Developed Markets Quarterly Outlook

November 2023*

Red Light, Green Light

Our baseline view remains a global slowdown in response to tighter monetary policy from developed market (DM) central banks. However, the exact timing remains uncertain given that excess pandemic savings and loose fiscal policy continue to support the US economy and hopes for a ‘soft landing’. Growing geopolitical risks in the Middle East add new uncertainty to the current cycle. Our allocations continue to balance these risks and identify opportunities.

Regionally, the trends are mixed. The US economy remained strong in Q3, recording 4.9% annualised growth. This pace should moderate closer to trend growth in Q4, but the Q3 print is still notable as it is not signalling an immediate recession risk to the US economy. We expect the long and variable monetary policy lags will weigh on activity and corporate earnings in 2024. However, excess pandemic savings and loose fiscal policy are supporting the US economy. The trend in Europe is less resilient. The Eurozone composite PMI recorded a new cyclical low of 46.5 in October, signalling a weaker backdrop. In China, the recovery remains fragile, but recent policy measures are starting to support the domestic economy, and we are seeing a stabilisation in several activity measures.

Geopolitical risks, as measured by the Geopolitical Risk (GPR) Index developed by Dario Caldara and Matteo lacoviello, spiked again in Q4 following events in the Middle East. Our baseline expectation is that the Israeli conflict will be contained and not lead to a major oil supply shock. However, the risk of more direct involvement from the US and Iran remains a possibility that could lead to severe disruptions to oil supplies in the region. This tail risk, in addition to the ongoing Russia-Ukraine war, will keep a risk premium in oil prices over the medium term, providing support for energy-linked assets. 

Market Strategy: The global MSCI ACWI Index 12m forward PE remains elevated at 17x and vulnerable to further shocks from tighter financial conditions or elevated geopolitical risks. Despite expectations for a global slowdown in 2024, investors can still find strategic value within international equities. Indeed, the ACWI ex-USA Index is trading at a forward P/E of 13x, below its historical average. Since the last Quarterly Outlook, we made one change to our country allocation:

  • Move Australia to neutral. We added Australian equity exposure last year in anticipation of a sharp China recovery. Iron ore prices have improved, and China’s recovery has progressed towards its 5% growth target. However, these trends have yet to translate into strength for Australian stocks, and we currently see more value in EM. We, therefore, shift our exposure more in favour of EM.
  • We keep our overweight in EM. EM earnings remain strong for 2024 in anticipation of a cyclical bottom in China’s earnings and semiconductor sales, while our valuation measures continue to signal an opportunity for re-rating if positive earnings are delivered next year. Short-term headwinds remain with US rates and the USD trading at elevated levels. But we expect these negative drivers to lose steam and then reverse.
  • We stay overweight in Canada and the UK. The price of brent crude has moderated, and our baseline view does not anticipate a repeat of 2022 price rises. However, the tail risk of escalation in the Middle East and a severe oil supply shock will likely keep some risk premium in oil prices, supporting Energy stocks.
  • We maintain our underweight to the Eurozone. Recent data continues to signal further negative pressure on earnings. Valuations have cheapened, but we expect further weakness if global growth slows. Higher energy prices remain a risk for the Eurozone.

Global Equity Allocation Breakdown

  Chg -2 -1 0 +1 +2
US –        
Canada –        
Eurozone –        
Switzerland –        
UK –        
Japan –        
Australia ↓        
EM –        

International Equity Allocation Breakdown

  Chg -2 -1 0 +1 +2
Canada –        
Eurozone –        
Switzerland –        
UK –        
Japan –        
Australia ↓        
EM –        

*This publication reflects asset performance up to 31 October 2023, and macro events and data releases up to 8 November, 2023, unless indicated otherwise.

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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.