"History doesn't repeat itself, but it often rhymes." These words, often attributed to Mark Twain, resonate as we navigate the current economic landscape.
Just as in 1994, the Federal Reserve started hiking interest rates in 2022 to combat rising inflation, sparking widespread fears of an impending recession. Many then braced for a hard landing, expecting the Fed's aggressive tightening to derail the recovery. But instead, the economy managed a soft landing—growth slowed, inflation cooled, and the US avoided recession. As we face a similar crossroads today, could history rhyme once again? As in the 1990s, several critical macro trends exist, with global economies diverging. The autumn of the US presidential election years has also meant a seasonally volatile period for financial markets.
Global Economy: A Tale of Divergence
The global economy currently paints a divided picture. On one hand, the US is demonstrating resilient growth, while Europe and China are struggling to find momentum. The US economy is heading for what many call a "soft landing"—a scenario in which the economy cools without falling into a recession. Despite a few weaker economic data points recently, robust household finances, solid corporate fundamentals, and an easing central bank stance support this outlook. Moreover, corporate earnings in the US are steadily improving, further reinforcing optimism about the country's economic prospects.
Meanwhile, Europe's economic struggles persist, but there is some light at the end of the tunnel. With potential growth expected to increase by 2025, European economies may soon see better-than-anticipated expansion. However, for now, the sluggish pace of recovery remains a concern. Across the emerging markets, China's outlook is bleak, weighed down by structural challenges and declining consumer confidence. That said, Beijing's policymakers stand ready to inject stimulus into the economy if growth slows further.
Inflation Falling, But Growth Concerns Emerging
On the inflation front, there is a notable shift. Inflation has been a significant headwind for households and businesses and is finally trending down. This cooling of prices is a welcome development, as it removes a considerable burden on consumer spending and corporate investment. With inflationary pressures subsiding, recession risks appear muted despite weak macroeconomic data points. Healthy corporate balance sheets and strong household fundamentals suggest that the economy remains solid, leaving little room for negative surprises.
Seasonal Market Volatility
Late summer and early autumn are known for their volatility in financial markets; this year is no exception. Historically, the year's final quarter tends to be the strongest for riskier asset classes, especially equities. Notably, US election years can bring additional uncertainty, which tends to keep investors on their toes. However, the broader market backdrop appears supportive, with several tailwinds favoring equities.
Among these tailwinds are:
- Central banks' moves to cut interest rates.
- The ongoing boom in artificial intelligence (AI) investments.
- Steadily improving corporate earnings.
This combination makes riskier markets, such as equities, particularly attractive in the near term.
Asset Allocation
Equities: A U.S.-Focused Allocation
When it comes to equity markets, the US continues to stand out. Strong economic growth, favorable corporate earnings, and AI-related investments contribute to US equities' relative outperformance. Furthermore, with the likelihood of a recession appearing low, US equities remain in an overweight position. Investors looking for solid earnings growth and economic stability will favor the US over other regions.
European property companies are worth considering for investment opportunities beyond the US. These companies, highly sensitive to interest rates, suffered in performance due to higher inflation and tighter monetary policy but stand to benefit from falling rates. As interest rate cuts become more prevalent, the sector could see a significant boost in performance.
Stock Market Returns in 2024
Source: Evli, Bloomberg, total returns in EUR as per 6.9.2024, World is MSCI All-Country World index
Fixed Income: Corporate and Emerging Market Bonds in Focus
On the fixed-income side, corporate bonds perform well in an environment where central banks are cutting interest rates and recession risks are low. With rate cuts on the horizon, corporate bonds present an attractive opportunity for income-seeking investors. This market segment benefits from the yield advantage and solid corporate fundamentals.
Emerging market bonds also offer an enticing opportunity. With central banks in emerging markets adopting more stimulative policies and growth prospects looking relatively stable, these bonds provide higher yields than their developed market counterparts.
Source: Evli, Bloomberg, total returns in EUR as per 6.9.2024
Key Themes to Watch
Several themes could shape the investment landscape for the remainder of the year:
- US Equities: Robust economic fundamentals, AI-driven growth, and no imminent recession risk make this a favorable region.
- European Property: Interest-rate-sensitive companies in Europe stand to benefit as central banks ease monetary policy and bond yields decline.
- Corporate and Emerging Market Bonds: With rate cuts on the way and a decent growth outlook, these fixed-income assets remain attractive for yield-hungry investors.
Conclusion
We hold on to a modest equity overweight since stocks will likely continue outperforming bond markets at the end of 2024. While growth disparities across regions persist, the broader outlook remains positive, especially for US equities and corporate or emerging market bonds, in our view. Inflation is cooling, central banks are stepping in with rate cuts, and earnings are rising—all pointing toward a potentially strong finish to the year for investors. The main risks to our view are related to growth risks: one related to further weakening US employment or a potential Trump presidency may raise fears of a weaker economy in 2025.
Peter Lindahl
