What we liked

• In Australia, the monthly inflation read came in at 3.4% over the year to February, showing further progress in the fight against inflation. This was against expectations of 3.5%. While the monthly read is less relied upon by policy makers, it does enhance the argument for the RBA to lower interest rates.
• U.S. job openings fell marginally in January, while the number of workers quitting their jobs dropped to a three-year low, indicating that labour market conditions were gradually easing. This is positive as it reduces wage inflation and provides more impetus for the US central bank to decrease interest rates.
• The headline German ZEW Economic Sentiment Index jumped from 19.9 in February to 31.7 in March. The market forecast a reading of 20.5. This continues a series of upward surprises in economic data in the Eurozone, increasing the likelihood that recent weak economic activity has troughed.
• China’s NBS private sector PMIs from the weekend painted a rosier picture of the Chinese economy. The Manufacturing PMI increased from 49.1 to 50.8, with the Non-Manufacturing PMI up from 51.4 to 53.0, exhibiting a continuation of recent better than expected data from the worlds second largest economy.
• China’s factory output and retail sales beat expectations in the January-February period, marking a solid start for 2024 and offering some relief to policymakers even as weakness in the property sector remains a drag on the economy and confidence.
• Japan’s central bank raised its benchmark interest rate Tuesday for the first time in 17 years, ending a longstanding policy of negative rates meant to boost the economy. The Bank of Japan’s lending rate for overnight borrowing by banks was raised to a range of 0 to 0.1% from minus 0.1% at a policy meeting.

What we didn’t

• Australian consumer sentiment eased from 20-month highs in March as worries about the economic outlook and family finances returned to darken the mood. The Westpac-Melbourne Institute index of consumer sentiment slipped 1.8% in March, from February when it jumped 6.2%.
• Australia’s economy grew just 0.2% over the December quarter, which was lower than the increase in population meaning that economic activity per person fell again.
• US unemployment rate crept up to its highest level in two years last month, despite more jobs being created than expected. The jobless rate rose to 3.9%, up from 3.7% in January, even as employers added 275,000 jobs, the Labor Department said. The jump in the unemployment rate was due to an estimated 334,000 more people reporting being out of work, however, the rate remained low by historic standards.
• US data showed hotter-than-expected inflation last month, slightly paring back expectations of an interest rate cut by the Federal Reserve at its June policy meeting.
• The US ISM Services index slipped to 52.6 in February from 53.4 in January, just shy of the 53.0 consensus expectation, further showing signs of a slowing economy from very strong levels. However, growth did become more widespread, with 14 of 18 industries reporting growth for the month – up from ten in January.
• US retail sales rose 0.6% in February from the previous month, although missing expectations of an 0.8% increase in spending. This was mostly attributed to higher oil prices, making the data indicative of a weakening, although still robust, US consumer.

Base Case

Our view of the most likely scenario for markets over the coming months, for which our portfolios are currently positioned.

74% Probability

A more sanguine view on global growth for the first half of 2024 prevails as economic data and supportive liquidity levels from central banks maintains economic momentum. While the U.S. has exhibited clear economic outperformance during 2023 vs the rest of the world, we are beginning to see other regions show relative improvement, as has been expected. That said with strong employment dynamics and robust household and corporate balance sheets, we expect the U.S. to also continue its economic activity growth over the coming months.

Our view remains that inflationary rates of increase are expected to continue moderating, although to remain above averages from the past decade. In isolation, this should be supportive for credit markets as well as valuations of growth assets and manifest in greater financial market stability over the medium-term. This is likely to be mitigated by earnings downgrades in some sectors, as lower inflationary pressures and impacts from higher interest rates put some pressure on company earnings and some household balance sheets.

The current environment leaves central banks, particularly the U.S. Federal Reserve, in a difficult position. Developed economy central bank choices appear to be to ease financial conditions and support the economy and financial system, while risking local currency weakness, higher yields and inflation or continue to fight inflation and risk more severe economic weakness and potential bond market/banking stress. The actions of policy makers to move in either direction will be a large driver of financial market performance over the coming months. We expect that continued liquidity injection from central banks to shore up the financial system will provide continued support, although this support may weaken over the next 2-3 months, potentially increasing market volatility.

