular. We are more cautious in the short term on bonds, but there’s not yet anything suggesting at this point that all bets are off.
Issuance on the primary credit market in August, a record for the month.
| BOND INDICES WITH COUPONS REINVESTED | AUGUST 2024 | YTD |
|---|---|---|
| JPM Emu | 0.39% | 0.66% |
| Bloomberg Barclays Euro Aggregate Corp | 0.30% | 2.57% |
| Bloomberg Barclays Pan European High Yield in euro | 1.26% | 5.89% |
EQUITIES
RESILIENCE
Co-CIO, Mutual Funds
OFI INVEST ASSET MANAGEMENT
Equity markets held up well, rallying after being hit early in the month by fears on the US economy and then by the unwinding of yen carry trades, before ending the month up slightly.
In the United States, the S&P 500 outperformed the Nasdaq and, especially, the SOX (the semiconductor index), which took a hit late in the month by Nvidia*. Nvidia is still a driving force but is having a hard time exceeding demanding earnings forecasts and is now projecting lower gross margins. In Europe, the DAX set new records, unlike Paris, which continues to lag behind, due to political uncertainties and its weighting of luxury stocks.
MARGINS HAVE HELD UP WELL
While not flamboyant, earnings season once again ended with net positive surprises (in number), on both the top and bottom lines.
Companies have clearly chosen to maintain their prices, even if that means spending more on advertising to support their sales. By sector, financials once again surprised on the upside, riding interest rates that are still higher than in their assumptions at the start of the year, while keeping their cost of risk under control. In contrast, companies exposed to discretionary consumer spending (luxury and automotives) and to business services (IT services) tended to lower their full-year guidance, as their customers are no doubt waiting for more visibility on interest rates.
RELATIVE VALUATION IN FAVOUR OF EURO ZONE EQUITIES
US markets look overpriced, driven by continued solid US growth (still at +3% in the second quarter), due, in turn, to consumption and business investment. The main source of weakness remains residential investment, which has been hit by high interest rates. And yet, wealth effects remain significant, including growth in employee headcounts and wages, and higher financial markets and real-estate prices. In the short term, the focus will be on the elections. After the nomination of Kamala Harris and the choice of Tim Walz as her running mate, the Democrats have caught up with the Republicans and even appear to have passed them up in some swing states previously in the Republican camp. A Democratic victory would perpetuate all the Joe Biden administration’s economic support measures but would also mean a hike in the corporate income tax rate to 28%.
In contrast, euro zone equity markets remain inexpensive but don’t have the same supports. Growth there is anaemic, and while households are recovering some of the purchasing power they lost during Covid, they also continue to save. Manufacturing output continues to be penalised by higher energy costs and less export momentum, due in part to a weaker-than-expected Chinese recovery. Their future performance will depend closely on what the European Central Bank (ECB) does and on whether it is able to promote a recovery of growth in the euro zone at a time when some countries will have to reduce their fiscal spending.
In any case, in late August, Fed chairman Jerome Powell laid out the path clearly during the annual seminar of the planet’s central bankers at Jackson Hole.
Since the start of the year, we had recommended a neutral stance on the asset class, advising underweighted investors to take on exposure during market dips. One such dip occurred in early August, but it was too brief, with European markets moving into negative yearto- date territory for just an instant. With European markets having met our full-year targets (and the US markets having exceeded them), we reiterate this neutral stance.
The market cap exceeded by Berkshire Hathaway*, a conglomerate that joins the six other US companies that have crossed this threshold, including Apple*, Nvidia* and Microsoft*.
| EQUITY INDICES WITH NET DIVIDENDS REINVESTED, IN LOCAL CURRENCIES | AUGUST 2024 | YTD |
|---|---|---|
| CAC 40 | 1,32% | 3,33% |
| EuroStoxx | 1,52% | 10,24% |
| S&P 500 in dollars | 2,38% | 19,19% |
| MSCI AC World in dollars | 2,54% | 15,97% |
EMERGING MARKETS
ASIAN EQUITIES: A LOOK BACK AT A SEEMINGLY UNEVENTFUL SUMMER
Chief Executive Officer
SYNCICAP ASSET MANAGEMENT
Since 30 June, Chinese equities are down by 1.0% (in USD), holding up rather well to a sluggish economy. Asian equities ex-China have gained 1.5%. Volatility in the semiconductor and artificial intelligence (AI) sectors worldwide has caused some turbulence, but the underlying trend remains positive.
