A resilient US economy (owing to consumption and wealth effects) and strong earnings expectations for the year are driving the recent upside in equities and increase in yields.
The big questions are whether this can continue given the already strong market movements, and whether these earnings expectations are credible asks Amundi, Europe’s largest investment manager.
Vincent Mortier, Group Chief Investment Officer Amundi, says “On the economic front, the past strength led us to forecast a less ugly US slowdown, therefore extending the late-cycle environment. Nonetheless, we do not see this as a beginning of a new cycle and expect a slowdown around the middle of the year, and continued disinflation.
“The factors listed below will be crucial to understand the direction of the economy and markets:
- US labour market. A moderation in demand is likely, led by a shift to higher savings, lower consumption and weak labour markets (stress in SMEs employing a large part of the labour force), along with subdued investment.
- Monetary policy divergences, with inflation in focus. While the BoJ raised rates after 17 years, the Fed and the ECB are looking to cut rates but would like to be sure on the future direction of inflation first.
- US elections and geopolitics. Volatility may rise, as we enter a more active campaign phase. Geopolitics and the risks of high debt globally may provide long-term support to gold.
- Emerging markets’ (EM) resilience. We slightly upgraded our growth forecasts in EM, mainly due to Asia and India, on strong domestic demand and exports. However, our growth expectations for China do not change.”
“Given this backdrop, we outline our stance on select areas below:
- Cross Asset. Risk assets have priced in the improved outlook for earnings and growth and continue to benefit from positive market sentiment. Without taking additional risks, we maintain our positive duration stance. In bonds, we are also slightly positive on Italian BTPs but are cautious on JGBs. In equities, we are overall positive. We are marginally constructive on Japanese equities, while we are neutral in the US and now on Europe. In Emerging Markets, we are positive on bonds and on equities (India, Indonesia and South Korea). In FX, we see some strength in the USD, BRL and INR, but fine-tuned our views based on recent movements. Overall, we prefer a diversified stance, with sufficient protections on geopolitical tensions (oil) crucial in the current environment.
- In fixed income, the evolution of inflation will be the main driver of policy actions and with that in mind we remain active and positive on US and UK duration. In Europe, we are close to neutral now after the recent move up in yields and dovish messaging from the ECB, but are defensive on JGBs. In corporate credit, fundamentals remain strong for Investment Grade, but default rates in low-rated credit (CCC) are rising, particularly in the US. Therefore, higher dispersion based on quality is likely. Thus, our focus is on quality, and we find lower maturity credit selectively attractive. In Europe, we favour Investment Grade over High Yield, and maintain a preference for higher quality (BB) or short maturities.
- Excessive sentiment in US stocks supports an equal-weight approach. We stay balanced by exploring defensive idiosyncratic opportunities rather than any particular traditional sector. On the other hand, in industrials, high-quality materials is selectively an attractive sub-sector. In Europe, we prefer blending quality cyclicals with a defensive stance. Sluggish growth in the region will continue, which leads us to upgrade staples, while we are cautious on technology. Overall, we like quality, and value in Japan and the US.
- Our structural stance on EM is constructive. We combine factors such as fiscal risks and external vulnerability for countries with our bottom-up views. This allows us to be positive on India, Indonesia, South Korea, and in LatAm (Brazil, Mexico). EM debt should benefit from Fed rate cuts along with continuing EM disinflation. However, geopolitical and idiosyncratic risks keep us vigilant.”