Investment Monthly: Markets rebound on easing US recession concerns

• Following the summer tumble triggered by US recession fears, rich tech valuations, sector rotation and an unwind of the Japanese yen for the carry trade, global equity markets have rebounded quickly. 
• Although activity is slowing in the US, it is not stalling. Solid earnings growth, along with some positive labour market data, have pushed US equities back to their recent highs. Meanwhile, a widely-expected Fed cut in September and the less hawkish tone of the Bank of Japan indicating gradual rather than quick hikes have restored market confidence. 
• Thanks to continued earnings growth, potential rate cuts and high cash balances, we think US equities will rally further. However, markets are likely to remain volatile given moderating growth and the upcoming US election. While we remain bullish on US equities, we stay diversified with exposure to global equities, favouring the UK, Japan, India and South Korea as well. A multi-asset strategy can also help investors achieve diversification while managing market volatility.

• The US economy slowing to more moderate levels temporarily led to sector rotation away from technology into small-cap stocks, but  investors have returned to the sector after valuations have come down. The AI boom and structural trends continue to offer opportunities within and beyond technology, including communications services, financials and healthcare.
• We upgrade US industrials to overweight due to re-onshoring and the support from both US presidential candidates who are keen to bring production back home and support employment in the sector. Both government and corporate investment and technological innovation are also supportive.
• Although falling inflation and still low unemployment are positive for consumer discretionary, some areas (e.g. autos) are facing margin pressures amid US economic growth and global activity slowing down.  We therefore downgrade the consumer discretionary sector to neutral across regions. Overall, we keep broadening our sector exposure to capture the earnings momentum.

• Fed Chair Powell’s statement at the Jackson Hole Economic Symposium that the “time has come for policy to adjust” set the stage for the first rate cut at the FOMC meeting on 18 September. He also pointed out that the labour market is no longer overheated with rising unemployment caused by an increase in labour supply rather than elevated layoffs.  
• US Treasuries rallied sharply in early August in response to rising recession fears, with Fed rate cuts of 1.2% by end-2024 being priced in. The expectation has now fallen to 1%, which is still higher than our projection of 0.75%. Nevertheless, cash returns will come down further and lose their appeal.
• The correlation between equities and bonds has declined significantly as a reaction to weaker economic data, reinforcing the important role of bonds for income generation and diversification. We continue to focus on locking in multi-year high bond yields and favour quality bonds, particularly investment grade with 5-7 years duration, which offer more attractive credit spreads than US Treasuries with similar duration risk.

▲ Overweight

We think global equities can rally further on the back of solid earnings growth, rate cuts and high cash balances. We look beyond the US and IT to capture the broad-based upside.

▲ Overweight

Despite slowing economic growth, Fed rate cuts and long-term structural trends should support broadening of earnings growth across sectors. We believe US recession risk is overstated and maintain our biggest overweight on US equities.

▲ Overweight

UK equities are very cheap compared to global markets and a bit more defensive. Both growth and the earnings outlook are improving with relative political stability post-election.

▶ Neutral

We find some value in Europe but stick to global companies with strong earnings. Spain stands out with its relative resilient economic momentum and attractive valuations.

▲ Overweight

Corporate governance reforms, improving earnings growth and the AI boom remain key drivers for Japanese equities.

▶ Neutral

We are most positive on EM Asia where corporate earnings growth is likely to rebound sharply in 2024. 

▼ Underweight

The region is impacted by high energy prices and global interest rates, as well as geopolitical uncertainty.

▼ Underweight

Political uncertainty in Mexico and slowing rate cuts in Brazil may trigger selling. 

▲ Overweight

We continue to diversify into the region to capture its structural growth opportunities, focusing on India’s strong growth momentum while the global AI trend should benefit South Korea. We remain neutral in China until growth improves.

▶ Neutral

Macro-economic data remain mixed while policy support is being ramped up to revive growth recovery. We prefer corporate governance reform winners, quality SOEs paying high dividends and internet leaders with solid earnings.

▲ Overweight

Robust cyclical growth, strong earnings momentum and continued structural reforms continue to drive India’s long-term growth, complemented by budget focus on fiscal discipline, job creation, and rural and agricultural reforms.

▶ Neutral

Lingering headwinds in the property market, weak consumer confidence and mixed economic data remain key challenges for Hong Kong equities. We prefer the insurance, telecom and utility sectors, as well as quality REITs and developers. 

▶ Neutral

Select high-quality Singapore REITs could benefit from the global central banks’ rate-cutting cycle.

▲ Overweight

The AI-driven tech investment boom has lifted higher memory prices and demand for high bandwidth memory chips while the Corporate Value-Up Programme contributes to re-rating of the equity market. 

▶ Neutral

The equity market is benefitting from the AI boom and strong demand for semiconductors. As valuations are expensive, we remain neutral.

▼ Underweight

Given market expectations of too many Fed rate cuts, we stay neutral on US Treasuries and UK gilts. Unattractive Japanese government bonds lead our overall government bond positioning to underweight.

▶ Neutral

The downward move in US Treasury yields has gone too quickly, leading us to hold a neutral position and shorten duration to 5-7 years. 

▶ Neutral

With the beginning of the rate-cutting cycle, we expect policy rates to go further down but markets have priced in too many cuts. We maintain our neutral stance and focus on locking in higher rates now.