CHINESE EQUITIES: POSSIBLY MORE RESILIENT IN THE SHORT TERM
The Chinese economic environment is challenging. The economy continues to be undermined by its real-estate sector, where prices are falling even faster. In Shenzhen, which had been one of China’s least affordable cities, property prices are down by 37% since May 2021. They have also fallen by about 25% in Beijing, Shanghai and Guangzhou over the same period. In reaction to these recurring challenges, the findings of the 3rd Plenum were disappointing, including a cap and long-term priorities (development of the service economy, reduction of local administrative barriers between regions to create a unified and more seamless market, strengthening the social security system, etc.) but nothing concrete was decided on resolving the realestate crisis, which is the current major issue.
In May the government had released credit lines to banks, so they would lend to local governments, in order to support real-estate prices. But actual lending is still far below targets, as banks fear damage to their balance sheets. Meanwhile, the overall message from the 3rd Plenum was focused not only on business; national security issues were mentioned as much as economic development ones... So, for the near future, companies will have to continue to deal with this challenging environment. And yet, aggregate earnings are expected to be up by 15%, which looks optimistic. In reality, and similarly to US companies, if we subtract e-commerce giants such as Meituan, Tencent and others, earnings growth is expected to be 10%, which is still not bad.
Overall Chinese momentum remains a challenge, with a government that does not seem especially concerned with restarting the economy quickly, nor with boosting the entrepreneurial spirit. But there are also some positive signs. Valuations on the whole are rather low (with a 2025 P/E of about 11) and both domestic and international investors have forsaken the equity markets. Foreign investors now account for just 3% of Chinese market cap, a 10-year low.
As a result, there may not be much more downside risk from current levels. It’s also true that we don’t see any short-term catalyst, barring a political surprise, which is always possible in China!
ASIAN EQUITIES EX-CHINA: BUY THE DIPS
In contrast, Asian equities ex China have been riding strong momentum for several months now, driven by three long-term themes: the global AI push (many major Asian tech players are fully integrated into the international value chain), growth in domestic consumption particularly in India, and China manufacturing workarounds (China +1). In the short term, however, current volatility in the semiconductor and AI sectors may continue, hitting share prices.
Regarding India, the trend remains positive for the long term. Its economy could grow by almost USD 2,500bn over the next five years, with the percentage of its population having an annual income of more than USD 15,000 moving from 5% currently to almost 20%. So, the domestic consumption outlook looks very promising, as does the outlook for infrastructures. Here again, this is a highly consensual investment theme that could encounter occasional phases of consolidation, especially as valuations are a little high, particularly in small and mid caps. We therefore believe that a phase of greater market volatility could begin and advise buying the dips, as this asset class still seems to have much long-term potential remaining.
The consensus forecast of the aggregate increase in earnings for Chinese companies in the MSCI China in 2024, which looks rather optimistic.
China is less and less dependent on developed economies for its exports. More than half of them now go to other emerging markets. The United States now accounts for just 15% of China’s total exports, and Europe, 12.5% Something to keep in mind on the subject of new import tariffs.
Document completed on 05/09/2024
Carry: a strategy that consists in holding bonds in a portfolio, possibly even till maturity, in order to tap into their yields.
Carry trade: a currency investment strategy that seeks to exploit interest-rate differences between two currencies.
Convexity: one of the main objectives of convexity strategies is to maximise a portfolio’s resilience to shifts in interest rates and market conditions.
Duration: weighted average life of a bond or bond portfolio expressed in years.
Inflation: loss of purchasing power of money which results in a general and lasting increase in prices.
Inflation breakeven rate: the difference between the yield on a traditional bond (nominal yield) and the yield on its inflation-indexed equivalent (real yield).
Investment Grade/ High Yield credit: Investment Grade bonds refer to bonds issued by borrowers that have been rated highest by the rating agencies. Their ratings vary from AAA to BBB- under the rating systems applied by Standard & Poor’s and Fitch. Speculative High Yield bonds have lower credit ratings (from BB+ to D, according to Standard & Poor’s and Fitch) than Investment Grade bonds as their issuers are in poorer financial health based on research from the rating agencies. They are therefore regarded as riskier by the rating agencies and, accordingly, offer higher yields.
ISM manufacturing index: the ISM manufacturing index of economic activity is based on a survey of purchasing managers in the industrial sector.
PER: Price to Earnings Ratio. A stock market analysis indicator: market capitalisation divided by net income.
Quantitative Easing: massive purchases of debt securities by a central bank.
Recession: a period in which a country’s economic activity shrinks, defined most often as decline in gross domestic product during at least two consecutive quarters.
Risk premium: reflects the additional return demanded by investors compared to a risk-free asset.
Spread: difference between rates.
Volatility: corresponds to the calculation of the amplitudes of variations in the price of a financial asset. The higher the volatility, the riskier the investment will be considered.
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