Simplify the complex with clear and concise market insights direct from our investment experts every week.
Equity markets with Bernard Swords, Chief Investment Officer
Equity markets have had a good start to the year – why is this, and what does it mean for our cautious stance on equities?
- The world index is up about 5.5% so far this year, but the performance has been quite concentrated (for context, the equal-weighted world index is up about 1% in euro terms).
- This reflects what is happening in earnings: large-cap ‘new economy’ names are doing very well this reporting season – and as a result, IT and Communication are the top-performing sectors, while the US is outperforming the rest of the world (driven by large-cap names)
- A concerning feature of this reporting season is that more companies are cutting guidance than raising it. We generally do not see this outside of recession periods.
- In Europe, where you have a much lower exposure to ‘new economy’ companies, earnings are coming in worse than forecast. This is why we have a cautious stance on equities despite the prospect of interest rate cuts. Earnings forecasts look too high and need to be reset downwards. If that happened, we could become more optimistic.
- Staying with Europe, euro area retail sales painted a bleak picture declining by over 1% month-on-month in December. Given record low unemployment and real wages now rising, the performance of the consumer is very disappointing and confusing. For that reason, we are keeping our equity exposure to the domestic euro area economy to a minimum.
- In the US, the ISM non-Manufacturing Survey surprised everybody to the upside, indicating the US maintained its year-end momentum. While in China, core inflation dropped to 0.4%, showing that the country is still skirting with deflation. So, economic data still shows an unsynchronised world.
Fixed Income with Elizabeth Geoghegan, Head of Fixed Income Strategy
How did fixed income markets fare last week – and what has led to the increased attractiveness of longer duration bonds?
- It was an up move in yields last week, driven by central bank push back in terms of the timing of cuts, and some better-than-expected US data. Despite the increases, it appears that bond yields are struggling to achieve any meaningful rises, as the market focus on cuts this year continues to provide an anchor for bonds.
- Against this backdrop and looking back on the moves in January, there are a few factors which can be considered as leading to an increased attractiveness of longer duration bonds relative to this time last month.
- Firstly, and most importantly, bond yields are higher again today. Most importantly however the driver of this move has been an increase in real yields across the board. The real yield is the yield that investors can achieve on bonds, after adjusting for inflation expectations, and so play a considerable role in terms of relative attractiveness.
- In contrast to rising real yields, inflation expectations continue to trend downwards, which supports a more dovish stance by central banks into the future.
- Thirdly, curves are less inverted today relative to late December. An inverted yield curve means that short duration bonds offer nominal higher yields relative to longer duration bonds.
- As longer duration bonds are more sensitive to interest rate moves and hence objectively considered riskier, investors would typically expect higher yields for higher duration bonds. Due to the unusual structure of interest rates today, longer duration bonds have lower yields relative to shorter duration bonds. However, this gap has been closing of late which helps to improve the attractiveness of longer duration bonds.
The week ahead: what to watch out for
The inflation report from the US will probably be the key release. In last month’s report, inflation looked like it might be starting to get sticky again. If that is reversed it will give financial markets a boost. Other releases from the US include Retail Sales and University of Michigan Consumer Confidence survey – and given all the recent releases, these are expected to be strong reports.
On this side of the Atlantic, fourth-quarter GDP for the euro area is expected to show no growth. Industrial production will be published, and no better news is expected in it. The economy may have bottomed in the euro area but there is no sign of it turning. Little is now expected of the euro area in 2024, but maybe it will be the surprise.