Taking the next step

We began the year under the threat of recession and inflation, but these concerns are now clearly lessening. While inflation is proving to be stubborn, it is loosening its hold on both the US and Europe. We believe that central bank rate-hiking cycles are over, with peak rates having been reached and the first rate cuts expected in June.

Recession is also not expected. Consumers continue to have a cushion of excess savings and real incomes are in a positive trajectory. If recession would come closer, the Federal Reserve will slash rates quickly. Unlike a few years ago, there is a lot that the Fed can do. As long as inflation is not a problem, the Fed can cut quickly and deeply.

Economic growth, while not stellar, is picking up. US growth is expected to be slightly above-trend at 2.1% in 2024, with Europe showing low but positive growth of 0.4%. Europe will do better in 2025, where we forecast growth of 1.6%, while the US slows to 1.9%.

The macroeconomic environment has also brightened since the beginning of the year. Manufacturing data is improving, and services data is stabilising. The US economy appears more resilient than Europe’s, based on the unusual combination of subdued wage growth and productivity growth. In Europe, wage growth is also rising somewhat, and inflation is muted due to lower energy prices. The ECB appears to be preparing the market for a 25-basis-point interest rate cut in June. And, after the latest Fed policymaker meeting, Fed Chair Jerome Powell is also indicating that a pivot point is nearing.

Last month, ABN AMRO took the first step toward a more positive view of equities through sector shifts that decreased the defensiveness of the equity portfolio and increased exposure to growth. ABN AMRO is now taking a cautious next step. At its latest meeting, the equities position was increased to a slight overweight. The bond allocation remains at a slight overweight and cash is underweight in all portfolios.

Equity market momentum has been stronger than we had expected. Of course, not all markets are showing the same gains. US markets, for example, are outperforming Europe, while emerging markets are lagging by even more. And, within the US, there is further divergence between the large US tech stocks that are in the midst of the artificial-intelligence boom, and all the rest. While valuations now appear stretched in parts of the IT sector, earnings and valuations are less of a concern overall.

In terms of the outlook for earnings, analysts are expecting a strong recovery for the next 12 months and for 2024, with 9.6% earnings growth expected in the US, 3.4% in Europe and 16% in emerging markets. We are less optimistic regarding the earnings outlook, but believe that sufficient opportunities exist within certain sectors, based on such trends as the start of a multi-year global capital expenditures cycle linked to AI, the energy transition and data infrastructure.

At the same time, the macroeconomic outlook is improving. We believe that in this new environment, where inflation is coming under control and interest rate cuts are just months away, that momentum will be strong enough to feed further gains. We are therefore cautiously increasing exposure to equities by moving from a neutral to a slight overweight exposure. For some clients, this increase in equity exposure has already “naturally” occurred with the rising equity markets of the past few months. (A situation known as market drift.)

No change was made to the regional allocation. We continue to favour the US (overweight) over Europe (underweight), with a neutral exposure to emerging markets. Our favourite sectors are information technology and health care (both overweight), while financials is underweight. Last month we increased exposure to the industrials and consumer discretionary sectors (to neutral from underweight).

High-quality bonds continue to be attractive. With US government bonds yielding around 4.2% and German Bunds at around 2.4%, bond markets are underway back to more normal yields and circumstances. These bonds are returning more than cash and can provide a portfolio buffer when more risky assets encounter problems. We continue to prefer higher-quality bond segments, such as government bonds and investment-grade credits, for their positive returns and lower risk profile. Central bank communications and actions remain the main drivers of fixed-income markets.

It has taken a great deal of patience, but we believe that investors can finally exhale. The threats of inflation and recession have clearly lessened. Consumers are well positioned, and companies can begin to look forward to interest rates beginning to track lower in the second half of the year.

One positive effect of the fight against inflation and much higher interest rates is that central banks once again have room to manoeuvre, if necessary. Today’s high interest rates will take some time to retreat to target levels, which will slow the recovery. But we believe that there are enough positive market indicators and areas of opportunity to begin cautiously increasing exposure to equities.

Richard de Groot

Chair, ABN AMRO Investment Committee