August 2024*
Global equities have come under pressure in recent weeks as macro and political drivers create market volatility. Overall, we assess the macro backdrop as mixed with pockets of strength in areas such as semiconductor demand to power Artificial Intelligence (AI) growth. However, the US labour market shows signs of softening, prompting an increase in our recession probability to 30% over the next 6-12 months. Our asset allocation continues to balance some pro-cyclical and defensive exposure. We are slightly increasing the latter by upgrading Switzerland to overweight and downgrading Canada to neutral.
Since mid-July, global equities (ACWI) declined and have seen a sharp rise in volatility. The market peak (July 16th) coincided with former President Trump’s improvement in polls and a potential political change. The mid-July market dynamic was more consistent with a rotation away from large-cap technology stocks (in favour of small-cap and value stocks) rather than a broad market sell-off. This dynamic shifted following the July 31st central bank meetings, and broad-based selling pressure intensified after the recent US payrolls report. The Bank of Japan hiked their target rate against consensus expectations, triggering a ‘carry trade unwind’, driving a sharp Yen appreciation and a significant decline in Japanese stocks. The Federal Reserve’s July meeting was more benign, but the FOMC failed to use the opportunity to ease policy and postponed their decision to the September meeting. Finally, the US payrolls report showed an unexpected 0.2% point rise in the unemployment rate (to 4.3%), triggering the ‘Sahm rule’, which has historically signalled when the US economy is in a recession. Does the recent price action and the rising unemployment rate indicate we are in a recession and bear market? We think the signs are more mixed at this juncture. We review what has changed over the quarter and what has not changed in recent months.
What has changed? The global growth backdrop remains above trend based on coincident indicators such as the global PMI composite index. However, growth has started decelerating for the first time this year (Chart 1). The recovery in China and Europe has stalled, and strong US growth appears to be transitioning to trend growth. The most recent Atlanta Fed GDP Nowcast estimate has fallen to a growth rate closer to 2%. The slowing labour market may be an early warning signal that US growth will decelerate further. We are adjusting our recession probability higher to 30% over the next 6-12 months. Still, we emphasize that our baseline view remains a more benign growth slowdown over the next year. Our broad set of leading indicators does not currently signal a sharp deterioration in global growth.
The rates outlook has also shifted slightly. We expected rate cuts this year, but the softer inflation and labour market data have intensified the pressure on the Fed to cut rates at the next meeting in September. The 10-year Treasury yield is now below 4%. Historically, the implication for stocks depends more on the growth backdrop and not just interest rates. We do not see a strong case for being heavily exposed to defensives relative to cyclicals or vice versa. Still, the combination of slower growth and lower rates favours an upgrade to more counter-cyclical sectors, given that defensive stocks have historically performed better in a lower rates environment (Chart 2). We upgraded our Switzerland allocation due to its higher weighting to defensive sectors.
In politics, the upcoming US election may result in some shifts in the US. The race remains close between both candidates (based on RealClearPolitics.com betting odds). It is too early to position aggressively for a particular election outcome. Still, markets have to price the possibility of a Trump victory that could see trade tariffs rise. US-China trade tensions are not a new theme and were a mainstay of the Biden administration. Higher tariffs for traditional allies such as Europe could be a new market headwind under a second Trump term.
| Chg | -2 | -1 | 0 | +1 | +2 | |
|---|---|---|---|---|---|---|
| US | – | |||||
| Canada | ↓ | |||||
| Eurozone | – | |||||
| Switzerland | ↑ | |||||
| UK | – | |||||
| Japan | – | |||||
| Australia | – | |||||
| EM | – |
| Chg | -2 | -1 | 0 | +1 | +2 | |
|---|---|---|---|---|---|---|
| Canada | ↓ | |||||
| Eurozone | – | |||||
| Switzerland | ↑ | |||||
| UK | – | |||||
| Japan | – | |||||
| Australia | – | |||||
| EM | – |
*This publication reflects asset performance up to 31 July 2024, and macro events and data releases up to 7 August, 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.