House View Q4 2024

Equities

Equities remain attractive, given the prospects for sustained economic growth, further interest rate cuts and with credit spreads and lending conditions stable. Corporate profit growth remains robust, with a high degree of visibility on future earnings, and profit margins remain resilient. Indeed, the profit cycle troughed much earlier than the usual historical pattern, which usually is long after rates have peaked and begun to decline.

Structural drivers such as high levels of investment in artificial intelligence along with rising expenditure on biotechnology, the energy transition and electrification, and defences, should continue to lend support.

However, the pace of gains is likely to moderate and volatility could pick up, given the stellar performance already delivered. We have reduced our overweight exposure and favour US stocks given the relative strength of the US economy, and Europe where valuations look extremely cheap notwithstanding the more depressed economic backdrop. By contrast we are underweight emerging-market and Asian equities.

Government bonds

While yields have fallen, government bonds continue to offer valuable diversification benefits in the event economic growth stalls. Interest rates may have started falling, but it seems they will end the cycle materially higher than prior to Covid. While market expectations for US rate cuts seem sensible, we believe the European Central Bank will end up cutting by a little less than the market expects and the Bank of England by more. In contrast, the BoJ will continue to tighten policy.

We are overweight the US and UK markets and underweight Japan. The US economy has slowed thanks to a weaker labour market. US bonds are not pricing in a recession, contrary to some headlines, but rather a “soft landing”. That suggests the risks to US yields are asymmetric, as interest rates could fall substantially should the slowdown in the labour market begin to accelerate signalling the economy was in danger of falling into recession.

We also like the UK market, favouring shorter maturity bonds given our expectation the Bank of England will be forced into lowering interest rates further and faster than the market anticipates. Longer dated bonds conversely will be held back by concern over the state of the UK government’s financial position.

We are underweight Japan as we believe the Bank of Japan may be forced to tighten policy by more than the market envisages (swaps implying rates only around 0.5% next year), given signs that inflationary pressures continue to build.

Credit

Corporate bonds have performed steadily. While the main fixed income asset classes (European and U.S. IG and HY, as well as EM external sovereigns and corporates) do not look especially cheap relative to safer government bonds, from a historical perspective, there is no reason to expect spreads to widen significantly so long as a recession is avoided.

Given our expectations economies are heading for a soft landing, we prefer riskier high-yield debt to more highly rated investment grade bonds.

1.  Synchronised rate cuts

With inflation risks subsiding and labour markets more in balance, the case for lower rates over the coming year appears more compelling. In our central scenario we see central banks delivering something close to what is priced into markets.

However, there is considerable uncertainty around the outlook – with the precise magnitude of easing likely to reflect the extent to which labour markets soften further from here. With central banks moving to cut rates before a material rise in unemployment, we expect a soft-landing can be delivered, which would support risk assets.

2. Soft landing; inflation risks receding

Ever since central banks started raising rates aggressively in 2022, there has been concern that tighter financial conditions could drive the global economy into recession. However, while interest-rate sensitive sectors such as housing did cool significantly, as the months went by in 2023 it became evident that economies could withstand higher rates, with output slowing, but not falling off a cliff. In aggregate, balance sheets remained healthy and fiscal support remained a constant tailwind.

Financial and credit conditions began easing some time ago, supporting activity and asset prices, as markets anticipated rate cuts in official interest rates. Easier monetary conditions should keep financial conditions loose and help deliver a soft landing.

3. US election – too close to call, too important to ignore

The outcome of this November’s US presidential election is too close to call. But it could have a major impact on the economic outlook both in the US and beyond and, with it, financial markets.

Whoever wins power, the deficit is likely to widen from an already historically high level, assuming their party controls Congress. If Trump were to win and chose to impose the kind of tariffs he has threatened, that would be a very significant escalation from his first presidency and would almost certainly result in retaliation from trading partners. As for Harris, if she were to hike corporate tax rates, it would reverse much of the cuts that came in the Trump administration and could be a material headwind for US companies. 

4. The AI capex boom, and monetising the technology

In previous editions of the House View we have looked at this theme from the perspective of its potential to boost productivity. But the prospects of monetising developments in artificial intelligence (AI), continues to grow in importance for investors.

The biggest technology companies and others have invested substantial amounts. But the return on that investment and clarity on the resulting use cases is still some way off. If the AI hype is to meet the lofty expectations of the market, monetisation and revenue generation – by both the producers of the tech and its adopters –  will need to follow.