Investment Team Handelsbanken Wealth & Asset Management
14 Aug 2024 15
Below, we outline some of our key views on the factors set to drive financial markets over the coming months, and what this means for our investment strategies.
What's next for the global economy and financial markets?
A noisy patch for financial markets…
Up until the second week in August, markets had become fairly comfortable with the narrative that the US economy was growing, but slowing. However, this started to shift as US economic data began to infer a potentially greater economic slowdown than originally envisaged. This raised questions around the future earnings trajectory of highly-rated US companies.
Against this backdrop, investors began to account (within asset prices) for more interest rate cuts from the world’s largest central bank (the US Federal Reserve, or Fed). As a result, bond yields fell, and bond prices rose.
Around the same time, the Bank of Japan raised interest rates for only the second time since 2007. Although this was well flagged in advance, investors started to predict more rate cuts. This led to concerns about how this would affect the Japanese economy. Japanese share prices dropped with historic speed, and – globally – the price of traditional safe-haven assets like government bonds and precious metals rose sharply. The situation was further exacerbated by low levels of liquidity (buying and selling in the market) due to the summer holiday season.
Nevertheless, by the end of the week, markets were only marginally lower than where they had begun. More US economic data updates signalled that an imminent and severe US recession was not on the cards, and the price of shares and other risky financial assets rallied, with ‘safe havens’ giving back some earlier gains.
… but expectations for interest rate cuts are still very changeable
Market expectations for interest rate cuts from the US central bank have been reacting to weaker US data. In late July, pricing in bond markets told us that investors were expecting two interest rate cuts from the Fed this year, but during the recent market volatility, this spiked to six rate cuts.
As we write, these expectations have come down a little, to four US interest rate cuts this year. It’s worth noting that the Fed’s ruling committee only has three scheduled meetings remaining in 2024, suggesting that one of these rate cuts would need to be double the usual size.
Within our own investment strategies, our bond market positions have benefitted from this environment of weaker economic data and higher expectations for interest rate cuts, including the Bank of England actually cutting rates in August. This marginally surprised investors, who had thought September would be the meeting to cut rates for the first time since the pandemic.
The US presidential election remains one to watch
Since our July update, President Biden has dropped out of the US presidential race, with his erstwhile running mate – Kamala Harris – stepping into the breach. US politics can certainly create noise in financial markets, but the more important issues for us to consider are the economic implications of whoever next steps into the White House.
The betting odds have changed dramatically since Biden dropped out and it now looks like a much fairer and more even fight between the two nominated candidates for the White House race. Trump prides himself on being pro economic growth, but he may have already played his best cards in his previous stint at the top. We’re a little wary of some of the potential policy impact of a second Trump presidency, given his rhetoric around NATO, Ukraine and European and Chinese trade tariffs.
Meanwhile, we wouldn’t expect Harris’ approach to economic and geopolitical matters to diverge hugely from Biden’s, though we’ll have to wait to discover more about her views as her fledgling campaign takes off.
Our chart of the month
Source: Bloomberg
What does this chart tell us?
The dark blue line is the VIX Index (in full: the Chicago Board Option Exchange Volatility Index). This is often referred to as the ‘Fear Gauge’. It’s an up-to-the-minute market estimate of the expected volatility of the S&P 500 Equity Index – the benchmark index for the US stock market.
On the same chart, the light blue line shows us the yield on the US 10-year government bond (as a reminder, bond yields move in the opposite direction to bond prices). You can see how yields fell in early August, as US economic data slowed and the market started to assume a higher probability that the US central bank would not only start to cut rates soon, but also cut rates by more than previously expected. Bond yields fell further as the VIX index spiked in the second week of August, reflecting investor nerves about growth and interest rate changes.
However, since then, the VIX index has retraced much of this spike, suggesting calmer investor sentiment, at least at the time of writing.
Scroll down the page to the sections below to find out what our market views mean for positioning in our investment strategies.
- Earlier this year, we slightly increased our stock market positions to reflect our view that we were approaching the later stages of a period of recession, and seeing some signs of embryonic growth in regions outside the US. We achieved an increase in stock market positions by reducing our positions in a number of other market areas, most notably alternative asset types and debt in developing economies.
- We favour the shares of larger businesses, as well as positions in healthcare, insurance and clean energy. With a few key exceptions, we currently prefer to limit the bulk of our stock market exposure to developed economies.
At the time of this update, we are 'neutral' when it comes to stock markets/shares. This means that we have not deviated for tactical reasons from our overall asset allocation framework - a way of dividing investments across different types of assets. As a result, our multi asset strategies currently hold a proportion of investments in stock markets which is consistent with our long-term average.
- Our multi asset investment strategies currently hold a higher proportion of assets in ‘fixed income’ markets (like government bonds) versus our long-term average positions. Having been a rather uninteresting part of financial markets for quite some time, bond yields rose higher in 2023 than they had done for many years (and bond prices, which always move in the opposite direction to yields, fell). This presented what we perceived to be an attractive buying opportunity.
- Building up our bond exposure has meant not only increasing the proportion of bonds that our strategies hold, but also the maturity of these bonds, particularly UK government bonds. Adding longer-maturity bonds gives us a greater sensitivity to movements in expectations for interest rates, and we continue to believe the market is underappreciating how much the Bank of England in particular will cut interest rates over the next 12-18 months, despite potential delays in starting this process due to the general election.
At the time of this update, we are slightly 'overweight' bond market investments. This means that we have deviated for tactical reasons from our asset allocation framework - a way of dividing investments across different types of assets. As a result, our multi asset strategies currently hold a relatively larger proportion of investments in bonds versus our long-term average.
- The ‘alternative’ investment space covers a diverse range of assets outside of traditional bond and stock markets, from commercial property to specialist hedge funds. Because of their wide variety, it’s difficult to make sweeping statements about alternative assets, and our overall ‘underweight’ stance in this diverse area of the markets hides some specific preferences.
- At present, we have a preference for assets which can drive financial returns, without being closely linked to mainstream financial markets. Among our positions in property investments, we have a preference for global assets over UK-based assets, believing that this allows us to access a much more diverse array of property, from data centres to telecoms towers. Other notable positions include a specialist hedge fund designed to protect against dramatic market falls.
At the time of this update, we are slightly 'underweight' alternative assets. This means that we have deviated for tactical reasons from our asset allocation framework - a way of dividing investments across different types of assets. As a result, our multi asset strategies currently hold a relatively smaller proportion of investments in alternative assets versus our long-term average.
If you’d like further information on how we divide investments in our strategies across different types of assets (i.e. our asset allocation framework, and our tactical deviations away from it), please contact us.