▶ Neutral

Europe is gradually recovering but absolute yields remain relatively less attractive compared to those in the US.  

▼ Underweight

We expect the next rate hike to occur in Q1 next year to minimise disruption to the reflation momentum and remain bearish on Japanese government bonds.

▼ Underweight

We remain bearish on EM local currency bonds given the strong US dollar and a slowing pace of disinflation across EM economies but stay positive on Indian local currency bonds for their attractive yields and strong liquidity support. 

▶ Neutral

We still find yields but remain selective and generally focus on quality issuers. 

▲ Overweight

We prefer quality bonds amid slowing global growth and rising market uncertainties. Investment grade is preferred because of its attractive credit spreads, resulting in a higher yield than on government bonds.

▲ Overweight

While US growth is slowing, we remain overweight on US investment grade for their quality and attractive yield pick-up.

▲ Overweight

Europe is recovering gradually, and we focus on quality issuers with medium duration, preferably companies with global business exposure. 

▲ Overweight

In expectation of Fed rate cuts, we focus on locking in multi-year high yields from Asian IG bonds with 5-7 years duration and favour Asian financials, Indian local currency debt, Indonesian quasi-sovereign bonds, Macau gaming and Chinese TMT.

▶ Neutral

High yield bonds are sensitive to potentially adverse economic developments and are trading at tighter valuations. Their yield pick-up is insufficient for rising default risks.

▶ Neutral

Despite low defaults and manageable refinancing risk, the risk premia of US high yield is too low versus investment grade.

▶ Neutral

Although growth has bottomed, spreads in high yield remain tight compared to historical averages, so are less attractive.

▶ Neutral

Given the property market challenges and mixed economic data in China, credit selection remains key and we prefer quality issuers to hedge against cyclical weakness and geopolitical risks. 

▶ Neutral

Uncertainty has driven gold to high levels but physical demand is waning at current high price levels. 

▶ Neutral

While geopolitics provide support for oil, spare capacity limits the upside. We expect oil prices to trade sideways.

We downgrade the sector in all regions on weak discretionary spending trends. Q2 results were mixed as customers became selective or traded down. Generally, companies’ H2 guidance was for slower growth. Even hospitality and tourism are seeing signs of cooling demand. Autos remain in turmoil as supply chain issue re-emerges and EV demand continues to decelerate. Home appliance demand remains subdued pending a recovery in home sales. 

Globally and in the US, the sector continues to benefit from an improving economic backdrop while interest rates look set to decline slowly with a modest impact on earnings. Capital market activity has picked up. Regional banks with significant exposure to the real estate sector and loans remain an area of concern. Weather related events including a forecast record Atlantic hurricane season are likely to weigh on the insurance and re-insurance segments.

We upgrade US industrials ahead of an expected pick-up in orders in H2. We expect a re-rating on earnings to ease valuations. Asian industrials are showing tentative signs of slowly improving fundamentals. Medium term, we remain positive on the sector as government policy remains supportive in China, Europe and, especially, the US where the Inflation Reduction Act (IRA) and CHIPS Act are driving significant investment in new production capacity and infrastructure.

Big tech stocks have seen some pullback as the rally broadens. AI will be the key driver for the sector as the technology becomes increasingly embedded leading to product and service capability enhancements, productivity gains and competitive differentiation. The next wave of AI development should benefit digital infrastructure companies focused on cloud, data centres, software and cooling technologies.

The US communications sector continues to deliver stellar earnings growth as fundamentals and attractive prices continue to attract investors. In Asia, the stabilising regulatory environment and low valuations offer an attractive risk-return profile. In contrast, Europe’s telecom services sector has little room for optimism. 

Copper prices remain the bright spot in the commodity markets on rising renewables, electrical and digital infrastructure demand, plus some strategic inventory building in China. Iron ore, steel and EV battery materials remain lacklustre. M&A activity has sparked interest in the miners. Chemical stocks remain range-bound while the chemical business remains subdued. 

The outlook for commercial real estate is mixed, with retail and office segments still looking unattractive, while warehousing is seeing improved demand and prices after a sustained period of weakness. The housing sector in some markets is showing tentative signs of improving sentiment in anticipation of lower interest rates. Chinese real estate remains problematic. Easing inflation and interest rates may lift sentiment and activity.

Strong competition and consumers trading down have created a weak pricing environment for companies in many markets. As a result, Q2 sales results were generally disappointing with margins squeezed by continuing wage inflation. The sector is trading in line with historical valuations limiting potential upside.

Low valuations, strong cashflow and high dividends appear to be insufficient to change sentiment towards the sector as energy prices remain range-bound. On a seasonally-adjusted basis, supplies appear plentiful and inventories adequate, backed  by the relatively mild winter in Europe. In 2024, energy prices may not benefit from geopolitical uncertainties as they have over the last two years.

New product launches, a less hostile pricing environment and the ebbing wave of major product patent expirations should help lift the sector after a period of under-performance. Healthcare sales growth should start to benefit from easier comparables while new pharma products should lift sentiment and expectations. In Asia, valuations remain high, trading well above historical levels.

Momentum is re-accelerating on renewable energy projects as governments have started to adopt more realistic pricing for new projects. Interest rate cuts could provide a tailwind and improve sentiment further. Utilities may benefit as interest rates fall and investors look to high dividend paying stocks.