What we liked

• The Australian monthly consumer price index was 2.1% higher than a year ago, holding steady at its lowest level since July 2021. While well within the RBA target the trimmed mean reading (which the RBA closely monitors) remains elevated at 3.4%. while some signs of encouragement on the inflation front, this monthly read is likely insufficient to trigger a rate cut by the RBA.
• US services sector activity unexpectedly accelerated in October to a more-than two-year high. The September ISM survey showed nonmanufacturing purchasing managers (PMI) index accelerated to 56.0 54.9 the prior month. It was the highest level since August 2022.
• US Federal Reserve cut rates by a further 0.25%. This now takes total rate cuts in US to 0.75% (from 5.50% to 4.75%) in the past two months, supporting consumption and other interest rate sensitive sectors.
• US manufacturing PMI increases to 48.4 in November. The new orders gauge above 50 for the first time in eight months. The reading of 48.4 beat expectations of 47.5. Despite below 50 indicating contraction, the new orders reading over 50 provides more confidence over future activity expansion.
• China retail sales surged 4.8%, the highest since February 2024, buoyed by holiday spending and Singles’ Day promotions. Perhaps an early sign of government stimulus providing confidence to the Chinese domestic economy.
• US retail sales increased slightly more than expected in October as households boosted purchases of motor vehicles and electronic goods. Retail sales rose 0.4% after an upwardly revised 0.8% advance in September, beating consensus of a 0.3% increase.

What we didn’t

• Headline inflation in Australia continues to reduce and is now below the upper band of RBA targets. Despite this it is unlikely that it is low enough or has been at levels below 3% for long enough to prompt an imminent rate cut by the RBA.
• In the three months to September, the UK rate of unemployment rose to 4.3%, up from 4% in the previous quarter. Job vacancies also fell, for the 28th month in a row, reaching their lowest level since May 2021.
• Euro zone manufacturing PMI rose to 46.0 in October, ahead of a 45.9 preliminary estimate but still below the 50mark separating growth from contraction.
• In October, China’s industrial production grew by 5.3% year-on-year, a slight slowdown from the 5.4% increase recorded in September. This missed consensus expectations of 5.6% and continues to highlight the struggles being seen in Chinese manufacturing demand.

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 cautious view on global growth over the short-term prevails, as global economic data continues to come in mixed. While the US remains the clear economic outperformer over the past two years vs the rest of the world and recently has shown signs of cyclical improvement, we may begin to see other regions show some relative improvement over the coming months. Combined with a more benign inflation environment and more central banks in a rate cutting cycle we expect risk assets to be well bid into year end.

Our view remains that inflation is expected to remain benign into year end, although to remain above averages from the past decade. In isolation, this should be supportive for credit markets as well as equities.

The initial reaction to the US election result is being viewed as market friendly and supportive of US economic growth and financial markets. Into year end we expect this trend to continue but remain cautious on sequencing of policy implementation strategies into the new year, once the new administration takes office. Australian economic growth is expected to remain positive but benign as catalysts for speedy interest rate cuts are seemingly lacking. Early signs in China of growth picking up is encouraging and expected to continue as recent stimulus trickles into the economy. Peripheral European economies are showing signs of relative strength, but the major economies of France and Germany remain weak. Should Chinese activity pick-up we expect this to assist a pick-up in these economies. We expect markets to favour a slowly improving global economy where supply pressures and inflation are not being stirred up.

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 thus supporting the economy and financial system, while risking local currency weakness leading to higher bond yields and inflation or continue to fight inflation and risk more severe economic weakness and potential bond market/banking stress by tightening financial conditions and liquidity. The actions of policy makers to move in either direction will be a large driver of financial market performance over the coming months. The recent moves in lowering rates in the US communicate that the central bank has chosen the growth and supporting employment market route. This is constructive for economic activity and risk asset performance, in particular monetary inflation hedges, such as precious metals.

Generally, we expect liquidity injections to continue to rise over the coming months. This is expected to provide continued support for financial markets over the medium-term.

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

Further weakening in employment leading indicators, or if we see central banks reducing their efforts to provide liquidity into financial markets would lead to this more defensive positioning. 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.

11% Probability

Global consumer demand for goods and services falls further than expected, with US economic growth showing signs of faltering and the rest of the world showing no sign of improvement from tepid recent growth. Inflationary pressures rebound placing the recent global general trend of interest rate cutting under pressure. This would act to create further headwinds for discretionary spending, placing pressure on economic activity. A reversion to bank stresses seen in March 2023 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 when 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.

With China’s property market remaining challenged, a potential debt/deflation spiral remains a risk. Should recent stimulus not act to support the property market and consumer confidence we could see high debt levels continue to place strain on economic growth. Such a scenario could also place further stress on the Australian economy as this would negatively impact demand for Australia’s largest export of natural resources.

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 rates. When combined with benign and waning inflationary pressures, as supply chain and employment 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 mostly contained to their regions.

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 remain contained.
Additionally, Donald Trumps recent victory in the US could act to ignite “animal spirits” in the US economy. This increased confidence could lead to more spending from small business and consumers, combined these cohorts have a major impact on the US economy. Such a scenario could also lead to greater credit demand, further fuelling the economic impact.

Fiscal support from governments and central bank liquidity could combine with sound cash levels on household and corporate balance sheets to accelerate the speed of the global economic recovery. Additional support could also come from increased leverage on household and corporate balance sheets. 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 positive for financial markets as loosening 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.