Recession fears recede, but geopolitics looms large Mid-year outlook

So far in 2024, the global economy has shrugged off the worry of recession, as positive growth rates have reappeared, although they are relatively weak. This picture is particularly evident in the US, where the once-common forecasts of a recession look increasingly unrealistic. This macroeconomic backdrop has led to a sharp shift in US Federal Reserve (Fed) rate cut expectations.

We expected three cuts from the Fed this year in our earlier forecasts, in contrast to the consensus expectation of six to seven. After a spectacular turnaround, the consensus now expects the Fed to cut rates once or twice, in line with our revised expectations.

A subdued growth outlook

This approach would support a continuation of the economic soft landing in the US through the second half of 2024, offering a controlled cooling of growth and inflation rates without a severe recession. But despite the remarkable sturdiness of the US economy so far this year, some cracks are beginning to show. The restrictive interest rate environment is hampering labour market demand, and high capital costs are slowing both investment activity and fiscal stimulus.

Our rather subdued growth outlook has a positive side. It reflects moderate demand pressure, which, along with supply side dynamics, is crucial for the pace of inflation. We expect core inflation to cool further on both sides of the Atlantic in the second half of the year, more noticeably in Europe than in the US.

Geopolitics will remain crucial

Geopolitics is likely to create turbulence for the global economy and financial markets in general. Anxiety is rising about the outcome of the US presidential election in November, and with it concerns about the nation's future foreign trade policies  at a time of fast-changing global trade patterns.

Although the period of 'hyperglobalisation' - where trade growth outstripped global GDP growth - is over, we anticipate that globalisation will continue in a more nuanced and segmented form. Significant trade decoupling or fragmentation is more likely to occur in sectors deemed crucial for national security, such as advanced technology, defence, and energy. Sectors deemed less sensitive are likely to return to easier trading flows.

Gold is unlikely to keep rising

Financial markets will remain finely tuned to geopolitics for the rest of the year, with the high level of tensions driving several asset class pricing. Gold has been a beneficiary of this trend as emerging market central banks pivoted away from the US dollar and conflict increased in the Middle East. That said, the substantial rise in the gold price is somewhat counterintuitive, giving the economic climate. We believe that gold will not continue its upward trajectory, therefore LGT is maintaining a neutral outlook on the metal.

Equity opportunities are expanding

Strong stock performance so far in 2024 has been led by large-cap stocks with solid balance sheets, above-average margins, and below-average volatility. At this point, late in an economic cycle, it makes sense to look farther afield for investment opportunities.

As earnings growth dynamics are expected to broaden going forward, we think this pronounced growth leadership may fade. In this context, we particularly like European small cap stocks that benefit from improving growth rates in Europe, falling interest rates, and attractive valuations.

Two further equity themes that continue to look interesting are bond proxies: high quality, dividend-paying stocks that have been negatively impacted by high inflation; and value stocks that offer earnings growth potential and are trading at attractive valuations. 

Bond maturities deserve consideration

Fixed income investors know that 2024 hasn't gone to plan so far. The postponement of rate cuts due to higher-than-expected inflation figures meant that fixed income markets did not benefit from falling yields. Yet the future path seems clear.

We still believe that most central banks are poised to transition from a restrictive to an accommodative monetary policy this year. However there could be further delays, which is why we are forecasting the bulk of the interest-rate cuts to take place next year.

The US and Eurozone macroeconomic trajectories have been diverging for some time, which suggests that the gap between the monetary policies of the Fed and the European Central Bank will continue to widen. In the Eurozone, where easing has already begun, we favour a gradual extension of duration in bond portfolios. With US dollar bonds, conversely, we suggest remaining with shorter maturities.

This development has implications for credit investors. In assessing credit risks, the emphasis on selection, individual issuer choice, and quality will only increase. Given current uncertainties, this may be an opportunity to improve the average quality of a bond portfolio without sacrificing significant yield.

Uncorrelated assets remain important

Government bonds have not provided good diversification from equities so far in 2024, and correlations between these asset classes are rising. While we believe that inflation will continue to abate and will no longer have the same impact on yields that it has had over the past two years, any future inflationary concerns could reinforce the positive correlation between equities and bonds. For this reason, we continue to see the benefits of investing in assets that are uncorrelated to equities, such as catastrophe bonds, hedge funds, and private market instruments.

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