This scenario is likely to see us maintain a positive view on growth assets over the medium-term. Despite this, we would expect bouts of volatility to emerge as market positioning and sentiment is strong, increasing the possibility of growth fears or exogenous shocks adversely impacting markets. As an example, some U.S. regional banks remain at risk of insolvency, should interest rates and rate volatility remain high.

This will likely remain the investment stance until such time that we see employment leading indicators weaken, or we see central banks reducing their efforts to provide liquidity into financial markets. Overall, asset allocation will retain a bias to growth assets, with short-term tactical positioning to be guided by macroeconomic developments and central bank actions.

Bear Case

Our worst-case scenario for the coming months, which we are prepared to position for should conditions deteriorate.

12% Probability

Global consumer demand for goods and services falls further than with US growth faltering and the rest of the world showing no sign of improvement from tepid growth recently experienced. Inflationary pressures and elevated interest rates negatively impact discretionary spending, further placing pressure on economic activity. A reversion to bank stresses seen earlier this year would be expected to further tighten bank lending standards also. This could act to place pressure on the currently very strong global employment conditions.

Geopolitical tensions could act to negatively impact supply chain bottle necks and energy prices, further exacerbating inflationary pressures and placing greater pressure on central banks to tighten monetary and financial conditions. Additionally, wage pressures and higher cost of lodging become more systemic as employees successfully lobby for wage increases. This will lead to a deterioration in company profits as increased input costs, and debt servicing costs (from higher interest rates) combined with lower demand converge to crimp company earnings.

Such a scenario would result in a tightening of financial conditions, while inflationary pressures remain elevated. This could see central banks continuing to withdraw monetary support (through higher interest rates) at a time as the economy is weakening. Additionally, an untimely withdrawal or reduction of central bank liquidity into the financial system could derail financial markets, which have become accustomed to liquidity support. When combined with reduced government expenditure, due to elevated indebtedness, this may cause consumer confidence and spending to fall, as prior government support is not fully replaced by gainful employment income.

Rapid escalation in geo-political tensions or a significant or systemic credit default, due to over-indebtedness in an environment of rising bond yields and elevated volatility in financial asset prices, could see a liquidation of risk assets within a compressed period. Such a situation would see us move rapidly and meaningfully into cash at the expense of equities. Further to this, the recent stresses seen in globally systemically important banks could lead to more bouts of liquidity events, which would be expected to have a pronounced negative effect on economic growth.

Above scenarios will see us take a more defensive position and reduce equity exposures replacing them with defensive assets, such as cash. The accelerating bond yield scenario would require a more nuanced shift toward companies and sectors that would be the greatest beneficiaries of such a move. Focus will be on a more defensive posture with capital preservation being the primary objective. A further shift towards defensive sectors such as healthcare, consumer staples and utilities would combine with higher cash levels in this scenario.

Bull case

Our most optimistic view for markets over the coming months.

14% Probability

Economies across the developed world experience better than anticipated economic growth. If then combined with waning inflationary pressures, as supply chain bottlenecks ease and productivity levels improve, we would expect a virtuous pro-growth asset environment as interest rate pressures subside. Additionally, current global conflicts remain contained. In this scenario disposable income for consumers would increase as inputs costs for corporates reduce. The result would be resilient earnings growth for companies as economic growth accelerates and costs are contained.

Fiscal support from governments could combine with sound cash levels on household and corporate balance sheets to accelerate the speed of the global economic recovery. In the event central banks resume measures aimed at suppressing interest rates below inflation levels and potentially adding further liquidity enhancement measures to support financial systems, we would expect this to further fuel asset prices.

This scenario would be very positive for financial markets as improving financial conditions act to fuel demand for growth assets in a low to negative real interest rate environment. We would act by ensuring a growth asset bias with low cash levels. Additionally, if leading economic indicators began surprising to the upside a net shift towards cyclical sectors leveraged to economic growth would occur.