2024 Midyear Multi-Asset Outlook: Favoring Equities, Credit, and Rates – in That Order

• We have a constructive-leaning view of multi-asset portfolios at the midyear point, with our outlook at the global asset class level boiling down to equities over credit, and credit over rates. But with consequential elections coming up, be prepared to adjust geographic tilts at the margin.

• In equities, promising areas include Asia-Pacific exporters and UK equity, which is inexpensive in the wake of Brexit and has above-average sensitivity to interest rate cuts.

• We view credit spreads as tight almost everywhere, with exceptions including Asia’s high yield market ex-China property as well as mortgage-backed securities (MBS), which offer normal spreads when most others are tight, and where banks’ ability to hold deposits should improve with rate cuts.

• We see above-average risk-adjusted return potential through duration – essentially by owning the global government bond market (ex-Japan) from the belly on out the curve. European curves look more interesting than Treasuries, with this differential poised to become much wider in the event of a Trump win that reflates the US while deflating other economies.

• Lastly, gold may serve as a strategic hedge as economic links fracture and geopolitical risks rise.

At the midyear point, our outlook for multi-asset portfolios leans constructive as we mull the potential impact of several critical drivers of asset class performance.

Importantly, a global easing cycle has begun. With the front door to easing (cutting policy rates) temporarily closed given the first quarter’s inconvenient inflation bounce, the Federal Reserve proceeded through the back door by using their other policy tool (tapering quantitative tightening). Shortly after, the European Central Bank (ECB) cut its policy rate for the first time since 2019. Globally, disinflation has come a long way, and other core central banks are now likely to join in.

Policy rate-cutting cycles are big moments. While favorable for markets overall, not all rate-cutting cycles are created equal. Those that transpire in the context of a soft landing typically involve only several cuts, whereas hard landings can bring on several hundred basis points of cuts. Soft landings have typically been very equity-friendly, with modest tailwinds for the rates market. In contrast, hard landing-inspired policy rate-cutting cycles have been very rates friendly, yet harsh on the stock market and credit spreads.

We do see a soft landing unfolding, accompanied by a convergence of economic growth across regions. Based on current macroeconomic policies, this convergence is marked by the US slowing from too hot to just right, while many other economies that never fully recovered from Covid look poised to accelerate toward more normal growth. With more companies likely to do well after policy rate-cutting begins, and once the soft-landing saucer bottoms and begins to rise again, we expect to see more opportunities without herding into US centricity, and a narrow list of companies stealing the show. The caveat here is that the November US presidential election could significantly alter the current policy trajectory, just as the snap election in France could change the course of Europe. Elections thus loom large over markets.

A consequential yet uncertain election argues for positioning down the middle

In the US, policy is expected to remain largely on autopilot under a Biden win but to shift toward a “run hot” bent under a second Trump term. When Trump first won in 2016, the output gap had quite a bit of slack, and the administration was slow out of the gate. At that time, run-hot policies teamed with deregulation resulted in favorable market performance. Today, the US was overheating quite recently (a condition that can often be hard on financial assets) and is just now approaching more balanced (if slower) growth – still resilient and with less inflation.

There is no slack at present in the output gap. Introducing run-hot policies against this backdrop – such as making expiring tax cuts permanent, closing the Southern border while the labor market is still tight (if easing), and increasing tariffs – may result in a much different market reaction. The upfront reflationary aspects of these policies would likely ebb over time amid toned-down regulation. Whether markets could look beyond reflation now in anticipation of deregulation later is a tough call. Former President Trump is also believed to be studying ways to curb the independence of the Federal Reserve. With all these policies in flux, as in his first administration, it’s important to keep in mind his tendency to soften policy changes when the stock market reacts poorly. We would expect more such episodes of “pain before gain.”

Under Biden, the current policy trajectory would likely continue, with US markets poised to keep doing well but for other stock markets to narrow the gap as growth elsewhere strengthens. Asian and UK equities might see the best upside, with relatively stable currencies. Under Trump 2.0, look for a stronger US dollar and stock market, yet with the US rates curve steepening on the long end. Reflationary policies for the US would also likely be deflationary for much of the rest of the world; US tariffs would reduce competition inside the US, with excess product building up elsewhere creating a more deflationary backdrop. International stock markets would have less upside, yet their rates markets could become the place to be.

The common thread for multi-asset portfolios in either a Biden or Trump victory, at the global asset class level, is equities over credit, and credit over rates – but be prepared to adjust geographic tilts at the margin.While it’s still too early to predict which way the election will go, it’s not too early to prepare portfolios to adapt as needed as the outcome comes into focus.

Global growth convergence creates opportunities to diversify

The US has experienced robust nominal growth in the post-Covid period, driven by a formidable fiscal thrust (which more than offset policy rate hikes) teamed with rapid immigration (which is helping loosen up the labor market in the midst of a strong economy). Most other regions have not had such tailwinds and have exhibited symptoms analogous to long Covid: Weakness that they just couldn’t shake off. Yet this divergence may now be starting to narrow as the US economy moderates while other global economies gain some momentum.

