Glittering prize

Please, please me 

Several things pleased me this week. The first (you won’t be surprised to learn) was Manchester United beating Liverpool in the quarter-final of the English FA Cup with a winning goal scored in the last minute of extra time. United supporters have not had a lot to cheer about this season but winning against the club’s biggest rival, at home, was very special. I forget what the other things were…. oh yes. Markets performed well too, driven by more evidence of the soft landing scenario. There were even some rate cuts – notably by the Swiss National Bank and, at the end of the week, by the central bank of Mexico. Markets responded favourably to more dovish signals from the US Federal Reserve (Fed) and the Bank of England. March has delivered healthy total returns across bond and equity markets. The bull market continues.

Finally, while working from home, I had several visits from a peregrine falcon that has taken to flying in and perching on a ledge that runs outside the window next to my desk. Apparently, London has a material population of falcons, some of which nest in the chimneys at Battersea Power Station (just down the road from my apartment). She is a beauty and each time, she stares at me for a few minutes through the window. It’s a lovely distraction from looking at my Bloomberg Launchpad pages! In a week of doves, she reminds me not to ignore the hawks!

It begins 

Last week I discussed the possible ‘landing’ scenarios. These mainly refer to the US given that is where economic performance has been so much stronger than expected. But we are possibly shifting into a new phase where the narrative might become global recovery. An important component of that is clearly easier monetary policies. The rate cutting cycle has started but the timing and extent of global rate cuts will depend on what happens with inflation. On that, the trend towards lower inflation continues to be steady. The UK recorded a further drop in the headline and core inflation numbers this week. As in the US, services inflation remains sticky, but it is inevitable that price and wage developments move more slowly in services and the direction of travel is clear.

Get real 

In most major economies, policy rates are above current annual rates of inflation. This is a proxy for ‘real’ short-term interest rates which turned positive in the US a year ago and in Europe during the late summer of last year. This triggered a period of risk-off in markets as perception of the policy stance shifted to ‘restrictive’. I am not sure we will see policy rates falling below inflation rates again any time soon, but rates will move lower to ensure there is no further increase in real short-term interest rates. This is positive for markets especially since rate cut expectations are modest. Currently, policy rates are between 150-200 basis points above headline inflation rates. Clearly there are concerns about core rates and all those different manipulations of inflation rates that the bears favour (headline ex-everything that’s going down), but my view is that policy will be eased, and that there is still a chance that the easing goes further than is currently priced in.

Cyclical recovery anyone? 

Lower rates are good for markets if they don’t reflect recessionary risks. When I look at some global data, it seems that rather than recession, the narrative might become more of a better-balanced global recovery. Data from the US, Europe, China, UK and Japan suggest business confidence is bottoming (same message from Purchasing Managers’ surveys). Consumer confidence is picking up in the UK, Europe and Japan. Asia export growth is strong. Taiwan, for example - central to the global electronics business - is seeing rising export orders and strong growth in actual export volumes to the US (while export growth to mainland China is negative – which is a different story). Global producer price inflation collapsed last year and remains very low which I take as good news that supply chains are operating more freely. All of this is feeding into upward revisions to global GDP growth forecasts.

Lower inflation globally 

It has been hard to apply typical cyclical benchmarks to the global economy in recent years because of the shocks experienced. However, it could be that we are experiencing an early-stage global recovery – albeit one that is beginning with strong policy stimulus tailwinds and with very little spare capacity in labour markets. Of course, there is a risk that inflation re-accelerates if global growth picks up. On the commodities side, most prices are well behaved although oil and gasoline prices have picked up and cocoa prices are through the roof (making the trip to the gas station more expensive overall!). However, despite that, inflation is forecast to be lower in 2024 in most developed and emerging market countries.

Strong fundamentals and technicals for markets 

A better balance to global growth is already being reflected in broader equity market performance. European markets hit a record high this week and performance over the last month has been led by Europe, mid and small cap indices, and value. The credit bull market continues as well, with US investment grade debt issuance up 35% year to date. In our recent review of fixed income markets, where our investors score various factors in terms of their expected impact on returns, the factor that captures trends in supply and demand flows (technicals) was positive across the board. There might be a lot of corporate bond issuance, but demand is strong, and spreads continue to move tighter.

Drivers 

Apart from lower rates and more balanced global growth, the secular drivers of equity market performance remain automation, digitalisation and the green transition. I saw some reference to weakness in US industrial production data as representing a sign of the cycle slowing. When I dug into the details though, the picture is not of industrial stagnation, but of very different growth rates across sectors. In the monthly data produced by the Fed, we see some very strong output numbers (computers and peripheral equipment up 9% year-on-year to February, communication services equipment up 25%, aerospace up 7% and electrical equipment up 6%). A US equity focus away from technology to more of the cyclical industrial space seems warranted based on strong capex spending and the prospects for a strong global trade cycle. The same argument holds clearly for Europe and Asia which have a cyclical and value tilt.

Spring optimism 

It’s been a very decent first quarter for investors. It is worth noting that anecdotally and based on data we see in the US on money market funds, there is still a lot of wealth held in cash. Cash rates have not come down so there is a psychological hurdle rate for investment in riskier asset classes to beat. That is totally understandable when there have been high levels of interest rate volatility and when global equity performance has been so concentrated, led by expensive US technology stocks and a single narrative around artificial intelligence. My feeling now is that growth is broadening, more investment narratives are worth investigating and the capital markets are liquid and largely free from any major credit concerns that growth can be financed comfortably. The average return of the S&P 500 in US Presidential election years has been around 11%. A more important point is that if we are now in a benign growth cycle – albeit one with a higher average interest rate than was the case in the last decade – then financial market returns could be more like their long-term averages. That means slightly higher for bonds than in recent years and slightly less for equities than over the last year. But good overall.

Honour and the glory 

I will be taking a break from this note for the next couple of weeks but back in time to report on the fortunes of Manchester United in the FA Cup semi-final. We have drawn Coventry City from the second tier of the English game. It won’t be easy; semi-finals rarely are. But it is United’s only chance of a trophy this year and awaiting them in the final is either Chelsea or Manchester City. That is some incentive to reach Wembley. A success would be fantastic for the United faithful. As the late, great Manchester United manager Sir Matt Busby said, there is nothing on earth like being a red.

(Performance data/data sources: Refinitiv DataStream, Bloomberg, as of 21 March 2024, unless otherwise stated). Past performance should not be seen as a guide to future returns.