Cross-Asset Quarterly Outlook

June 2024*

Waning Support for Global Equities Versus Bonds

  • Global data remains buoyant on the surface, but the headline numbers are masking deceleration in US activity.
  • The macro backdrop has led to some rotation away from US equities while global equities outperform bonds.
  • Our asset allocation favours an overweight to Rates and Commodities versus an underweight to Credit, while Equities remain neutral.
  • This quarter, we adjust our intra-equity exposure, moving UK equities to underweight, and reducing the size of our Eurozone underweight.

Global markets maintained some pro-cyclical flavour over recent months, with global equities outperforming fixed income. However, the March-May period (Chart 1) revealed some interesting rotations starting to occur. Commodities were the best-performing asset class, overtaking equities. Within commodities, industrial and precious metals led, while energy was a laggard despite ongoing geopolitical risks. Within equities, the US marginally underperformed the global aggregate (ACWI), while Europe and China (the largest weight in EM) outperformed.

The asset rotation reflects some shift in underlying macro fundamentals. The global composite PMI was above trend at 52.4 in May, supporting stocks. However, ex-US data has become a more significant contributor to the recent improvement, supporting international equities. The US economy remains resilient following a Fed tightening cycle last year, but there are growing signs that US strength is moderating. The Atlanta Fed’s GDPNow model estimate dropped sharply to 1.8% annualised growth this quarter, and the Citi US economic surprise index fell into negative territory. In addition, the US unemployment rate has been trending higher, which may trigger the now famous “Sahm rule” recession indicator later this year. Further softening in US data will likely limit the global manufacturing expansion, given that the US consumer is one of the primary sources of final demand.

The mixed macro backdrop suggests investors should limit their pro-cyclical exposure due to unattractive global equity and high-yield (HY) credit valuation measures. The ACWI 12-month forward P/E is still elevated at 18x, while global credit spreads have narrowed close to previous cyclical extremes. In addition, the equity earnings yield has tightened further relative to bond yields, close to its early-2000 low (see Chart 2). We favour gradually increasing government bond exposure with the US 10y Treasury yield above 4%, and the yield is likely to move lower once the Fed begins cutting rates. Our equity allocation remains neutral. Cyclical indicators support short-term equity strength; however, our bias is towards reducing equities exposure relative to bonds later this year as global macro momentum weakens.

We continue to favour some commodity exposure via industrial metals. Industrial metals are historically cyclical and have benefitted from Europe and China’s recent activity improvement. Some of this demand will likely fade if the US economy slows. However, industrial metals offer long-term value and exposure to the renewable energy transition and growing energy needs linked to Artificial Intelligence (AI). Both themes will remain relevant to our strategic allocation over the coming years. 

Chart 1: Asset Returns, Mar-May, %

Source: Bloomberg

Chart 2: S&P500 Earnings Yield Spread, % pts

Source: Bloomberg

*The publication reflects asset performance up to May 31, 2024, and macro events and data releases up to June 5, 2024, unless indicated otherwise.

The information contained herein is obtained from sources believed by City of London Investment Management Company Limited to be accurate and reliable. No responsibility can be accepted under any circumstances for errors of fact or omission. Any forward looking statements or forecasts are based on assumptions and actual results may vary from any such statements or forecasts.