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Schroders Global Market Outlook

14 June 2024 Sebastian Mullins, Multi-Asset Fund Manager at Schroders

Global markets rebounded in May after a shaky April. After a string of higher than expected inflation prints, the market was anticipating a more hawkish tilt from the US Federal Reserve (Fed). However, Jerome Powell doubled down on his dovish stance saying that it was unlikely the next move would be a hike. This caused all assets to rebound in May after selling off the month prior as the market shifted away from higher for longer and back to a more goldilocks view of the world.

The rest of the month was a welcome relief for the Fed, as economic data came in positive but weaker than expected, confirming their dovish tilt. The latest US inflation reading was another welcome relief, with both consumer prices (CPI) and personal consumption expenditure (PCE) in line with expectations. This isn’t to say inflation was weaker, but if inflation continues to be in line with expectations, the prospect of a pre-election rate cut is back on the table. US growth remains solid, supported by real wage gains fuelling consumption gains. The US labour market does look to have taken a step down in the pace of hiring, and weaker payroll growth is the key to allowing the US Federal Reserve to cut rates in September. 

The relief rally has definitely catapulted risk assets into expensive territory. The current Price-to-Earnings (PE) ratio of the S&P 500 has eclipsed 27x. The Shiller PE (cyclically adjusted price-to-earnings ratio) has risen to 34.5x, which is the top 1% of history, going back to the 1800s. While past performance is no guarantee for future performance, history would suggest that implies a 0% return for the next decade for US equities. Credit is no different. Credit spreads have tightened significantly and are back to being expensive, with US investment grade spreads only tighter less than 20% of its history and US high yield less than 14%. This complacency has led to low volatility across the board. The US equity volatility index (VIX) remains below 13%, which is one of the lowest readings in years and rarely stays this low for long. Even bond volatility has subsided, falling to around 90 which is the lowest reading since the 2022 bond sell off. Low volatility means you can buy a put option on the S&P 500 at the cheapest price in over 20 years. The only thing cheap right now is protection. 

We remain positive on equities but are becoming more cautious. Sentiment and positioning has become stretched yet again, but we would rather be long and nervous than to start downgrading just yet. Our base case of strong economic growth in the US remains unchanged, but economic surprises are weakening and the distribution of outcomes is likely widening. The US economy in aggregate appears resilient, along with US equity profits. However, cracks are starting to appear within the more stretched consumer segments and smaller corporates. Spreads in CCC US corporates remain wide, highlighting stress in lower quality corporates. This will not likely appear in aggregate data or S&P 500 earnings just yet, but the well telegraphed long and variable lags of monetary policy should start making an impact now, if they are to have an impact at all. We are therefore focusing on the microdata for any sign of cracks at the lower end of consumers and smaller end corporates as they will likely be the canary in the coal mine that higher rates are starting to bite. For these reasons we prefer to stay long risk but increase our protection through put options as we await to see whether growth is simply weakening or cracking, and whether inflation can resume its descent allowing the Federal Reserve to cut rates sometime in 2024. 

Credit valuations are highly varied across markets providing opportunity for credit rotation. Both US investment grade and high yield spreads are expensive relative to their own history and relative to other regions. Europe and Australia remain cheap in comparison, with spreads above their US counterparts despite higher credit quality and lower default rates. Within the US, securitised credit remains cheaper than corporate credit, with spreads on government guaranteed mortgage-backed securities above investment grade corporate bonds. We therefore prefer securitised credit over corporates within the US and prefer holding European and Australian corporate credit. 

We believe bond valuations are improving and bond yields are starting to look interesting. At the time of writing, the European Central Bank is expected to cut rates in June, with further rate cuts in a quarterly cycle. Although the latest European inflation reading was a hiccup and growth looks to have bottomed, inflation is expected to be closer to 2% by the end of the year allowing an easing of policy towards 3% by the middle of 2025. We prefer German and Australian duration to the US given the differing growth dynamics. 

We retain our positive view on the US dollar (USD), driven by continued expectation around US growth and inflation upside, along with positive carry. We continue to favour emerging market currencies for carry and stay neutral on the JPY. We remain negative on the European block (EUR, CHF, GBP).

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