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When hawks fly like doves

16 April 2024

Despite this rosy picture, we are also aware that many things could go wrong.

The global growth cycle hit its lowest point in 2023 and is now picking up and earnings estimates have been creeping higher. Although central banks are hesitant to lower interest rates at this moment, they are conveying more accommodative signals to the market, which maintains the prevailing ‘risk-on’ sentiment.

This time last year, California’s Silicon Valley Bank collapsed and sparked a brief banking crisis in the US, roiling financial markets and ultimately claiming a few additional regional bank victims.

Fast forward to March 2024: the St Louis Financial stress index is the lowest since the Fed began raising rates. Bank deposits have stabilised and risen since the 2023 banking panic, showing that confidence in the banking system is returning. What a difference one year makes.

Indeed, while the number of Fed rate cut expectations has moved from seven at the start of 2024 to three as of now, markets do not seem to care: the S&P 500 just crossed 5,200 for the first time ever, the Nikkei 225 index is trading above 40,000 for the first time in three decades, the Europe Stoxx 600 hit new all-time highs, gold is trading above $2,200 for the first time ever, oil prices are creeping higher, copper has suddenly broken out and US corporate bond spreads remain very tight. Last but not least, Bitcoin has hit a new all-time high at $73,000 dollars.


Are we in the middle of a new mania?

To be fair, there are indeed some reasons to be cheerful. First, the global economy is doing better than anticipated. A global manufacturing recovery seems to be unfolding, US consumer sentiment is holding up, China is finally considering deploying more fiscal stimulus, the hard landing scenario seems unlikely and the ‘no landing’ probability is rising.

Better-than-expected economic numbers are propelling earnings estimates higher while artificial intelligence (AI) could trigger a productivity boom which should help keep corporate margins at a high level.

Market dynamics are also sending positive messages to investors: the upward trend remains robust, the participation to the upside is broadening, cyclicals are outperforming defensives and commodities are starting to pick up. Meanwhile, bond volatility is decreasing and the dollar is stabilising.

Finally, investors seem to be cheering the fact that central banks will still cut rates despite the resilience of economic growth and the stickiness of inflation. The ‘reflation’ thesis was corroborated by two important central banks meetings.

First, Bank of Japan Governor Kazuo Ueda decided to end the policy of negative rates. This move was widely anticipated, and the dovish tone around this decision pleased investors and didn’t lead to the yen appreciation which was feared by markets.

In the US, the Fed has kept interest rates unchanged as expected. But there was a positive surprise for investors: as compared to their December forecasts, the Fed is expecting higher real GDP growth (2.1% vs. 1.4%), lower unemployment (4.0% vs. 4.1%) and higher core PCE inflation (2.6% vs. 2.4%), but it is still anticipating three rate cuts this year. This sounds reflationary for markets: as in the case of Japan, the Fed hawks are flying like doves.

This positive mix of decent growth, stable inflation (albeit at a higher level than central bank’s target), loosening financial conditions and upward trending markets with broader participation to the upside lead us to keep our global equity allocation unchanged (with the market effect, our tactical asset allocation to equities is now slightly higher than our strategic asset allocation).


So why not increase our equity allocation further?

Despite this rosy picture, we are also aware that many things could go wrong. The sectors of the economy which are the most affected by higher rates (e.g. US commercial real estate, small- and medium-sized enterprises, etc.) continue to struggle.

Sticky inflation in services and the rise of commodity prices could lead to higher headline inflation in the months to come – hence preventing rate cuts by central banks at a time when global debt keeps ballooning.

A cracking of market heavyweights could lead global indices lower. Geopolitical conflict escalation in Ukraine or Middle East remains a risk. Investor sentiment appears complacent and elevated equity market multiples do not leave any room for disappointment. As such, we are keeping our global equity allocation close to our strategic asset allocation and we won’t be adding more exposure to equities at this stage.

However, we believe some sector and style rotation could continue to unfold. Indeed, the ‘reflation’ thesis might trigger new leadership within equities. We are starting to see some large-cap tech stocks stalling while sectors such as energy and materials have been outperforming the S&P 500 index recently.

Within non-US markets, we are keeping our preference for Japan and staying neutral on Europe. Although momentum in China's equity markets is on the rise, we are currently choosing not to increase our investments in this region.

On the rates side, Treasury supply continues to rise and, coupled with sticky inflation, is exerting upward pressures on long-dated bond yields. In this context, we are decreasing our allocation to government bonds 1-10 years from positive to neutral and the 10 years+ government bonds from neutral to negative. Proceeds are reinvested into cash which continues to offer positive real yields.

The downtrend in credit spreads has continued towards multi-year lows. We remain neutral on credit with a preference for quality (investment grade). On an aggregate basis, our fixed income positioning has moved from neutral to negative.

Within commodities, we are maintaining our allocation to gold. The resilience of the yellow metal despite higher rates and exchange-traded fund outflows is remarkable. Gold continues to offer a protection against geopolitical shocks and currency debasement. The recent technical breakout seems to indicate further upside ahead.

In Forex, we are keeping our neutral stance on the euro, Swiss franc and pound against the dollar. Central banks on both sides of the Atlantic seem to be on a wait and see mode for the time being. We still believe that the change in monetary policy in Japan (raising rates at the time other central banks are contemplating a cut) could lead to some yen appreciation – hence our positive view on the yen versus dollar.

Charles-Henry Monchau chief investment officer at Bank Syz. The views expressed above should not be taken as investment advice.

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