Developed Markets Quarterly Outlook

February 2024*

The Year of the Pivot

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.

The macro narrative has shifted on some fronts for 2024. Investors’ growth expectations are less pessimistic than in early 2023, and rate expectations have shifted lower as inflation measures have fallen. The Fed raised interest rates by 525bps over 2022-23, and their dot plot is now signalling three rate cuts this year. The exact number of rate cuts and the timing of the first cut remains debatable, but over the past 50 years, a decline in bond yields has consistently followed the last Fed rate hike. Our changes this quarter reflect a move towards assets that typically perform better during rate-cutting cycles.

On a similar note, Technology stocks have historically benefited from rate cuts given the lower discount to future earnings. The US has the highest weighting to Tech, which should support earnings growth. Still, we are reluctant to hold overweight exposure to the US at a 20x forward P/E multiple, which already reflects significant optimism. Instead, we favour Emerging Markets (EM) exposure, which includes a considerable weighting to advanced semiconductor stocks and a more attractive valuation. 

China remains the largest weight in EM and a key driver of global growth and commodity demand. China’s outlook remains challenged by various structural issues, but real GDP growth of “around 5%” remains achievable this year, and policymakers appear committed to keeping growth stable. Despite these efforts, the ongoing property sector weakness should limit demand for industrial commodities (such as iron ore) this year. As a result, Australia will likely be a laggard. However, EM can still outperform despite its direct exposure to China. Chinese stocks have a weak correlation to GDP, and the overall EM index is highly exposed to growing demand for advanced chips. The MSCI EM Index is expected to deliver 18% earnings growth this year and outpace the broader ACWI. Cheap valuations, a fall in US rates, and a decline in the US dollar will also help reinforce robust EM earnings growth.

Geopolitical risks should remain an ongoing theme for oil prices, with Middle East tensions being the primary driver. We look for oil prices to be supported by these risks. However, US shale production has exceeded expectations, which will reduce the impact on supply if tensions escalate. We, therefore, trim our overall Energy exposure (via a reduction to the UK) but maintain some Energy allocation (via a small overweight to Canada).

Market Strategy: Our allocations balance a ‘soft’ and ‘hard’ landing scenario given the contrast between resilient current activity and warning signals from forward-looking indicators (e.g., an inverted yield curve and tight credit conditions). However, we made changes this quarter to reflect further evidence that the outlook for Developed Market (DM) rates (ex BoJ) has shifted to potential cuts later this year. Since the last Quarterly Outlook, we made the following changes to our country allocation: 

  • Upgrade Switzerland to neutral. Switzerland tends to outperform other European markets as rates fall. We are therefore closing our underweight.
  • Downgrade the UK to neutral. The UK trades at a low multiple and may see some rebound with any oil price strength. However, our empirical models suggest it will likely lag the benchmark as rates fall.
  • Downgrade Australia to underweight. We see limited upside in iron ore demand, while Australian Financials are expected to see profits come under pressure.
  • Upgrade the Eurozone to a less negative underweight. Business surveys continue to signal contraction in the Eurozone from higher energy prices and past policy tightening. However, the deterioration in activity may be moderating, favouring a smaller underweight allocation.

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 January 2024, and macro events and data releases up to 7 February, 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.