Simplify the complex with clear and concise market insights direct from our investment experts every week.
Equity markets with Bernard Swords, Chief Investment Officer
How are markets progressing since the start of the year?
Given the strong end to 2023, it’s not surprising that equity performance is flat since the start of the year. Here’s why.
- Sentiment indicators ended the year at very high levels. Opinions on economic growth, inflation and interest rates were very benign at the end of 2023 – and some of these opinions are going to get challenged.
- So far, the growth-interest rate play-off is being challenged. A strong retail sales figure in the US leads to a decline in the equity market because investors fret about what that means for interest rate cuts – a ‘good news is bad news’ mentality. Whatever about the short-term gyrations, for the longer term, good news is good news.
- Since the start of the year, there has been a rotation in sector performance. In Q4 2023, it was all about cyclicals as growth data remained strong in the US and expectations of interest rate cuts increased.
- This year the mood has changed: defensives are in positive territory (Healthcare and Consumer Staples). A good portion of this can be attributed to mean reversion.
- Interestingly, among the cyclical sectors, it is the subgroups that have structural stories or less sensitivity to the economic cycle that are performing. Industrials are the best performing cyclical group and within that, Commercial and Professional Services are performing best.
- Within Financials, Insurance is the best performing industry and the one with the least sensitivity to the economic cycle. This is a trend that started to emerge in the last quarter and one we expect to continue for the rest of this year.
- Meanwhile, we will be keeping our exposure to the Pacific region low, after the Q4 GDP release from China showed the economy slowing due to decelerating consumption growth. Without a more co-ordinated policy response, we expect the Chinese economy to remain under pressure.
Fixed Income with Elizabeth Geoghegan, Head of Fixed Income Strategy
We saw a back-up in yields last week – what caused this?
Markets were adamant that we had hit the peak in interest rates and that a significant amount of rate cuts lay ahead. However, last week, we saw a sobering of these expectations, with the 10-year Bund now at 2.3%. Markets still expect rate cuts this year, but that expectation for a March rate cut from the European Central Bank (ECB) has really fallen away. What’s been the catalyst?
- Firstly, I think the reversal was somewhat inevitable, it was just a case of timing.
- However, the more meaningful source is probably the comments from central banks both in the US and Europe, where members really tried to push back on these over-excited market expectations specifically focusing on early or imminent cuts.
- An extreme example of this is ECB member Robert Holzman: in an interview at the World Economic Forum in Davos, he said that markets should not assume any rate cuts in 2024. Whilst this is an extreme example, it highlights that central banks really don’t want markets expecting big cuts early into the year. This will be down to a number of reasons, such as strong labour markets and still above target inflation readings.
The week ahead: what to watch out for
The ECB meets for its first monetary policy meeting of 2024 on Wednesday. While there is no expectation for an interest rate cut, all eyes will be on ECB President Christine Lagarde and how she manages commentary around the future path of interest rates. Historically, the impact of the delivery of her messaging has been a little hit and miss. So, her challenge this week will be quite the tightrope: on one hand, she will need to acknowledge the progress of inflation, but on the other side, she is tasked with tempering over-excited market expectations for imminent rate cuts. Can she deliver the perfect balancing act?
There will be more indicators of economic growth in the developed world, including the main business sentiment indices (PMIs) from the euro area. Will they show any life in the region’s economy? Another data release will be the Consumer Sentiment survey, which has been depressed for the last 12 months despite unemployment at record lows. We need to see this improve to get more comfortable about the growth outlook for the region.
Following on from strong US retail sales figures last week, which indicated the US consumer continues to perform better than expected, we will get the broader measure of activity, fourth quarter GDP.