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The old adage "sell in May and go away" has served as poor advice thus far for investors in May. The S&P 500 is up nearly 5% for the month, while the technology-heavy Nasdaq has gained roughly 8%. Small-cap and mid-cap stocks have fared well also, with the Russell 2000 Index returning over 3% and the Russell Mid-cap Index returning about 1.5% over the same time period. Overseas, we've seen strong performance from both international developed and emerging-market stocks as well, with both the MSCI EAFE and MSCI EM Indexes higher by about 4% in May. After a challenging April, the Bloomberg U.S. Aggregate Bond Index has risen roughly 1.3% in May, helping recoup some of last month's losses. Commodities is the silent bull market, outperforming all asset classes – except cryptos – since the start of the year.
As we move into the second half of 2024, the one billion dollars question for investors is whether the equity bull markets will continue.
As explained in the next sections, the weight of the evidence built on our 5 pillars process points towards a neutral / positive stance towards equities. Positive nominal GDP growth prospects for the months ahead, with reduced downside risks, still warrant a positive assessment of the Macro cycle at that stage. The combination of positive real cash rates and QT, on the one hand, and easy broad financial conditions and expected rate cuts on the other hand, warrants to maintain a neutral assessment on liquidity conditions. Earnings growth is neutral with a positive momentum and earnings revision though much of these revisions are led by a small number of mega cap tech stocks. Equity valuations are not cheap – both on an absolute and relative basis.
Macro cycle: POSITIVE (unchanged)
Liquidity: NEUTRAL (unchanged)
The global economy remains in solid expansion over the spring, as the favorable trends at play since the end of 2023 continue to blossom. In the United States, activity in the service sector is still the main driver of GDP growth, with high employment, elevated wage growth and unabated support of fiscal policy being powerful supports to consumption spendings. As household consumption weights close to 70% of the US GDP (consumption of services alone being almost 50%), the ongoing positive dynamic in this key component keeping US GDP growth above its trend rate. In the meantime, Europe continues to recover after the soft patch of 2023 and still exhibits a clear growth momentum. Here too, the service sector is also the main driver of the expansion, even in Germany where the slowdown had been most pronounced last year. A favorable economic dynamic is also visible in Asia, where Japan benefits from rising global demand for its manufactured goods at a time when households face a long-forgotten phenomenon for them, rising prices. In China, the real estate market remains a drag on consumption that the government is trying to fix without reigniting an investment bubble. But industrial activity is recovering and supports a pace of expansion in line with the target set by the authorities.
To be fair, some signs have appeared recently that raise the risk of a deterioration in this positive economic environment for the second part of the year.
Global growth is settling on a soft-but-positive rate after two years of slowdown
Eurozone – Economic activity continues to recover and is gradually converging toward 1% after the 2023 recession
The deterioration in US consumer sentiment is one of them, as rising prices in several goods and services, from gasoline to housing, affect the purchasing power of a growing part of the population. In a context of high interest rates that make the use of credit cards and other forms of credit very expensive, persistent inflationary pressures are eroding households’ purchasing power and confidence despite the positive dynamic of the broader economy. Five months ahead of the Presidential election, this situation is clearly unwelcome for Joe Biden, who is likely to pull every lever he can in the near future to enhance the economic sentiment of US voters. An economic growth slowdown just ahead of the election would indeed hamper the chances of re-election for the incumbent President.
US economy – The labor market is slowing down at last, a welcome development for easing inflationary pressures. But also a downside risk for growth
Lingering weakness in China’s domestic consumption is also a potential risk for the second half of the year. The world’s second largest economy can no longer rely exclusively on external demand for its growth, especially in a context of rising protectionist pressures in its two key export markets (US and Europe). Selective measures to stabilize the real estate market and prospects of rising government support via public debt issuance should help support a recovery in consumption spending, but the domestic momentum is still subdued in China for the time being.
The risk of weak or weaker domestic demand in the US and China, half the world’s GDP between them, has to be closely watched in the months ahead even if, for the time being, ongoing dynamics and the likely support of government policies still point to a continuation of the positive growth trend over the summer.
Much of the economic developments will also depend on the evolution of inflationary pressures in the coming months. The inflation picture is quite contrasted across the main economic areas and might dictate divergent monetary policy responses by the end of the year. In China, weak domestic demand keeps inflation at a depressed level (+0.3% in April) that provides room for monetary and fiscal policy support. In Europe, inflation appears to be on a clear slowing trend (+2.4% in April) and is getting close to the ECB’s 2% target. This will allow the central bank to start relaxing its monetary policy stance with a first rate cut in June, likely to be followed by more easing by the end of the year. The situation is less clearcut in the United States, where inflation is still significantly above the Fed’s 2% target (+3.4% in April) and has proved to be stickier than expected since the beginning of the year. The latest data were encouraging in showing some softening of upward price pressures, but inflation remains a key issue for US households and for the Fed. The ongoing easing in US labor market tensions should gradually alleviate those inflationary pressures, but the risk of inflation persisting for some time in the US cannot be ruled out. It could disrupt the positive scenario expected for the second half of 2024, by dampening consumer sentiment and spendings, and preventing the Fed from relaxing its monetary policy stance.
