2024 midyear investment outlook: opportunities amidst divergence

The global economy is in a soft patch. But, despite widespread expectations of a global economic slowdown in 2024, growth and inflation have performed above expectations across most major economies. Divergence has re-emerged as a theme, with individual economies likely to see various growth and inflation experiences going forward.

We believe demand-side resilience has delayed the disinflation narrative across major western economies, particularly in the US. We continue to anticipate falling inflation over the forecast horizon across most economies. Disinflation is likely to happen more quickly in non-US developed market economies. This trajectory may only elicit marginal rate cuts from major developed market central banks though.

The pass-through effect from central bank policy tightening has taken longer than expected and is being felt most at the margins. This includes a modest increase in credit card balances and rising delinquencies in the US.

Eurozone: economic growth bounces back; we expect interest rate cuts soon

The eurozone economy has diverged from the US in some significant ways. Over the last several years, US growth has been stronger than eurozone growth. Recently though, eurozone economic momentum has been improving relative to the US, despite numerous geopolitically induced economic headwinds - including the Russia-Ukraine war.

Now, we’re seeing a substantial pick-up in positive economic surprises. And while there had been significant divergence in economic activity between northern and southern Europe (with the South outperforming), recently we have seen improvement in northern Europe – particularly Germany. Forward-looking indicators suggest a continued pick-up in growth towards trend rates.

Recently, we’ve also seen more disinflationary progress in the eurozone relative to the US. Core inflation has moved closer to target. Services inflation, while still elevated, has moderated. The eurozone labour market has loosened somewhat. Consumer inflation expectations have moderated as well and can be considered well-anchored.

With inflation close to central bank targets, the European Central Bank (ECB) has started loosening policy and made its first interest rate cut. Gradual easing is likely to follow.

We anticipate that the start of interest rate cuts in the eurozone will support the growth pick-up. Overall, our near-term European outlook anticipates a modest acceleration in growth. This will be helped by rising real wages, with a return to trend growth gradually over the rest of this year.

When it comes to emerging market (EM) Europe, we see a continued reduction of high inflation levels. We believe economic growth will be below-trend (but improving) and will be higher than in developed markets.

The UK: growth less abundant, but economic activity on the up

In the UK, we expect the economic trajectory to be similar the Eurozone but with more muted growth given its country-specific headwinds, like the lingering effects of Brexit. Economic activity has been improving recently, reflecting a modest recovery as forward measures have been picking up. Inflation has also been improving, but to a lesser extent than what has been seen in the Eurozone.

It looks like the Bank of England will begin to cut rates later than the ECB, but we still expected it to cut interest rates at least once before the end of the year. High wage and services inflation remains a challenging backdrop that could limit further easing.

Investment implications: silver linings for risk assets, bonds and private credit

The UK stock market has a substantial weighting in resource-related stocks (energy and metals and mining) and we expect it to benefit from the strength in commodity prices. 

There’s a general election in the UK on 4 July 2024. While this could bring uncertainty, it could support the stock market and sterling if a sense of optimism takes hold in the same way it did in 1997 (when there was last a switch from a longstanding Conservative government to Labour).

European and UK companies have substantially increased their stock buybacks, which could provide another tailwind for European and UK equity markets.

Strong fundamentals underpin many fixed income assets, helping to explain extremely tight credit spreads in both investment grade and high yield credit. To take advantage of the resilient and improving growth backdrop, we favour some credit risk to take advantage of this environment. Interestingly, European high yield markets appear less stretched than their US counterpart (judging by spreads). We also see relative value in European investment grade.

We also like the diversification properties of European bank loans, which tend to have similar volatility to investment grade credit but with greater return potential (in our opinion) due to the high current yield. With near-zero duration, loans have also been relatively immune to recent interest rate volatility compared to other fixed income asset classes.

We also anticipate strong performance from EM European equity and sovereign debt. We also look favourably upon European real estate, where we believe that significant negative sentiment is already reflected in the price, and there is meaningful upside potential as the environment improves.