DBS CIO Insights 3Q24: 'risk assets in play' key investment takeaways
Indonesia, 24 Jun 2024 -
3Q24 Investment Summary
Macro Policy
Fed to wait and see for the rest of the year amid stubborn inflation. Expect the ECB to ease before the Fed. BOJ to hold rates, scale back JGB purchases. China policy support to continue.
Economic Outlook
Global growth momentum is normalising with signs of weakness surfacing, from ISM Manufacturing orders to retail sales. Services in Europe remain strong, while China’s labour market is on the mend.
Equities
US equities to stay resilient amid “greedflation” and robust earnings outlook. AxJ outperformance to persist, supported by policy measures and undemanding valuations. Stay overweight on US and Asia-ex Japan, neutral on Japan, and underweight on Europe.
Credit
Yields are at an inflection point between tight policy and softening economic momentum. Sweet spot remains in A/BBB credit, with a duration barbell between 1-3Y credit for high absolute yields and 7-10Y credit for wide spreads.
Rates
Potential Fed and ECB easing this year should translate into steeper curves. The BOJ continues to buck the trend; the JGB curve may well flatten. We expect CGB yield curves to steepen as China ramps up fiscal stimulus.
Currencies
The greenback’s strength is likely to wane due to a less exceptional US economy, central banks aligning with the Fed’s delayed rate cut, and risk from the upcoming US elections.
Alternatives
Heightened geopolitical risks, wider performance dispersion, and reduced asset correlations are supportive of larger opportunities for alpha. This warrants a closer look at hedge fund strategies for outperformance.
Commodities
Signs of a broadening rally within commodities as copper gained on China’s “green” demand and mine disruptions, while severe supply shortages see cocoa notch stellar gains.
Thematic focus: Global Big Tech
Innovations like reusable rockets and SmallSats have unlocked new possibilities in the space economy, ranging from satellite internet and Earth observation to space travel.
Our call to be fully invested since the start of the year has paid off, as reflected in the continued run in equities and compression of credit spreads. In 2Q24, while the Fed acknowledged modest progress on inflation in its June FOMC meeting, it reiterated the need for a cooler economy before rate cuts can begin. While investors contemplate the effects of higher-for-longer interest rates, the S&P 500 continues to notch record highs, after a knee-jerk pullback in April this year. Recent economic data point to a US soft landing, with tapering growth and price pressures that will lead to the Fed gradually cutting rates. It appears that the “eventuality” of a rate cutting cycle – no matter how shallow – is sufficient to sustain the rally.
We maintain our view that policy easing is on the cards, with Fed Funds futures pricing in the first cut in November to December. With the easing of supply chain pressures globally, the current high inflation/high bond yield environment is predominantly demand-driven as the macro picture remains robust. Even after a strong rally in the first half of 2024, we believe that equity markets will stay resilient in the second half of the year, driven by profit margin resilience, positive corporate earnings outlook, undemanding valuations, and liquidity support from a growing US monetary base, which is closely correlated to the S&P 500.
While we remain structurally bullish on technology stocks, we expect further broadening of the market rally. As household demand continues to drive consumption, the following segments are poised to benefit in a higher-for-longer interest rates environment:
Big Tech with huge cash holdings
: Big Tech companies operating with the latest innovations and technologies are poised to register strong earnings growth in the years ahead (consensus forecast estimates earnings growth at 44% in 2024 and 19% in 2025).
Upstream energy companies with low gearing
: End demand tends to remain stable even in a high interest rate environment given its inelastic demand and geopolitical uncertainty.
Large-cap financials with low exposure to commercial real estate
: Elevated rates are positive for the net interest margin outlook of banks as interest income tends to reprice faster than the interest expense for loans. Remain cautious on banks with outsized exposure to commercial real estate.
Overall, US economic resilience and persistent inflation are prompting the Fed to maintain policy rates. However, we expect equity markets to continue performing, and maintain our preference for bonds over dividend-yielding equities.
Key highlights of our tactical calls for the coming quarter are:
Cross Assets – Maintain preference for bonds over equities
We retain a preference for bonds over income-generating equities given their attractive risk-reward. The negative yield gap between US equity dividend and 10-year treasury yields has widened, underpinning the relative attractiveness of bonds over equities. Year-to-date flow of funds data further evidences broad-based preference for bonds on a cross asset basis.
Equities – Stay Overweight on Asia-ex Japan
The revival of AxJ equities continues in 2Q24, with China outperforming on optimism that the worst of policy headwinds are over, amid the recent slew of supportive government measures. Despite the strong YTD rally, China equities continue to trade at a steep valuation discount to developed markets, suggesting room for further upside. Current underweight portfolio allocations among investors and strong earnings outlook will further support positive momentum.
Bonds – Adopt “barbell” approach by going short duration in 1-3Y segment and long duration in 7-10Y segment
US Treasury yields surged this year as investors pared back their rate cut expectations – from six to seven cuts by January 2025 to two cuts currently. This resurgence provides an attractive window of opportunity for bond investors to benefit from higher yields as well as stronger capital gain opportunities should the Fed cut more aggressively than expected. In any case, the next policy move for the Fed will be a rate cut instead of a hike. Staying in cash will thus entail reinvestment risks.
At this stage of the credit cycle, we advocate a “barbell” approach for credit investing by focusing on:
Short duration IG credit in the 1-3Y segment
: This provides investors with the highest beta to rate cuts.
Long duration IG credit in the 7-10Y segment
: This provides investors with wider spreads and sensitivity to rates.
Alternatives – Embrace hedge fund strategies for diversification benefits; stay overweight on gold
The post-Covid environment has brought new elements investors had not previously considered. Given such uncertainties, hedge funds that specialise in macro strategies could serve as a good hedge for a traditional 60/40 portfolio that derives returns more primarily from economic considerations.
Even with the lack of clarity surrounding rate cuts, there remains an overall bullish skew for gold given its nature as a haven asset amid geopolitical risks and de-dollarisation concerns. Strong bar and coin demand from private investors further adds to the long-term fundamental demand for bullion.
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