MARKET INSIGHT – March 2024

MARKET INSIGHT

Prime Partners’ monthly analysis of global economic and financial market news.

Resilience and caution

The 2023 fourth-quarter earnings season is drawing to a close and, in general, corporate releases have once again been of a high quality. The figures reported, as well as the guidance given by the top executives, have regularly confirmed several trends that we have been observing for many months now.

The US economy is still firing on all cylinders, almost making investors doubt that a soft landing is really in the cards for the coming months. However, this strength continues to be mainly due to the excellent performance of the services sector, despite the fact that industrial activity is clearly in recession. Even more so in Europe than in the US, industrial sectors are in a slump, especially in Germany. High interest rates, coupled with much lower growth rates, are having a greater impact on the countries of the old continent.

Finally, it is hard not to mention the technology component, where the results of some of the industry’s mega-caps – led by Nvidia – now clearly demonstrate that we have entered the age of artificial intelligence, and that this revolution is taking place mainly on American soil, already generating considerable revenues in various sectors (semiconductors).

There is something ironic about the times we are living in, if we put ourselves in the shoes of central bankers, notably those of the US Federal Reserve. Having implemented one of the quickest monetary tightenings in the history of the developed world in order to combat inflation, America’s monetary powers-that-be now find themselves faced with economic data that regularly indicates that the US economic engine is doing better than resisting – indeed, that it has simply adapted to a restrictive interest-rate environment after more than ten years of easy money, culminating in the Covid years when all the floodgates were wide open.

As mentioned in earlier issues of this monthly note, the reasons for this phenomenon are well known, and it is no economic miracle. The restrictive monetary policy wisely coincided with the expansionary fiscal policy pursued by the Biden administration. In addition, the acceleration of the energy transition and the advent of artificial intelligence have also counterbalanced the cooling effects of rising interest rates on the US economy. The result is an enviable situation for the United States, where inflation has been falling sharply for several quarters now, without damaging the country’s economic momentum, and where the strength of the job market continues to provide strong support for consumer spending.

There is something ironic about the times we are living in, if we put ourselves in the shoes of the central bankers

As February draws to a close, however, we must be careful not to take this fine mechanism for granted. Recent US inflation figures show that the final steps on the road to the Fed’s 2% target will not be easy. More than ever, the long-awaited rate cuts will not be made hastily, and their triggering will be conditional on the arrival of economic data confirming that the time has come to start loosening the monetary stranglehold.  In other words, Jerome Powell and his colleagues will need a little more certainty than at present that the labor market as well as consumer and producer prices are easing.

Europe, for its part, has little or no support from a booming technology sector, and is therefore suffering more severely from the industrial recession facing the economies of several of its members, led by Germany and France. Mrs. Lagarde finds herself at a crossroads between not wanting to get ahead of the FED in initiating a rate-cutting cycle, and an economic slowdown that should not be allowed to take hold for too long. The only good news is that inflation seems to have been largely brought under control, and the fears of 2022 related to energy are behind us.

Finally, a word on the Chinese economy which, despite some recent signs of improvement (or rather of no further deterioration), still appears to be mired in a real estate and potentially latent banking crisis. For the time being, government measures seem too timid or misguided, allowing neither the Chinese consumer to get the economic engine going again, nor foreign investors to feel confident enough to return.

Generally speaking, and contrary to what some headlines would have us believe, the equity market does not seem to be deluding itself at current levels, even if we acknowledge that it is now somewhat expensive. The all-time highs we are seeing on several indices are not necessarily the harbingers of an imminent correction (historical data does little to support such a theory), but rather an indication that the game is becoming tighter and mistakes more costly.  Recent earnings releases have not spared companies whose figures were deemed disappointing by the market, and the same is true, if not more so, when the outlook disappoints. 

This difference in treatment between good and bad performers is rather reassuring, and although it remains concerning that the S&P 500’s rise over the last four months has been heavily concentrated in a few mega-cap technology stocks, it is clear from the results just published by these companies that this coincides with a growth in their revenues, as well as their outlook, which they report as good, if not excellent. It is therefore appropriate to be cautious in terms of both diversification and stock picking, without allowing ourselves to be overly fearful.

The imminent end of the earnings season will bring macroeconomic news back into focus, along with the attitude of central bankers. Here again, we believe it bodes well that market expectations for interest rate cuts this year are now better aligned with the FED’s rhetoric. This leaves less room for disappointment, and puts investors’ sentiment more in tune with the reality of the economic data on which central banks depend for their actions.

The imminent end of the earnings season will bring macroeconomic news back into focus

As for bonds, the current high interest-rate environment, and especially its potential prolongation, is clearly not the most favorable backdrop for the asset class. With this in mind, the bond holdings in our portfolios continue to include very short maturities, particularly in dollars. We also note the good start to the year for high-yield instruments, whose issuers are benefiting, among other things, from the strength of the US economy. In general, as with equities, our approach to fixed income emphasizes the diversification of selected strategies and the importance of sound credit analysis when picking individual issuers, at a time when the extended period of high interest rates is putting the most fragile balance sheets to the test. 

Finally, after the first two months of the year, which we consider to have been good for the performance of our allocations, it is important to remember the benefits of investing in an asset class with a proven ability to decorrelate from the equity markets. The alternative long/short strategies we hold and our exposure to gold therefore remain attractive, as we enter a period of a few weeks where macroeconomic news and pronouncements by central bankers are likely to take center stage once again.

Leaving aside these market considerations, it is also worth mentioning that the geopolitical climate is far from improving in 2024. The stalemate in the armed conflict in Ukraine and the continuing war between Israel and Hamas leave little room for hope of détente this year. We bear in mind that these two situations, in addition to their potential for escalation, are vectors of volatility for financial markets, notably through energy prices. Furthermore, as mentioned on several occasions over the past few months, the US election is likely to take on increasing importance as the year progresses, with potential turbulence once again depending on polling results and future policy announcements.

We conclude this note as the title suggests. The resilience of the US economy is no pipe dream, and the current levels of the equity indices are a fair reflection of this. We must therefore continue to capitalize on it in our allocations, without overlooking the key elements of valuation, diversification and, of course, common sense in the months ahead.  After all, caution is the better part of valor, isn’t it?