In transition

Stock markets continue to have positive returns in 2024 – with new highs seen in the US and Europe. The bond market had a more difficult start to the year, but the outlook for lower interest rates remains supportive. Market sentiment is, in general, positive, although doubts and uncertainties remain.

It is important to note that equity market returns are dominated by the outperformance of a few sectors, and positive equity performance is not broad-based. There is also a wide divergence in returns among regions, with Japan and the US powering ahead, while emerging markets lag.

The US Federal Reserve and the European Central Bank are expected to begin cutting rates in 2024, but the timing is uncertain. It will depend on data related to inflation, unemployment and economic growth. We expect the first cuts will come in June, although market consensus is more optimistic, which could create disappointment and market volatility. In 2024, we expect economic growth in Europe to remain muted, while the US should see growth of around 2.1%, which is slightly higher than trend growth.

In this environment, the overall asset allocation remains unchanged, with a slight overweight to bonds and a neutral allocation to equities. Within the equities portfolio, sector exposures were adjusted to reduce the defensiveness of the portfolio.  

The equity team implemented the following adjustments to the sector allocation:

• The overweight allocations to the health care and information technology sectors were slightly reduced, but remain overweight.
• The consumer discretionary and industrials sectors were increased from underweight to neutral.

The goal of these changes is to establish a less defensive (more cyclical) sector positioning in anticipation of renewed growth later in the year. And while trimming the IT sector is, in effect, trimming the portfolio’s growth tilt,  it comes after a period of exceptionally strong outperformance and now-high valuations. The IT position remains overweight, based on trends in digitalisation and artificial intelligence (AI). The semiconductor industry is also expected to start to recover later in the year and into 2025.

The more defensive health care sector was trimmed to less of an overweight given its tendency to underperform in risk-on environments. It nonetheless remains a sector with stable cash flows and low debt levels that typically support stock buybacks and dividends. We thereby stand by our overweight allocations to both IT and health care.

We see opportunities in the industrials and consumer discretionary sectors. They are both expected to benefit from a slow but progressive improvement in the investment environment in the coming months. This view is supported by recent economic data, especially in the US. 

The industrials sector, for example, is expected to benefit from the start of a multi-year global capital expenditures cycle that will see further investing in low-carbon solutions, AI, data infrastructure and electric grids. Stabilisation in China should also boost the industrials sector.

The consumer discretionary sector is increasingly attractive based on long-term demographic trends, such as the rising Asian middle class and growing demand for services. At the same time, rising real wages are offsetting the recent decline in excess savings; and lower inflation could support corporate margins.

The new sector positioning, in which the financials sector remains underweight, is the result of a desire to take some profits after a tremendous run and then using the proceeds to add exposure to the areas where we see the most opportunity. Overall, the sector positioning is now more balanced.

We retain a neutral allocation to equities based on how much good news has already been priced-in after the recent market rally. Despite a better-than-expected US earnings season, Europe’s is, so far, disappointing; and this is despite analysts having lowered their expectations. We remain less optimistic than consensus regarding earnings growth in 2024, although better-than-expected economic growth in the US will enable US corporates to avoid an earnings recession.

In terms of regions, we continue to favour the US (overweight) versus Europe (underweight) and emerging markets (neutral).

Government and investment-grade corporate bonds remain attractive investments in the current environment where interest rates have peaked and rate cuts are expected. We prefer these higher-quality bond segments for their positive returns and lower risk profile. High-yield and emerging-markets bonds are not preferred, based on the still-possible prospect of recession or a serious downturn that could lead to an increasing number of defaults. Central bank communications and actions remain the main drivers of fixed-income markets.

The sector changes that we have made are a further step in leaving our previously defensive positioning for a more growth-oriented, cyclical stance. It aligns with our expectations for a slight improvement in economic growth later this year. But we are not yet “out of the woods.”

The global economy is expected to grow at a subdued pace in the near term, as high interest rates continue to bear down on demand in advanced economies. Global trade and industry is bottoming out, but  no sharp rebound is expected while interest rates remain restrictive.  

On the positive side, inflation has fallen significantly, and is now within touching distance of central bank targets. Geopolitical issues, however, such as the wars in Ukraine and the Middle East and disturbances in the Red Sea increase uncertainty. Further declines in inflation will enable central banks to pivot to rate cuts by mid-2024 and financial conditions are already easing in anticipation. But a tight monetary policy, which will linger through the rate-cutting period, will put a lid on any recovery.

Richard de Groot, Chair, ABN AMRO Investment Committee