Growth Is Converging Between the US and the Rest of the World

Composite PMIs

Source: Bloomberg as of 29 April 2024.

In China, a cyclical recovery after a period of pronounced weak growth is being aided by the nearing end of a global manufacturing recession for consumer goods. Yet this is complicated by China’s increased state-led investments in export-oriented industries like electric vehicles and solar power (which are market-distorting policies) while still expecting status quo market access to other countries. We think that’s unlikely. Other state-led investments into converting China’s own economy to new energy should be more fruitful. Yet this upturn may not last long, as the symptoms of a balance sheet recession continue to build (including deleveraging and a lack of confidence in making significant purchases or investments). Escape velocity is nowhere in sight.

Outside of China, many of Asia’s economies are finally on more sustainable upturns, and we think the region’s trade recovery has more room to grow given leverage from the end of the manufacturing recession, as goods inventories worldwide have cleared. Europe is also showing signs of a cyclical recovery, with strength in manufacturing and service purchasing managers’ indices, improving industrial demand, and a potential pickup in China’s economy supporting European growth for the rest of the year. The ECB’s June rate cut is a further tailwind, though fiscal tightening in response to EU requirements could be a modest economic drag. As of this writing, populist-leaning elections look poised to produce a tougher environment to effect cohesive macroeconomic policies.

In contrast, signs of a normalization (in growth, inflation, and rates) in the US are finally emerging. Consumers are becoming less fearless in their spending and use of credit cards, if focusing more on essentials. The US labor market is easing as a result of more supply, not less demand, with job creation tapering down to more sustainable levels.

In sum, we see a moderate convergence of economic conditions globally, with more participation than the very narrow markets we saw last year. Policy cuts in the context of soft landings have lacked the several hundred basis points of declines typically required to pull through better small-cap and emerging markets performance. However, several cuts paired with growth convergence have opened the door for broader developed market equity performance.

Multi-asset positioning views

Equities …

Looking toward the second half, we are constructive on risk assets, and equities in particular. With a global easing cycle now in progress, we see downside risks receding, bolstered by strong supply-side factors that are likely to free up growth potential while keeping inflation in check. Promising areas include Asia-Pacific exporters, where the rolling recession in goods manufacturing appears to have ended. UK equity is very inexpensive in the wake of Brexit, in our view, and has above-average sensitivity to interest rate cuts. It is also supported by a positive immigration tailwind in an aging world. Unlike small-cap and emerging market (EM) equities, Europe and Japan equities have tended to outperform in soft landings. Given the UK’s statistical undervaluation, policy rate cuts are likely all that is needed to initiate modest outperformance. Markets also like policies that are not too extreme to the left or right, and after fairly extreme policies by the Conservatives up to and since Brexit, the policies from a new center-left Labor party could surprise markets to the upside.

… Over credit …

While we view credit spreads as tight almost everywhere, we think they deserve to be, and conditions are likely to keep them tight. Exceptions include Asia’s high yield market ex-China property (the proverbial baby thrown out with the bath water) as well as mortgage-backed securities, which offer normal spreads when most others are tight, and where banks’ ability to hold deposits should improve with rate cuts.

… Over rates …

US inflation and rates backed up earlier this year and are now bending back down. We see a new “coming off the boil” tone to the US economy and inflation. The Treasury and the Fed also appear to be cooperating to cap upside volatility, with the Fed ending quantitative tightening early (and to a greater degree than expected) while the Treasury initiates a bond buyback program. We see above-average risk-adjusted return potential through duration: essentially, by owning the global government bond market (ex-Japan) from the belly on out the curve. Japan looks to us like an uninvestable bond market currently as authorities gradually take their thumb off their rates curve. At present, European curves look more interesting than Treasuries, with this differential poised to become much wider if a Trump win reflates the US while deflating others.

… + Gold.

China’s push for de-dollarization by shifting reserves from US Treasuries to gold, along with the central bank’s efforts to stabilize the yuan, is bolstering gold’s position. These actions have given an unusual 5% annualized tailwind to gold returns since Russia’s invasion of Ukraine, by our estimates. The potential for further global trade friction is rising as China reduces the market’s role in its own economy while boosting state-led direction and subsidies for its chosen industries. Market-based economies that had granted China access to their markets, on the premise that China would be opening theirs while reducing subsidies, will be rethinking such access. Military risks are also ratcheting up as Putin attempts to reclaim post-Soviet borders, Iran and Israel spar more directly, and North Korea and Venezuela coordinate more closely with Russia and China. As economic links fracture and geopolitical risks rise, gold serves as a strategic hedge.

Looking past November

With impactful elections approaching, we think positioning that emphasizes diversified global equities over credit over rates offers a comfortable place to be. Yet it will likely prove wise to be ready to adjust as needed, as policy pivots could have a big impact. For now, we see brightening prospects for multi-asset portfolios overall and believe our equities-first mantra will hold through year-end.