Inflation is still too high for central banks (especially the Fed), but gradual disinflation remains the most likely scenario
The broad economic picture therefore remains quite positive for the time being and is most likely to remain supportive as we head toward the summer. A combination of positive economic growth, supportive fiscal policy, abating inflationary pressures and monetary policy easing (including a stabilization in liquidity conditions) would indeed be a favorable environment for the remaining of 2024. However, lingering inflationary pressures in the US, and question marks around domestic consumption in the US and China are potential downside risks that will have to be watched closely in the coming weeks.
Our scenario: A favourable economic environment heading toward the summer, but watch for inflation in the US and domestic demand in China.
Indicators review summary - our five pillars
EQUITIES
Earnings NEUTRAL (unchanged)
The first quarter earnings season is almost completed and has been slightly ahead of expectation even, in aggregate, revenues have seen little revision. As a result, earnings estimates have been mostly revised upward for the US and Switzerland that is seeing a boost from the weaker Swiss franc following the move by the SNB. Elsewhere, revisions are more muted notably in Japan due to a slowdown in economic activity.
Comparing the S&P500 and the S&P500 Equal Weight, we see that mega caps (Mag7) are expected to contribute meaningfully to earnings growth this year while investors expect a broadening of earnings growth in 2025 as market cap and equal weight are showing close growth rate.
This scenario coupled with an earning growth acceleration next year in the US and Europe is positive for equity markets but, as stated in our macro view, would be challenged should consumption get weaker in the US.
Valuation. NEUTRAL (unchanged)
Valuation is contrasted across regions with higher than historical multiples in the US and Europe reflecting the acceleration in earnings growth in 2025. This is also the reason of our neutral stance as expectations are relatively high in both earnings and valuation but the earning momentum (i.e., revision) remains positive.
China remains the stand-out with below historical median valuation levels, but the economic outlook remains challenged and earnings are expected to decelerate next year.
Market trends
The market concentration effect continues in the US with the Mag7 representing the bulk of earnings growth and the performance of the index, and we are not yet seeing a reversal of this trend.
Another strong trend is the “AI trade” notably visible in the semiconductor space as Nvidia and the SOXX index are performing strongly.
Regions and Sectors
In terms of our global equity positioning, we continue to prefer the US market due to a still, albeit slowing, economy but its high exposure to technology companies that benefits from the AI investment cycle. We also favor European equities as the first rate cut in this cycle by the ECB looms. On the other hand, we remain cautious on Japanese equities as earning revisions are negative due to soft economic activity. In China, we are waiting for more signs of stabilization in the real estate sector.
FIXED INCOME
We maintain a prudent approach in our fixed income strategy, influenced by a bearish perspective on long-duration bonds and a judicious stance on credit sectors. Despite our general caution, we have upgraded our view on short and intermediate government bonds from neutral to positive, while continuing to express concern for bonds maturing beyond 10 years. Our position on Investment Grade (IG) credit remains neutral, while we adopt a negative stance on High Yield (HY) and USD-denominated Emerging Market (EM) debt.
Government Bonds:
For bonds with maturities under 10 years, we now hold a positive outlook, anticipating favorable conditions for yield improvements by year-end over potential declines. This change is driven by several factors:
- Economic Stability: A normalization in the US economy paired with a gradual decline in inflation rates, despite occasional volatility.
- Monetary and Fiscal Policies: Efforts by the Federal Reserve and US Treasury to stimulate demand, including easing quantitative tightening and enhancing liquidity in the Treasury bond market through a buyback program.
- Valuation and Market Dynamics: Real rates remain above 2%, offering attractive value relative to equities, and the market anticipates a prolonged monetary policy normalization process, expecting over two years until reaching the terminal rate.
- Historical Trends: Bonds have traditionally shown strong performance ahead of the first rate cut, especially 2 to 4 months prior. With the first rate cut projected for Q3/Q4 2024, we are approaching a favorable period.
However, our cautious perspective persists for longer maturity bonds, influenced by an inverted yield curve, negative term premiums, and ongoing rate volatility. Additional concerns include uncertainty over the Federal Reserve's timing for the first rate cut, policy normalization trajectories, and the implications of a growing US fiscal deficit and increased Treasury issuances.
