Enough reasons for some optimism

As the year began, equity markets had a cautious start and bond markets are volatile. With inflation less of a worry, markets are looking forward to interest rate cuts from the Federal Reserve and the European Central Bank (ECB). The idea is that lower interest rates and easier financial conditions will spur corporate growth and earnings. The US and European central banks have indicated that their extended rate-hiking periods are likely over. The question is how long until they make a move and start to cut interest rates?

Lowering interest rates will acknowledge that economic growth and inflation have slowed enough for policymakers to take their foot off the brake with less restrictive monetary policies.

We expect both the Fed and ECB will cut rates for the first time in June. But it will only come after more disinflation is seen in both the US and Europe. The US labour market also needs to further cool and payroll growth has to slow. In Europe, we have somewhat higher inflation against a backdrop of weaker macroeconomic data. And the ECB is also waiting to see how some wage negotiations turn out. We expect sluggish growth in both Europe and the US in the first half of the year, with a small pickup in the second half.

The ABN AMRO Investment Committee decided to maintain its neutral allocation to equities and to increase the allocation to bonds to a slight overweight, through the sale of hedge fund assets.

Corporate earnings remain under pressure in Europe as the European economy slows. The US is holding up better than had been expected, and US earnings growth is picking up again. Nevertheless, analysts are still cautious and, on balance, downgrading their earnings expectations. Interest rates also remain high. Growth in China is also not helping. Its economy is still trying to recover from a dip last year. There are also ongoing problems in its property sector and from a slowdown in global demand.

We are comfortable retaining, for now, a neutral stance toward equities. Before increasing our exposure, we would like to be certain that recession risk has died out and to see more good news from manufacturers and stabilisation in the services industries.

Within developed markets, we remain more constructive on the US (overweight) versus Europe (underweight). This is driven by better earnings dynamics despite slightly more demanding valuations. The information technology and health care sectors continue to be preferred.

The outlook for bond returns is usually attractive around the peak of hiking cycles and becomes even better as the first central bank rate cut nears. We believe that the peak has likely been reached and rate cuts are expected to begin in June.

While the bond rally at the end of 2023 has already delivered a significant decline in yields, we expect even lower yields in the course of 2024. (As bond yields fall, bond prices rise). But yields may not move significantly lower until we are closer to the first rate cut. Given the deteriorating economic outlook, we continue to prefer high-quality (sovereign and investment-grade corporate) bonds over riskier bond market segments, such as high-yield and emerging-markets debt.

At the latest meeting, the Investment Committee increased the allocation to high-quality bonds by reducing hedge funds. This move led to an overweight bond allocation. A “cash alternative” hedge fund strategy had been introduced in late 2021, when most bonds had negative yields. Over the past two years, bond markets have reversed and the return outlook has brightened. The decision was therefore taken to sell the hedge fund strategy.

We expect 2024 to be a good year for diversified investors. Bond markets are in a sweet spot. And while we are now focused on high-quality bonds, if the US remains resilient other asset classes offering more return could also become attractive. Despite overall earnings expectations being lowered, there are areas of opportunity within equity markets. This includes the information technology (IT) and health care sectors.

IT is well positioned, given digitalisation and artificial intelligence trends. And the health care sector has had a strong start to the year, based on new drugs and innovation. After earnings growth in the health care sector was dented in 2023, due largely to one-time acquisition costs, double-digit growth is expected in 2024.

In general, we are somewhat more optimistic regarding the US economy than consensus and we believe that central banks will cut rates more or less by what the market expects. Of course, we also recognize risks. After such an extended period of rate hikes, recession remains possible. The timing of interest rate cuts is also uncertain and could lead to volatility and market disappointment. We still do not know if the Fed and ECB have been successful in bringing inflation under control and avoiding a more serious slowdown. If the US economy reignites, for example, it could easily delay the Fed’s first move. Nonetheless, as the year begins, we see enough reasons for investor optimism -- despite the risks.

Richard de Groot
Voorzitter ABN AMRO Beleggingscomité