We are keenly aware that investors face a diverse array of global risks. Alongside inflation, geopolitical risks are a particularly salient feature in the investment landscape.
Key risks on our radar include potential for escalation in the conflicts in Ukraine and the Middle East, as well as the outbreak of new conflicts elsewhere. These have potential to add to inflationary pressures and disrupt financial markets. However, we take heart from the fact that shipping costs are falling again. This suggests that the disruption to shipping in the Red Sea by Iran-backed Houthi rebels that we discussed in our February multi-asset outlook, Opportunity Knocks, is likely to have a minimal effect on inflation.
Whilst there are risks on the horizon, history suggests that we should hold our nerve and remain fully invested. To the extent market setbacks occur, they are often swiftly followed by market recoveries. As such, oftentimes the worst course of action has been to make large portfolio changes.
So where to for investors?
One of the hardest adjustments can be the switch from a defensive positioning and mindset after a period of market upheaval to embracing risk and capitalising on the opportunities available. We made our first step in that direction at the start of the year, increasing equities from neutral to a modest overweight. Over the last six months, as economic growth has picked up and the risks of a damaging economic recession have receded, we believe that the time has come to increase our equity exposure in multi-asset portfolios further.
Granted, the markets’ optimism from the end of 2023 has been tempered somewhat. Persistent inflation – particularly in the US – means that interest rate cuts might be delayed as central banks try to finally squeeze inflation down to their preferred level of around 2%.
But financial markets are well aware of this: bond yields have risen again, meaning their prices have fallen. Investors are now pricing in one or two rate cuts in 2024, far fewer than the six or seven rate cuts when expectations were at their peak. This is not all bad news. In our view, it would require a substantial change in the outlook for inflation and interest rates to cause further disruption to equity markets.
Company earnings should remain supported
The key point for investors is that stronger economic growth is usually good for company earnings, and therefore good for equities and corporate bonds. Robust earnings and dividend growth continue to be supportive, even after the rallies we have seen to date.
While we believe the equity market recovery is likely to widen in due course, we continue to see potential in the largest US companies. Their remarkable performance is well-founded on superior earnings growth and robust business models, with further support provided by share buybacks. In our view, US technology companies, including some members of the ‘Magnificent 7’[1], could have more to offer but a selective approach and a focus on quality will be key.
In the UK, we are encouraged by the extent to which inflation has fallen and the uptick in leading indicators of economic growth. We believe that the outcome of the UK general election poses little risk to the UK market because of the close similarities between the economic policies proposed by the Conservative and Labour parties. Any further improvement in UK PLC could revitalise international investors’ interest in the market. We keep a look out for opportunities.
In terms of fixed income, corporate bonds continue to be attractive on a relative basis, with government bonds less so. Turning to corporate bonds, the ‘spread’ or extra yield offered by corporate bonds over government bonds has tightened in recent months, but there a number of factors that lead us to believe this is sustainable. For example, many UK defined benefit pension schemes are keen to offload their liabilities to insurance firms, who in turn make significant investments in corporate bonds. This should keep investment demand for corporate bonds high.
[1] Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla
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