Quarterly Perspectives 2Q 2024
Arthur Jiang
Raisah Rasid
Adrian Tong
Jennifer Qiu
J.P. Morgan Asset Management is pleased to present the latest edition of Quarterly Perspectives. This piece explores key themes from our Guide to the Markets, providing timely economic and investment insights.
THIS QUARTER’S THEMES
Overview
- The global economic and policy outlook is increasingly uneven. While the U.S. remains resilient, European economic activity remains soft, with potential for recovery. Meanwhile, Chinese consumers are seeking leisure and enjoyment, but in a budget-friendly way against a backdrop of continued consolidation in its housing market. Asia’s export performance is picking up and central banks in the region may have more flexibility to relax monetary policy later in the year.
- Steady growth in the U.S. and expected rate cuts by the Federal Reserve (Fed) in mid-2024 could add to the positive backdrop for both stocks and bonds. While some assets, such as U.S. mega cap tech companies and corporate credit, are comparatively expensive, others are still reasonably valued and can potentially benefit from the advancement of generative artificial intelligence (AI) and the rise of emerging market (EM) consumers. In health care, biotech and pharmaceuticals are also consistent themes that benefit from technological advancement.
- We believe cash is unattractive in this environment on a relative basis, given stronger income and total return potential in fixed income and equity income strategies. An uneven growth outlook and elevated geopolitical tensions amid a busy election year underscore the importance of tapping into international opportunities to diversify asset allocation while managing uncertainties.
U.S.: Gliding towards a soft landing
- The U.S. economy is still growing at a brisk pace, supported by household spending. This is, in turn, backed by rising real wage growth and a low unemployment rate. Meanwhile, spending by corporate America looks mixed. AI and the tech sector should still record strong investment spend, but higher borrowing costs could cool broader capital expenditure.
- Potential balance sheet stress for certain regional banks deserves some attention. While the Fed and U.S. Treasury Department have the tools to mitigate systemic risks in the financial system, weakened bank balance sheets could undermine banks’ ability to lend.
- Given the upcoming presidential and congressional elections, government spending should also be subdued. Overall, the timing of a deceleration in growth is likely to have been pushed back to later in 2024.
- Despite inflation rebounding in January, we believe price pressures should continue to ease through 2024. Elevated shelter costs and the sharp rise in auto insurance are likely to recede as we approach the second half of the year. This should provide the Fed with the right conditions to start cutting rates.
Central banks: Growth vs. inflation trade-off
- Given the U.S. economy’s resilience, the Fed sees more value in waiting before undertaking rate cuts. As inflation cools through the year, we see June as the earliest opportunity for the Fed to start cutting rates. In its March forecast, the Fed’s median projection is for 75bps cuts in 2024, followed by another 75bps bps in 2025.
- Investors have come to terms with the Fed’s more gradual approach. The futures market is pricing a total of 67 bps of cuts in 2024. Converging rate cut expectations between market participants and the Fed will likely help contain the upside risk to U.S. Treasury yields.
- Other central banks, such as the Reserve Bank of Australia, Bank of England and European Central Bank, are facing a more difficult dilemma amid persistent inflation and weaker growth prospects. For now, these policy makers are still focused on taming inflation, especially given the potential risk of wage-driven inflation from tight labour markets. Meanwhile, the Bank of Japan has returned to positive policy rate.
China: Stimulus now, confidence later
- Lunar New Year tourism data shows a rise in tourist volumes but softer per capita spending. This is consistent with the more cautious consumer sentiment on account of a comparatively weak labour market and dampened wealth effect due to the correction in housing and stock prices. Fixed asset investment is still largely supported by state spending on infrastructure. Private investments may remain subdued for now as manufacturers work through excess capacity.
- Beijing continues to implement policies to support the real estate sector. A “white list” of residential projects was drafted to guide banks to provide liquidity to developers. This will likely help ease the financial stress of some real estate developers and improve buyers’ confidence on project completion. That said, as expectations of property prices remain subdued, more time is needed to reinvigorate sector momentum.
- To achieve the government’s 5% GDP growth target, a step up in both monetary and fiscal policy stimulus would be required. Businesses would also need more policy transparent to restore corporate confidence and spur private investment.
The return of the export engine
- The Asian export revival continues with South Korea, Singapore and Taiwan posting double-digit year-over-year export growth in January. Despite the prospects of weaker growth in the U.S. and Europe later in the year, demand for electronic components is likely to remain strong, fueled by the rising demand for AI processing power across both data centers and consumer electronics.
- While inflation in the region is easing towards central bank targets, there is little urgency to cut rates among policy makers. In the second half of 2024, potential rate cuts by the Fed and other developed market central banks should create space for a gradual easing of monetary policy in these north Asian markets.
- The U.S. presidential election in November and U.S.-China tensions are likely to prompt questions about the future state of manufacturing supply chains in the region and globally. This could create opportunities in infrastructure and labour development in South and Southeast Asia.
Moderating growth and easing policy are positives for risk markets
- The backdrop for risk assets, such as equities and corporate credit, remains constructive on the back of a moderate expansion of the U.S. economy and expected easing of monetary policy closer to neutral levels in the next 18 months. We believe cash remains a less attractive asset class given the reinvestment risk as deposit rates could fall in the quarters ahead.
- Parts of the investment spectrum are starting to face valuation challenges. Investors will need to increasingly adopt an active approach when engaging opportunities in equity and credit markets while also moderating their return expectations. We believe greater geographical diversification is critical to achieve robust risk-adjusted returns as well as consistent income.
- Given significant divergence in manager performance and emerging headwinds in selective alternative asset classes, we believe active management is critical to navigating private market opportunities, including private equities and real assets such as transport and infrastructure.
Manage downside risks with fixed income
- With the divergence in rate cut expectations between market participants and the Fed narrowing, this could be a good opportunity to extend duration in developed market government bonds. Volatility in fixed income markets has also receded with softer inflation prints, allowing bonds to once again play a role as a traditional diversifier in portfolio construction.
- In the corporate bond market, we reiterate the importance of understanding the sources of potential return. Generally, lower risk-free rates and falling bond yields can provide reasonable returns for investors. Meanwhile, investment-grade and high yield corporate credit spreads could remain tight as fundamentals look sound, but further tightening would be hard to achieve. This implies a narrower scope for additional returns from spread compression.
Harness global diversification to navigate an uneven growth outlook
- Given the uneven growth and inflation outlook around the world, as well as international and domestic political uncertainties, we believe a globally diversified equity allocation is an optimal way to tap into opportunities presented by cyclical and structural growth themes while managing risks.
- A strong rally in equities, led by a narrow number of companies, raises questions on the sustainability of equity performance. A potential short-term pull back could be triggered by regulatory changes or other challenges to earnings growth, while a wider adoption of AI across industries could help broaden market performance. We believe there are still opportunities to be found in U.S. large cap stocks, but stress the importance of bottom-up stock picking to uncover companies that can harness this new technology to drive earnings growth.
- We stay constructive on Asian equities on the back of the export recovery. Tech exporters, including South Korea and Taiwan, could continue to enjoy potential positive surprises in earnings outlooks. Improvement in Japan’s corporate governance continues to be rewarded by investors, while South Korea is looking to adopt similar reforms. China and Hong Kong offer interesting value opportunities despite the cyclical and structural challenges facing the Chinese economy. We believe Asian markets offer a good mixture of growth and dividend opportunities.
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