Invesco releases 2024 Midyear Investment Outlook “Opportunities Amidst Divergence”

• Diverging economies: Divergence has re-emerged as a theme, with individual economies likely to see various growth and inflation experiences going forward.
• Gentle easing: Expect falling inflation across most economies in the second half, but at a trajectory that elicits only marginal interest rate cuts.
• Rate cuts? The precise number of rate cuts is less important than the timing of them, especially as the market narrative remains highly volatile.

Hong Kong, 18 June 2024 – Invesco today released its 2024 Mid-Year Investment Outlook (link) with insights on the near-term expectation for global markets through the remainder of the year.  

Despite widespread expectations of a global economic slowdown in 2024, growth and inflation have continued to perform above expectations across most major economies. The Outlook focuses on the path of inflation and how global central bankers are weighing the balance of risks as they begin to cut interest rates.

Kristina Hooper, Chief Global Market Strategist at Invesco, commented: “Markets today reflect a relatively optimistic macro scenario. Volatility is expected in the near term as markets react to shifts in the rates outlook, including any supporting or conflicting data points along the way. The precise number of cuts is less important at this stage than the timing of them, especially as the market narrative continues to be highly volatile. There could also be a significant risk that some markets may be overly positive and have not fully priced in potential problems. With individual economies likely to see various growth and inflation experiences going forward, we believe divergence will be a core theme through the rest of 2024.”

Base case: Below-trend (but resilient) growth and “gentle easing”  

In the Outlook’s Base Case, demand-side resilience has delayed the disinflation narrative across major western economies, particularly in the US. Falling inflation across most economies in the second half continues to be the expectation, with disinflation realized more quickly in non-US developed market economies but at a trajectory that elicits only marginal interest rate cuts.

As supply and demand factors come into better alignment over time in Western developed economies, inflation should continue to fall towards central bank targets with a gradual return to trend growth rates, aided by marginal rate cuts from major central banks. Disinflation will likely occur at a pace significantly slower than previous expectations, leaving the global economy in a soft patch driven by a restrictive monetary policy backdrop that translates into below-trend but still resilient growth. 

Thus far, the US economy has been less affected by tighter monetary policy. But after a series of upside surprises in US macro performance, underlying growth appears to be showing signs of weakness. The US will likely grow at a modestly below-trend rate for the remainder of this year, constrained by the effects of restrictive monetary policy. 

Meanwhile, inflation is likely to continue a bumpy path downward through the end of the year, and the stabilization of inflation at above-target rates should likely limit the degree and pace of monetary policy loosening. The Base Case expects two rate cuts from the Fed this year, likely beginning in the third quarter. 

Kristina noted: “US equity markets have benefited from continued earnings growth and moderating inflation, as well as thematic stories such as the rise of artificial intelligence. Current elevated US equity valuations suggest a lot of positive sentiment is priced in.  My expectations for growth remain resilient, although the risks for disappointment are elevated. I favour risky assets are but with limited upside potential due to this backdrop.”

In the Eurozone, economic momentum has been improving despite tight monetary policy, a softer global economic environment, and numerous geopolitically-induced economic headwinds. While the eurozone labour market appears to have softened somewhat, real wage growth has improved as inflation has fallen appreciably lower. 

Growth in the eurozone has been weaker than in the US, while disinflationary progress has been more substantial. With inflation close to central bank targets, the European Central Bank (ECB) introduced its first cut at its June meeting, with more likely to follow but at an uncertain pace. This could also support growth going forward. Overall, the near-term European growth outlook has seen a modest pick-up, and growth should gradually return to trend rates over the remainder of this year. 

The United Kingdom should perform similarly to the eurozone but on a delayed timeline and with less near-term monetary policy easing. Activity has recently been improving, reflecting a tepid recovery as forward measures have been picking up. The Bank of England (BOE) is expected to cut rates at least once before the end of the year as activity remains soft, but high inflation remains a challenging backdrop that is likely to limit further easing.

The Outlook expects a rebound in economic activities in Japan, supported by wage increases, improved manufacturing output and fiscal stimulus.  The latest spring wage negotiations indicated a significantly higher pace of wage growth versus recent history, which should help support consumption growth and lend support to continued normalization of inflation.

