The big picture
Markets tug of war: Disinflation slows, political risks rise
It became increasingly clear in the first half of 2024 that central banks had succeeded in taming inflation without tipping economies into recession. Economic growth has stabilised, aided by increased government spending.
Global economic output looks set to grow by about 2.7 per cent in 2024, down from 3.0 per cent last year. Nonetheless, labour markets remain tight and there is little slack in most economies. Growth is improving most rapidly in the euro zone, which is currently undergoing a mini boom. Real disposable incomes are rising as wage growth is high and inflation is falling. These conditions have enabled the European Central Bank (ECB) to begin cutting rates, lending further support.
As for the US, growth looks likely to cool in 2024, reflecting the ongoing impact of higher interest rates and a reduced contribution from government expenditure. Nonetheless, healthy growth in household disposable incomes, improving corporate profitability and increasing investment in areas related to technology and the green transition will ensure the economy continues to expand at a respectable pace.
While sub-three per cent growth used to be considered weak for the global economy, bringing inflation down from very high levels without inducing recessions or high unemployment should be considered a success story for policymakers and governments, to the extent their actions influenced the outcome.
Given a "hard landing" and recessions in major economies were seen as a real concern earlier in the year, this "soft landing" has come as a relief to equity markets. Nonetheless, it involves a trade-off, as while growth remains robust the decline in inflation has stalled in many places.
Financial markets have responded by pricing in fewer and less extensive rate cuts than had seemed likely at the start of the year. There is little doubt interest rates have been raised to levels that constrained growth and lessened inflationary pressures in all major economies. The question now is: how restrictive are rates at current levels, and for how long they will need to be kept in such territory?
The evidence is mixed. In the US, underlying inflation is just below three per cent and is unlikely to fall to the central bank’s two per cent target for another year and a half. It is a similar story in the euro zone, where inflation has recently picked up again despite a comparatively weaker economic backdrop.
The ECB, along with the central banks of Canada, Sweden and Switzerland, have begun cutting interest rates in response to falling inflation. However, accompanying statements have been cautious, signalling little prospect of a further rapid decline. The Bank of England (BoE) and US Federal Reserve (Fed) should follow suit in due course, although they too are likely to be cautious, responding to data rather than being proactive in loosening monetary policy.
Figure 1: Aviva Investors growth projections
Future statements are not reliable indicators of future performance or future scenarios.
Source: Aviva Investors, Macrobond. Data as of June 30, 2024.
What this means for asset allocation
Equities
The resilience of major economies enabled equities to shrug off the rapid scaling-back of the anticipated rate cuts, with stocks posting impressive gains in the first half of the year. Emerging-market equities outperformed their developed-market peers; within the latter, European stocks lagged, weighed down partly by concern over the political situation in France.
With the threat of recession fading, equities look poised for further gains in the second half of the year. So long as major economies do not slow materially, the recovery in corporate earnings should continue to feed into higher stock prices. Having said that, the pace of the rally is likely to moderate somewhat given the cooling of the US economy and the fact valuations are now far from cheap, with markets having rallied by around 30 per cent since last October.
Figure 2: Asset allocation – equities
Note: The weights in the asset allocation table only apply to a model portfolio without mandate constraints. Our House View asset allocation provides a comprehensive and forward-looking framework for discussion among the investment teams.
Source: Aviva Investors. Data as of June 30, 2024.
Government bonds
Inflation remains on a downward trajectory, but the pace of decline has slowed appreciably this year. Although central banks will ease policy as unemployment gradually rises, rates are likely to end up being meaningfully higher than prior to the pandemic. Central banks cannot afford to allow inflation expectations to become ingrained.
The Fed will likely begin its cutting cycle this year but may struggle to meet market expectations, which are for rates to be cut by around 150 basis points by the end of next year. The BoE is rapidly approaching its first rate cut and we feel it will ease more than markets expect. The ECB, having cut rates in June, is likely to proceed more cautiously than expected given the economic recovery underway.
Given the likelihood the US economy will slow, we see scope for government bond prices to appreciate modestly from here, although concern over high fiscal deficits limits any upside.
We see more value in UK bonds given the sluggish state of the economy. Conversely, we believe Japanese government bonds to be unattractive, with a sharp decline in the yen set to continue fuelling inflation.
Figure 3: Asset allocation – government bonds
Note: The weights in the asset allocation table only apply to a model portfolio without mandate constraints. Our House View asset allocation provides a comprehensive and forward-looking framework for discussion among the investment teams.
Source: Aviva Investors. Data as of June 30, 2024.
Credit
A combination of modestly tight monetary policy, very loose fiscal policy and slow but solid growth continues to support corporate bond markets in both Europe and the US. The recovery in corporate earnings, along with the prospect of interest-rate cuts, is fuelling investors’ appetite. But a stable environment does not imply compelling risk-adjusted returns, because the additional yield offered relative to safer government debt is already low by historical standards.
