• Divergence between US and Eurozone
• High service sector inflation doesn’t stop ECB cutting interest rates
• Overweight in equities, larger underweight in US investment grade credits

Global equity markets delivered strong returns in May, fueled by growing confidence that the US economy is on track for a soft landing. The MSCI All Country World Index rose by 3.8% last month. Technology and growth stocks led the rally. Markets that had lagged behind the global rally for much of 2024 began catching up in May. Notably, the defensive Swiss market was among the top performers, advancing 6.4%. China also recovered, with unexpectedly strong economic figures, resulting in a 2.5% increase in the MSCI China Index. As investors seek positive growth momentum and attractive valuations, their focus is shifting away from the US towards more regionally diversified investments, where the potential for outperformance seems greater. Positive news on US inflation has aided the recovery of fixed income markets from April's losses. Although Eurozone bond performance was more subdued, the 10-year Bloomberg US Treasury Index returned 1.5% over the month.

 

Recent data indicates that the US economy is cooling, raising the likelihood of a Federal Reserve pivot in the second half of 2024. Despite a stronger-than-expected ISM survey data for the services sector, the headline ISM manufacturing index (48.7) indicated further contraction in US factory activity. Real GDP figures for Q1 2024 were revised down to an annualized rate of 1.3%. Similarly, April's retail sales, which were weaker than expected, confirmed that domestic demand is normalizing. Positive inflation news is beginning to surface, allaying fears that the disinflation process is stalling. April's headline CPI print, which was below market expectations for the first time since October, was followed by the April core PCE index, which stood at 0.25% - a four-month low. We believe that the softening housing market and the slowing price trend in new rental leases suggest that shelter inflation will continue to decelerate in the coming months. Additionally, April's Job Openings and Labor Turnover Survey (JOLTS) showed job openings falling to their lowest levels since February.

 

We are observing an economy that is gradually slowing down, yet still growing. This decline in growth appears to be a healthy deceleration that should facilitate further disinflation, allowing policymakers to cut rates. We believe the current risk balance strongly favors a Fed rate cut rather than a hike. Therefore, any significant economic weakness is likely to be mitigated by a "Fed put." This potential for looser financial conditions creates a favorable environment for stocks. While the Fed maintains a patient, data-driven approach, the global trend towards rate cuts is evident, with the Swiss, Swedish, and Canadian central banks already initiating easing cycles. Last week, the European Central Bank joined this trend, cutting interest rates for the first time since 2019. This decision was made despite signs of accelerating economic activity and persistent wage and services inflation. However, ECB President Lagarde emphasized increased confidence in the inflation outlook and noted that the current rate level remains contractionary.

Divergent monetary policies and uncertainty regarding interest rate paths are likely to remain sources of volatility for foreign exchange and government bond markets for some time. However, investors should remember that the reset in yields has restored bonds' dual role in portfolios: providing income and diversifying against negative growth surprises. Higher interest rates have led many investors to hold more money market investments or cash than usual, but lower rates will likely prompt at least some of this money to be redirected. In this context, fixed income is a natural destination. We believe bonds offer an attractive asymmetric absolute return profile given the current inflation and growth mix. We continue to favor high-grade bonds over high-yield ones and remain selective within the investment-grade corporate bond segment. We believe that yields in the European investment-grade market still offer potential for attractive returns and appealing income, while the spreads between US investment-grade bonds and government debt are historically low and do not adequately compensate for the additional corporate risk.

With the majority of the first quarter earnings season being behind us, we were particularly encouraged by the upward revisions in guidance and the expansion of earnings beyond mega-cap technology stocks, in addition to the fact that results exceeded our expectations. The resilient economy should allow earnings to recover, while we expect discount factors to decline as inflation normalizes and central banks embark on an easing cycle. Earnings expectations are being revised upward in both the U.S. and Europe, which should ultimately support stock prices. We are increasing our equity position in Europe, where we see the economy improving, the ECB cutting interest rates, earnings expectations remaining defensive, and valuations looking reasonable.

Please find attached our last Asset Allocation Update for June.