With inflation moderately stronger, the Bank of Japan (BOJ) will likely implement at least one additional rate hike by end-2024 and possibly initiate quantitative tightening as it is likely to see a higher probability of sustained 2% inflation.

These factors are likely to spur global investors to raise their allocations to Japanese equities, helping to bring about a potential outperformance of Japanese stocks versus other developed markets. The weakness in the yen may continue in the short run, although policy easing by the Fed and tightening by the BOJ could mitigate the weakness in yen toward the end of this year.

An improving economic environment is expected in China, where there is ample room for positive surprises. Growth appears to be strengthening, helped by factors such as a recovery in exports and fiscal policy support.

Property market-related problems — including further decreases in property investment, lower consumer sentiment, and a decrease in local government funding — pose significant challenges to economic growth.  The economy has been supported by an improvement in external factors, as indicated by recent export growth.  Market sentiment is likely overly pessimistic, indicating a higher probability of growth surprises versus consensus expectations.

Outside of China, Emerging Markets (EM) have faced a challenging global economic backdrop. Arguably, they’ve been hit harder than major economies by the wartime global commodity price shock, high inflation, and rapidly tightening global monetary policy. The Fed’s pivot back to a high-for-longer stance on interest rates, as well as a stronger dollar, have posed a challenge for many emerging markets.

Nonetheless, EMs should experience relatively resilient growth amid resolute efforts to bring inflation down. Once Fed rate cuts materialize, lower rates and a weaker dollar should provide support to EM assets. 

Kristina added: “There is indeed a striking divergence in both macro and growth performance across EM countries, which include some compelling turnaround stories among several important EM fallen angels. Accordingly, we argue for an active approach to EM to help capitalize on differences in fundamental macro features and country stories across the EM space, instead of a binary overweight/underweight passive style.”

Investment Implications

Given the positive macro backdrop, the Outlook favours an overweight to risky assets, albeit with a need to keep risks controlled as very tight valuations limit the upside for risky assets. 

Within equities, cyclical and small caps are favoured, given relatively attractive valuations and greater sensitivity to the economic cycle, as well as developed ex-US and emerging markets equities. 

Bonds offer attractive opportunities, especially for longer holding periods despite yields sitting near their highest levels in decades.  Strong fundamentals underpin many fixed income assets, helping to explain extremely tight credit spreads in both investment grade and high yield credit. Some credit risk is favoured to take advantage of this resilient and improving growth backdrop. The diversification properties of bank loans are also attractive; given the near-zero duration, we expect them to be relatively immune to interest rate volatility. Strong performance from emerging markets local and hard currency bonds is also anticipated. 

Opportunities also exist in real estate. Significant negative sentiment is likely already reflected in prices, and there could be meaningful upside potential as the environment improves. For example, cuts in policy rates provide scope for reductions in real estate debt costs and capitalization rates, which could lead to renewed transaction activity and progress toward price recovery. 

Among major currencies, the US dollar should begin to weaken this year as the Fed begins to cut rates, which would favour currencies such as the euro, the pound and the Brazilian real.

Alternative scenarios

Since the start of the year, growth has remained considerably more resilient and inflation more stubborn than anticipated. The degree of divergence across economies has increased, with inflation taking different paths in major economies.

A "hard landing" could still occur, where the lagged impact of an already-committed policy mistake begins to appear and proves to be too much for the US economy to handle. In this event, expect considerably weaker growth and sooner policy easing.  Alternatively, persistent inflation could require policymakers to keep rates higher for longer, resulting in a greater economic effect than currently anticipated. 

In such a “hard landing" scenario, assets such as cash, defensive equities (such as consumer staples, health care, utilities), long-duration sovereign bonds and currencies such as the Swiss franc and Japanese yen are favoured.

Conversely, an upside scenario for the US is also a possibility, in which already-realized cooling on the demand side helps lower inflation pressures. This would enable the Fed to ease sooner and more, with a likely weaker dollar and a favourable bias for risky and non-US assets.

In this “soft landing” scenario, the US economy would be presently in (or even exiting) a midcycle slowdown and would reaccelerate in the second half of 2024. Outside the US, surplus economies like the eurozone as well as twin-deficit emerging markets would benefit. 

-ENDS-

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