Investment-grade yields of 3.8 per cent in euros and 5.5 per cent in US dollars, with a yield pick-up of only 100 basis points over “risk-free” government bonds, are not especially appealing when cash and money markets offer similar, if not higher, yields
Figure 4: Asset allocation – credit
Note: The weights in the asset allocation table only apply to a model portfolio without mandate constraints. Our House View asset allocation provides a comprehensive and forward-looking framework for discussion among the investment teams.
Source: Aviva Investors. Data as of June 30, 2024.
Key investment themes
1. Limited rate cuts
Real interest rates had been trending lower for the best part of 40 years, since the mid-1980s. That changed with the pandemic. The COVID-19 pandemic, the associated societal lockdowns and the ensuing economic recovery and inflation surge has coincided with a realisation that some of those secular forces forcing rates down – most notably globalisation – have been going into reverse.
The drive to deliver on climate change, and demographic changes such as the mass retirement of baby boomers, which is likely to deplete overall savings, are likely to exert further upward pressure on interest rates in the coming years.
Figure 5: Markets pricing central banks will cut rates only as low as the average of the pre-GFC years
Source: Aviva Investors, Bloomberg, Macrobond. Data as of June 30, 2024.
2. Fiscal support
The use of counter-cyclical fiscal policy during the pandemic proved highly effective in supporting the private sector through a period of lost activity and uncertainty. It was undoubtedly a key factor in the pace of recovery once economies re-opened and households could start spending and businesses producing again. The large energy price support packages unveiled across first Europe, and then many other countries, in the wake of Russia’s invasion of Ukraine, suggests governments may have become emboldened to intervene.
We expect they will continue to provide far more support than had hitherto been considered the norm, as and when required. At the same time, efforts to tackle climate change and enhance domestic economic security and build up military capabilities will all demand extra government spending. Deficits will be wider in coming years than they have been for decades.
Figure 6: Fiscal deficits (as a per cent of GDP) are expected to be notably larger over the next five years than the prior 20 years
Source: Aviva Investors, Macrobond. Data as of June 30, 2024.
3. Shifting power, evolving priorities
Elections this year are likely to prove highly consequential for domestic and foreign policies in several countries. In many instances there is likely to be a change in government. While we expect industrial policies to remain in fashion, priorities may evolve.
Globalisation, as measured by trade and capital flows, is still alive, yet protectionism is on the rise. Multinationals are adjusting their supply chains and diversifying away from China for a variety of reasons. Tariffs, sanctions and countersanctions have proliferated, as have subsidies, as governments strive to bolster domestic firms’ capabilities in sectors such as technology, energy and defence equipment. Protectionism could be ratcheted up still further depending on the outcome of elections in the US, Europe and beyond.
Figure 7: Number of trade restrictions imposed annually
Note: 2024 based on annualised figure for H1.
Source: Source: Aviva Investors, Global Trade Alert. Data as of June 30, 2024.
4. AI to the rescue?
When it comes to the broader economy, the potential economic benefit of artificial intelligence (AI) boils down to one factor – productivity (output per hour worked). In short, a positive supply shock in the form of a productivity boost should be disinflationary and translate into stronger economic growth.
Weaker productivity growth helped explain much of the long-term decline in bond yields seen from the mid-1980s until 2022. An AI-led jump in productivity could decisively reverse this.
At this stage the size of any potential boost to productivity is little more than conjecture. However, it is worth monitoring as a regime of both rising economic growth and interest rates might imply a more positive correlation between stock and bond returns. As such it could have significant implications for asset allocators.
Figure 8: Globally, 18 per cent of work could be automated by AI
Source: Aviva Investors, Goldman Sachs Global Investment Research. Data as of March 26, 2023.
Read the House View
House View Q3 2024
In our House View for Q3 2024, we discuss how central banks look to have succeeded in taming inflation without tipping economies into recession.
Never miss the latest House View
Sign-up to receive quarterly emails on our collective view of global markets.
House View Q3 2024
Join our House View Q3 2024 webcast where Peter Smith, Senior Investment Director, Vasileios Gkionakis, Senior Economist & Strategist and Sunil Krishnan, Head of Multi-asset Funds discuss the first half of 2024 and the economic outlook.
About the House View
The Aviva Investors House View document is a comprehensive compilation of views and analysis from the major investment teams.
The document is produced quarterly by our investment professionals and is overseen by the Investment Strategy team. We hold a House View Forum biannually at which the main issues and arguments are introduced, discussed and debated. The process by which the House View is constructed is a collaborative one – everyone will be aware of the main themes and key aspects of the outlook. All team members have the right to challenge and all are encouraged to do so. The aim is to ensure that all contributors are fully aware of the thoughts of everyone else and that a broad consensus can be reached across the teams on the main aspects of the report.