Chart: US Bond Volatility Trends - Lowest Since 2022
Source: Syz CIO office, Bloomberg
In Europe, we maintain a neutral stance despite a recent uptick in Eurozone economic activity. Our baseline scenario still anticipates the first ECB rate cut in June, though the pace of normalization remains uncertain and highly dependent on economic data. With wages remaining high, particularly in the services sector, and European inflation sensitive to commodity prices, caution is advised. The tightening of spreads, especially between Italian and German 10-year yields, further necessitates a cautious approach. We remain neutral on UK government bonds, as the latest inflation figures (a smaller drop than expected) and the decision to hold a snap election on July 4th give the Bank of England all the economic justification it needs to possibly delay its monetary policy adjustment until August.
Chart: ECB Monetary Policy Outlook - Market Perception Shifts
Source: Syz CIO office, Bloomberg
Corporate Bonds
Our neutral stance continues in the investment-grade segment, where credit spreads have tightened significantly to their lowest since 2021, reducing the safety margin (now only 15% of total yield). The current market conditions are "priced to perfection," necessitating vigilance. Additionally, for the first time since 2022, there are more BBB-rated bonds with a negative outlook than those with a positive outlook. Despite these factors, the solid macroeconomic backdrop and concerns over US Treasury sustainability suggest that reducing credit exposure prematurely might be inadvisable. In the high-yield domain, we prefer subordinated debts and recognize opportunities in short-term maturity corporate high-yield bonds, given their favorable risk/reward profile.
Chart: Breakdown of Yield in Different Fixed Income Segments
Source: Syz CIO Office, Bloomberg.
Emerging Markets
Our stance on hard-currency EM debt remains negative, although we identify attractive investment opportunities in bonds with up to 4-year maturities and yields above 6.5%. The strengthening US dollar and rising US real interest rates pose significant challenges, overshadowing the recent relative outperformance of this segment. Market sentiment towards EM debt has worsened, reflected by persistent negative capital flows, and increased short interest in USD-denominated EM debt. Valuations are notably stretched, with EM corporate spreads at their narrowest since 2007.
Chart: Emerging Market Corporate Spread Evolution (in bps)
Source: Syz CIO Office, Bloomerg
FOREX
Given recent macro developments in the US, the timing and extent of the Fed’s rate cuts in 2024 is more uncertain and might be respectively later, and less than expected.
As a result, there is no more reason at this stage to hold a positive view on the EUR and CHF, as the scenario of a stronger USD has an increased probability.
EUR/USD: Rates and macro dynamics are less negative for the EUR, but macro developments importantly also support the USD --> our rating is NEGATIVE.
CHF/USD: Fundamentals no longer warrant additional CHF appreciation, and the real rate differential pleads for a firmer USD vs Swiss franc at least in the short run. In the short-term, the USD might benefit from the real interest rate differential (nominal rate - inflation rate) that has recently become more supportive for the greenback: inflation in the US is slowing while short-term nominal rates remain high, which leads to rising real USD rates. As real CHF rates remain broadly stable, a higher real rate differential supports the US dollar --> our rating is NEGATIVE.
JPY/USD: It is highly likely that Japanese authorities will intervene as the JPY has been testing the 160 level against the dollar. Nevertheless, there is no guarantee that this intervention will prove effective. The BoJ is "trapped”: Japan is experiencing increasing inflation expectations alongside a continuous devaluation of the yen, exhibiting an almost perfectly negative correlation. This reflects the dilemma of an economy burdened by excessive debt, necessitating continuous accommodative monetary policies in the face of structural inflationary pressures. If Japan wants to slow its FX devaluation, they could raise rates. However, that would greatly increase their deficit, which the BOJ would have to monetize, and thus accelerate money supply growth --> our rating is NEUTRAL.
ALTERNATIVES
We remain positive on gold, which continues to exhibit low volatility with other asset classes and should be a beneficiary of any tail risk event. We note that a significant gap remains between gold and real yields. Why? 1) With debt sustainability having become an ever-increasing issue, the market anticipates that real interest rates cannot stay at this level for too long; 2) Investors buy gold asinsurance against adverse circumstances (inflation, recession, etc.) 3) There is heavy demand stemming from central banks, especially in emerging markets.
We are keeping a positive stance on commodities as a portfolio diversifier and protection against inflation upside. Commodity prices are moving higher, driven by strong US growth, geopolitical uncertainty, segmentation of global trade and AI demand for energy. We also note that Commodities relative to equities currently stand at a near record low.
Source: Vontobel
We maintain a neutral view on Hedge Funds. We like well-established Global Macro funds that have a multi-portfolio managers approach. We cautiously like Relative Value funds but are wary of liquidity conditions. We like having a core position in a diversified systematic strategy with a long-term commitment. We prefer staying away from Equity long/short and directional funds as their beta is too high. We do not like Event Driven funds as we believe the merger & arbitrage landscape will be very challenging in 2024.
