Rising noise levels in markets test investors
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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
The writer is co-head of investment and group chief investment officer at Schroders
Equity markets have largely made a strong start to 2024 as investors rushed to price in a monetary policy pivot — in the form of anticipated rate cuts — from central banks. That has left valuations looking stretched across asset classes.
But it is already clear that 2024 will bring many different events that will lead to a reshuffling of the pack of investment opportunities.
Some of these events are already clearly marked on investors’ calendars, such as the many elections taking place around the world this year — most notably the US presidential election on November 5. Other events are less foreseeable, such as the attacks on shipping in the Red Sea and subsequent reaction from western nations. We do not know how current epicentres of conflict will evolve; whether they will become more entrenched, for example, or draw in more participants.
Overall, it makes for a complicated, and at times alarming, environment for investors to navigate. It’s important to remember, though, that not all the events of 2024 will be significant from a financial market perspective. The US presidential election is clearly one where the stakes are high, but that’s not the case for every poll.
A practical approach for investors is to focus on understanding how divergent policies and events — financial and geopolitical — give rise to different risks and opportunities.
Let’s take fixed income. The global economy is still in slowdown, which should be a benign environment for bonds, but we need to keep an eye on the long end of the yield curve as the US election approaches. Thanks to the dollar’s status as reserve currency, America has had the luxury of being able to run a large deficit. But signs of fiscal profligacy from candidates may push the patience of markets too far and could result in higher volatility for longer-dated bonds.
Europe, by contrast, has run more conservative fiscal policies. This is supportive of the bloc’s bonds.
Again, in emerging markets many countries have run orthodox monetary policies that now leave their debt markets in a good place. We are quite positive on local currency emerging market debt.
Equities have not moved as quickly as bonds to incorporate rate-cut expectations. While equity valuations have risen, they are not at extreme levels. Much of the move last year was concentrated in the so-called Magnificent Seven large-cap US stocks — and even these are underpinned by earnings. There may be scope for equities to move up further.
This will be particularly relevant to investors currently holding cash. Our recent analysis, looking at data from 22 rate-cutting cycles stretching back to 1929, has found that the average return for US equities has been 11 per cent in the 12 months following the first US rate cut.
If we do get the “soft landing” of slowdown but not recession, that should be supportive for equities. The question comes back to divergence: will those gains spread out to neglected areas of the market, including undervalued regions such as the UK?
China continues to face a growth problem as it copes with the ramifications of its property crisis, and while the outcome of the US election could bring significant changes for markets, we don’t think a shift in stance towards China will be one of them. The current protectionist tilt and race for technological supremacy is likely to remain intact regardless of who wins.
This weaker economic picture for China, and slowdown in the global economy more generally, does not create a bullish backdrop for commodities. But a strategic allocation to commodities can still make sense as a diversifier, especially in the context of intensifying geopolitical strains. One area of commodities where the outlook does look positive is gold. It typically performs well in periods when central banks cut rates.
For the dollar, an about turn in the consensus around early rate cuts could result in near-term strength versus other currencies.
Ultimately, the main thing is to remain invested in order to take advantage of these diverging opportunities as they emerge. It’s a truism as old as the hills but well worth saying again: there is a temptation during periods of uncertainty, noise and alarming headlines to seek “safety” on the sidelines. And unlike much of the past decade, it is now possible to obtain an attractive nominal return on cash. But, even if US rate cuts aren’t as imminent as some may hope, cash rates are still likely to come down, making cash less of a winner. At the same time, market moves can play out very rapidly. A position on the sidelines could mean missing out.