What we liked

• Strong employment figures in Australia, with the unemployment rate falling to 4.1% last month, even as the participation rate – the share of working-age people either with a job or looking for one – hit a record high of 67.2%.
• U.S. services sector activity jumped to an 18-month high in September amid strong growth in new orders, more evidence that the economy remained on a solid footing in the third quarter. The nonmanufacturing purchasing managers (PMI) index accelerated to 54.9 last month, the highest level since February 2023, from 51.5 in August.
• The US non-farm payroll rose by 254,000 in September, resulting in unemployment falling from 4.2% to 4.1%. this was the biggest increase in 6 months and relieved some recent concerns over a weakening jobs market.
• US retail sales were up 0.4% in September, beating expectations of an 0.3% increase. This exhibits a generally resilient US consumer.
  • British pay growth cooled in the three months to July to a more than two-year low and employment shot higher. This is likely to keep the Bank of England on track to cut interest rates again before the end of the year.
• Annual UK consumer price inflation eased to 1.7% in September from 2.2% in August, the lowest reading since April 2021. This further supports rate cuts in the UK.
• China’s retail sales last month grew 3.2% after a 2.1% lift in August, beating expectations for a 2.5% increase. Industrial production also beat expectations, increasing 5.4% versus expectations of a 4.5% increase. Both are tentative signs of an improving economic picture in China.

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.
• Australian retail sale missed expectations, rising by 0.1% for the month versus the expectation for an 0.3% rise. While the miss is a negative, it does follow a very strong prior months read (0.7% increase). So, while a disappointment for the monthly read, retail sales numbers remain reasonably robust in the face of interest rates remaining elevated.
• The US manufacturing sector remained weak in September, with the Institute for Supply Management (ISM) index holding steady at 47.2. This ongoing softness is coupled with a noticeable decline in manufacturing jobs.
• Chinese manufacturing activity remains weak, with both the NBS and CAIXIN measures of manufacturing activity in contraction in September. While the rate of decline is troughing it is too early to call a turnaround in Chinese manufacturing activity.

Base Case

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

75% Probability

A cautious view on global growth over the short-term prevails, as global economic data continues to come in mixed. While the U.S. 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. While markets are currently overbought following a strong run up, a combination of solid economic growth in the US, an improving global economic picture and downward pressure on inflation should combine to see risk assets well bid into year end.

Our view remains that inflation is expected to continue moderating 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, This is likely to be mitigated by weaker earnings from sectors that are interest rate sensitive and have a larger exposure to lower income household spending.

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.

The sequencing of these events will be important. We continue to expect heightened market volatility due to mixed economic data and potential for a close US Presidential election. Despite this, we expect that any volatility in credit markets will lead to further liquidity injection from central banks to shore up the financial system. Positively, liquidity has begun to trend higher over the past month and is expected to continue to grow over the second half of 2024. 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, although more defensive sector weightings may be warranted over the coming few months. 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

GGlobal consumer demand for goods and services falls further than expected, with US growth faltering and the rest of the world showing no sign of improvement from tepid recent growth. Inflationary pressures and elevated interest rates negatively impact discretionary spending, further placing pressure on economic activity while simultaneously restricting central banks from easing interest rates. 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.

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 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.
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 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.