Markets remain focused on monetary policy, with the dominant view still being that we are now close to the peak of the monetary tightening cycle. There is an assumption that this peak, when reached, will allow a policy pivot. This is despite evidence that inflation is still not yet fully under control, with uncomfortably high rates of core inflation in many economies. Fears around possible future stagflation have also not completely dissipated and energy costs are another concern.
What this means, in our view, is that expectations of an imminent sharp change in economic or policy direction are likely misplaced. Central banks will have good reasons to be cautious, even if this is indeed the peak of the tightening cycle. For developed market central banks, still buoyant labour markets (with their positive impact on consumption), combined with lingering inflation worries will make steering economies towards a soft landing more difficult. China, meanwhile, is trying to engineer the reverse: a not too soft “take off” for economic growth. Emerging market central banks must carefully address a range of other monetary policy issues too.
Central bank action will also not be perfectly synchronised. Any further Fed Funds rate hike would come as a surprise and we still seem on course for a slow sequence of U.S. rate cuts in 2024. The ECB rate hike earlier this month was also probably its last in this cycle, although sticky core inflation in Europe seems likely to delay rate cuts in 2024. And the Bank of Japan could move in the opposite direction entirely, with two small technical hikes next year designed to finally return its policy rate to positive territory.
We remain confident that the central banks can manage us through these continuing policy realignments. For the developed markets, our base case is a soft recession or anaemic growth, followed by a moderate recovery. For China, we expect an eventual modest recovery in the final quarter of this year, led by services and some easing of restrictions in the property sector.
Against this macroeconomic background, investment management will call for subtle changes of direction rather than dramatic shifts in strategy. With inflation pressures unlikely to subside completely, fixed income yields are unlikely to slide down, although yield curves are expected to become less inverted. With corporate fundamentals likely to remain sound, despite the expected temporary economic deceleration, we do not expect sharp credit spread widening.
Equities, too, look likely to ride out any slowdown reasonably well, with earnings growth soon resuming. This will be largely driven in the U.S. and elsewhere by a reinvigorated technology and communication services sector. Relatively modest 12-month overall return targets for most equity markets will conceal a range of other specific opportunities too, including an expected reduction in the valuation discount for European vs. U.S. stocks. Potential future dips could also be seen as buying opportunities.
Commodity prices remain vulnerable, as always, to uncertainty around global and (in particular) Chinese growth. But supply concerns have already pushed up oil and energy prices as we approach winter in the northern hemisphere. Copper prices could receive some support from continuing activity in electrical vehicle and renewables sectors here. Gold could also be in demand in coming months from investors trying to hedge against perceived recession risks.
So where will the key future crossroads be? My suggestion would be for investors to also look beyond monetary policy to ongoing profound changes of direction in the real world around us. We attempt to capture these in our long-term investment themes, discussed later, which cover the three areas of next-phase technology, resource transition and population support.
We can already see the potential of technology to address environmental issues and change how we live. What may be less evident is how markets are evolving to better channel capital, and the implications for investors, not just in terms of opportunities but also valuations and risk assessment.
These changes mean that this is an exciting time to be an investor, but also one that calls for circumspection. Portfolios need to be managed carefully to anticipate both policy and structural economic changes. We are looking forward to providing you with assistance here.
Christian Nolting
