A look back at last month and an outlook for the months ahead

What we liked

  • Consumer prices in the U.S rose 0.3% from March to April, down slightly from 0.4% the previous month. Following some stronger than expected readings, the weaker read was a welcome indicator for the market as it relieves pressure on the U.S Federal Reserve increase or maintain higher interest rates.
  • New orders for key U.S.-manufactured capital goods rebounded more than expected in April and shipments of those goods also increased, suggesting a moderate improvement in business spending on equipment early in the second quarter. Durable goods orders gained 0.7%, with shipments up 1.2%
  • Consumer prices in China rose at a faster pace than expected, with the consumer price index in April recording a 0.3% increase year on year. China has struggled to produce inflation on weak demand, causing some concern of a debt/deflation spiral. In this context, we see the higher inflation print as positive.
  • China’s factory output topped forecasts in April, helped by improving external demand. Industrial output grew 6.7% year-on-year in April, accelerating from the 4.5% pace seen in March and above the 5.5% increase tipped by analysts.
  • German investor morale improved more than expected in May, reaching its highest level since February 2022, when Russia invaded Ukraine, according to the ZEW economic research institute. The economic sentiment index rose to 47.1 points from 42.9 in April. Analysts polled by Reuters had expected a May reading of 46.0

What we didn’t

  • Australian retail trade figures were slightly up in April, but spending was still flat for the year, as Australians continued to keep an eye on what they spend. While up 0.1% for the month, this benign rise was below market expectations of 0.2%. this signifies continues pressure on Australian households battling with higher interest rates.
  • Australia’s monthly inflation reading came in higher than expected at 3.6% versus the market expectation of a 3.5% rise. This read maintains pressure on the RBA to maintain higher interest rates at higher rates for longer.
  • Americans unexpectedly paused their spending in April from March as inflation continued to sting and elevated interest rates made taking on debt more burdensome. Retail sales were unchanged, coming in well below economists’ expectations, and follow a revised 0.6% pace in March. This is further evidence of a slowing in demand from the U.S consumer.
  • U.S ISM manufacturing purchasing managers index for May fell to 48.7 from 49.2 in April. This was below the median estimate and of 49.6 and indicates contracting U.S manufacturing activity. This shows a slowdown in the U.S economy is gradually taking hold.
  • Chinese retail sales rose just 2.3%, the slowest increase since December 2022, off the 3.1% increase in March and far short of the forecast 3.8% rise expected by analysts. While positive, it shows the challenges for regulators in China to reinvigorate domestic consumer 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 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.

11% 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.

15% 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.

Stock in Focus – Eaton Corporation

Investment Thesis
  • Structural grower – ETN is one of few global businesses exposed to structural growth in electrical infrastructure spend. As such, it has a competitive edge in an industry with growing demand that is also experiencing supply issues. The company and its other major competitors all recently reported strong earnings beats related to their electrification business. Encouragingly their order books also experienced growth, providing us with confidence that the sector has a long runway of growth ahead of it.
  • Clean energy transition – Independent estimates indicate that the U.S. needs to expand electricity transmission systems by 60% by 2030 and may need to triple current capacity by 2050 to accommodate the country’s rapidly increasing supply of cheaper, cleaner energy and meet increasing power demand for electric vehicles and electric home heating and reduce power outages from severe weather. As a major electrical infrastructure provider, the company designs, develops, and sells energy-efficient products, technologies and services that help customers in managing electrical, aerospace, hydraulic and mechanical power more reliably, efficiently, safely and sustainably. As such, we see a long runway of demand and earnings growth for the business.

Eaton Corporation plc was “founded in 1911 and is today based in Dublin, Ireland.” It is listed on the New York Stock Exchange and is currently valued at ~USD$135B.

Eaton Corporation plc operates as a power management company worldwide. The company’s Electrical Americas and Electrical Global segment provides electrical components, industrial components, power distribution and assemblies, residential products, single and three phase power quality and connectivity products, wiring devices, circuit protection products, utility power distribution products, power reliability equipment, and services, as well as hazardous duty electrical equipment, emergency lighting, fire detection, explosion-proof instrumentation, and structural support systems.

The company engages in steelmaking and steel fabrication, engineering and construction, chemicals and materials, and system solutions businesses in Japan and internationally. The company offers steel plates, sheets, and slags; bar and rod materials; structural steel; pipes and tubes; titanium and stainless products; and railway, automotive, and machinery parts for applications in automotive, energy, infrastructure, and consumer electronics markets. It is also involved in construction; waste processing and recycling; supplying electricity, gas, and heat; and the provision of coal-based chemical products, petrochemicals, electronic materials, materials and components for semiconductors and electronic parts, carbon fiber, and composite products. In addition, the company offers computer systems engineering and consulting, IT-enabled outsourcing, and other services.

Its Aerospace segment offers pumps, motors, hydraulic power units, hoses and fittings, and electro-hydraulic pumps; valves, cylinders, electronic controls, electromechanical actuators, sensors, aircraft flap and slat systems, and nose wheel steering systems; hose, thermoplastic tubing products, fittings, adapters, couplings, and sealing and ducting products; air-to-air refuelling systems, fuel pumps, fuel inerting products, sensors, and adapters and regulators; oxygen generation system, payload carriages, and thermal management products; and wiring connectors and cables, as well as hydraulic and bag filters, strainers and cartridges, and golf grips for manufacturers of commercial and military aircraft, and related after-market customers, as well\ as industrial applications.

The company’s Vehicle segment offers transmissions, clutches, hybrid power systems, superchargers, engine valves and valve actuation systems, locking and limited slip differentials, transmission controls, and fuel vapor components for the vehicle industry. Its eMobility segment provides voltage inverters, converters, fuses, circuit protection units, vehicle controls, power distribution systems, fuel tank isolation valves, and commercial vehicle hybrid systems.

Saward Dawson Wealth Advisors Pty Ltd, a Corporate Authorised Representative of Akambo Pty Ltd t/a Accountants Private Advice

The information presented in this publication is general information only, and is not intended to be financial product advice. It has not been prepared taking into account your investment objectives, financial situation or needs, and should not be used as the basis for making an investment decision. Before making any investment decision you need to consider (with your financial adviser) your particular investment needs, objectives and financial circumstances.

Some numerical figures in this publication have been subject to rounding adjustments. Akambo Pty Ltd (including any of its directors, officers or employees) will not accept liability for any loss or damage as a result of any reliance on this information. The market commentary reflect Akambo Pty Ltd’s views and beliefs at the time of preparation, which are subject to change without notice.