The House View document serves two main purposes. First, its preparation provides a comprehensive and forward-looking framework for discussion among the investment teams. Secondly, it allows us to share our thinking and explain the reasons for our economic views and investment decisions to those whom they affect.
Not everyone will agree with all assumptions made and all of the conclusions reached. No-one can predict the future perfectly. But the contents of this report represent the best collective judgement of Aviva Investors on the current and future investment environment.
House View contributors
Michael Grady
Head of Investment Strategy and Chief Economist
David Nowakowski
Senior Strategist, Multi-asset & Macro
Joao Toniato
Head of Global Equity Strategy
Vasileios Gkionakis
Senior Economist and Strategist
Important information
THIS IS A MARKETING COMMUNICATION
Except where stated as otherwise, the source of all information is Aviva Investors Global Services Limited (AIGSL). Unless stated otherwise any views and opinions are those of Aviva Investors. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. Information contained herein has been obtained from sources believed to be reliable, but has not been independently verified by Aviva Investors and is not guaranteed to be accurate. Past performance is not a guide to the future. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested. Nothing in this material, including any references to specific securities, assets classes and financial markets is intended to or should be construed as advice or recommendations of any nature. Some data shown are hypothetical or projected and may not come to pass as stated due to changes in market conditions and are not guarantees of future outcomes. This material is not a recommendation to sell or purchase any investment.
The information contained herein is for general guidance only. It is the responsibility of any person or persons in possession of this information to inform themselves of, and to observe, all applicable laws and regulations of any relevant jurisdiction. The information contained herein does not constitute an offer or solicitation to any person in any jurisdiction in which such offer or solicitation is not authorised or to any person to whom it would be unlawful to make such offer or solicitation.
In Europe, this document is issued by Aviva Investors Luxembourg S.A. Registered Office: 2 rue du Fort Bourbon, 1st Floor, 1249 Luxembourg. Supervised by Commission de Surveillance du Secteur Financier. An Aviva company. In the UK, this document is by Aviva Investors Global Services Limited. Registered in England No. 1151805. Registered Office: 80 Fenchurch Street, London, EC3M 4AE. Authorised and regulated by the Financial Conduct Authority. Firm Reference No. 119178. In Switzerland, this document is issued by Aviva Investors Schweiz GmbH.
In Singapore, this material is being circulated by way of an arrangement with Aviva Investors Asia Pte. Limited (AIAPL) for distribution to institutional investors only. Please note that AIAPL does not provide any independent research or analysis in the substance or preparation of this material. Recipients of this material are to contact AIAPL in respect of any matters arising from, or in connection with, this material. AIAPL, a company incorporated under the laws of Singapore with registration number 200813519W, holds a valid Capital Markets Services Licence to carry out fund management activities issued under the Securities and Futures Act (Singapore Statute Cap. 289) and Asian Exempt Financial Adviser for the purposes of the Financial Advisers Act (Singapore Statute Cap.110). Registered Office: 138 Market Street, #05-01 CapitaGreen, Singapore 048946.
In Australia, this material is being circulated by way of an arrangement with Aviva Investors Pacific Pty Ltd (AIPPL) for distribution to wholesale investors only. Please note that AIPPL does not provide any independent research or analysis in the substance or preparation of this material. Recipients of this material are to contact AIPPL in respect of any matters arising from, or in connection with, this material. AIPPL, a company incorporated under the laws of Australia with Australian Business No. 87 153 200 278 and Australian Company No. 153 200 278, holds an Australian Financial Services License (AFSL 411458) issued by the Australian Securities and Investments Commission. Business address: Level 27, 101 Collins Street, Melbourne, VIC 3000, Australia.
The name “Aviva Investors” as used in this material refers to the global organization of affiliated asset management businesses operating under the Aviva Investors name. Each Aviva investors’ affiliate is a subsidiary of Aviva plc, a publicly- traded multi-national financial services company headquartered in the United Kingdom.
Aviva Investors Canada, Inc. (“AIC”) is located in Toronto and is based within the North American region of the global organization of affiliated asset management businesses operating under the Aviva Investors name. AIC is registered with the Ontario Securities Commission as a commodity trading manager, exempt market dealer, portfolio manager and investment fund manager. AIC is also registered as an exempt market dealer and portfolio manager in each province of Canada and may also be registered as an investment fund manager in certain other applicable provinces.
Aviva Investors Americas LLC is a federally registered investment advisor with the U.S. Securities and Exchange Commission. Aviva Investors Americas is also a commodity trading advisor (“CTA”) registered with the Commodity Futures Trading Commission (“CFTC”) and is a member of the National Futures Association (“NFA”). AIA’s Form ADV Part 2A, which provides background information about the firm and its business practices, is available upon written request to: Compliance Department, 225 West Wacker Drive, Suite 2250, Chicago, IL 60606.
AIQ Investment Thinking
Get our perspective on key themes influencing investment markets globally.