Broadening horizons

We see global macro conditions as benign and supportive of solid investor returns over the medium-term. The inflation threat now appears over and this is allowing central banks to lower interest rate settings back towards neutral. This, in turn, reduces the recession threat and ensures greater longevity in this economic cycle. A backdrop of falling interest rates but still positive economic growth has traditionally boded very well for risk assets like equities.

An interesting development over the past quarter has been some rotation within equity markets, with a broader range of sectors and markets now starting to benefit from the healthy backdrop. Mega-cap technology stocks have largely been responsible for the rally in equity markets so far, however this now starting broaden out, a theme we expect to persist for some time now.

US Manufacturing Construction Investment

Seasonally adjusted annual rate (billion USD)

The US economy remains robust with solid consumer spending and income growth, a healthy corporate sector and falling interest rates. The capex outlook also remains strong due to fiscal policy and transformative spending in green energy, AI, infrastructure and reshoring activities. We are monitoring the recent easing in labour market conditions but still see recession risks as low given that much of the increase in unemployment has been driven by growing labour supply, while layoffs and unemployment claims remain low.

Conditions are patchy in the rest of the world. The Chinese economy continues to battle against headwinds caused by an overleveraged property sector and ageing demographics, though encouragingly policymakers are seeking to address this. In Europe, most major economies continue to produce sub-par growth as the effects of the recent tightening cycle and sustained inflation continue to take effect.

Likewise, the Australian economy has been held back by the pressures of high interest rates on consumption and housing construction. This is the price we have had to pay to get inflation under control. It is important, however, not to extrapolate this weakness. The economy is likely to improve from here given changing prospects for consumption and business investment. There is already some evidence of higher household spending from tax cuts, strong wages growth and easing cost of living pressures.

Probability of Recession

Bloomberg economists consensus

Asset allocation needs to reflect the changing macro and interest rate landscape. While this is a generally positive backdrop we are watching a number of lingering risks. The largest of these is the US election and the risk of a disputed result. Diversification is the best way to protect against country-specific election risks. We have also been adding exposure to interest rate securities where potential returns have increased significantly thanks to elevated base rates and still reasonable valuations.

The better macro and profit outlook is a positive for equity markets. The complication, however, is that stock prices have moved ahead of the macro and are already priced for a positive outcome. This has been particularly the case for the US tech sector which continues to trade at premium valuations levels, putting a ceiling on future returns.

Investors need to be increasingly selective and we recommend positioning for a sustained rotation into sectors that will benefit from a reacceleration in activity and broadening in economic growth. Mid and small-cap companies and emerging markets stand out as key opportunities.