In an ever-changing investment landscape, perspective is power

Monthly Investment Update

U.S. Faces Rising Recession Odds   

In its latest projections, the International Monetary Fund (IMF) revised up global economic growth forecast to 3.2% for 2024 and 2025. Economic growth projection for 2024 was revised up by 30bps relative to October’s forecast. Regardless, projections for global growth in 2024 and 2025 remain below the historical (2000–2019) annual average of 3.8%, underscoring impacts from restrictive monetary policies, withdrawal of fiscal support, as well as low underlying productivity growth. For developed economies, growth is projected to rise from 1.6% in 2023 to 1.7% in 2024 and 1.8% in 2025, marking an upward revision of 20bps for 2024. For emerging and developing economies, growth is expected to remain stable at 4.2% in both 2024 and 2025, with a moderation expected in emerging and developing Asia. Geopolitics and ability of global central banks to manage a “soft-landing” will be key determinants to this and next year’s global GDP growth.

FED Chair Jerome Powell conceded at the Jackson Hole Symposium that the balance of risk has shifted to the labor market side of the FED’s dual mandate. Unemployment unexpectedly rose to 4.3% having already exceeded the FOMC’s 2026 median forecast and longer-run projections. Moreover, the move up has triggered the “Sham Rule” as the three-month average unemployment rate rose more than 50bps above the 3.6% trough in preceding 12 months. Historically, the Sham Rule had a perfect track record in predicting U.S. recessions since the 1960s. Market expects a minimum of 75bps in rate cuts by end-2024 for total of 200bps of cuts by this time next year. U.S.’ July CPI rose 2.9%YoY (year-over-year) and although shelter cost ran hot at 5.4%YoY, the totality of the data provided the necessary confidence that inflation will soon deaccelerate towards FED’s 2% target. This clears the way for the FED to start cutting interest rate back to neutral starting September.

The Conference Board projects U.S. consumers and businesses are prone curb spending and investments, suggesting real economic growth may decelerate to 0.6% annualized rate in Q324 and 1% annualized rate in Q424. Credit card and auto loan transitions into delinquencies are still rising above pre-pandemic levels, with percentage of balance at least 30 days past due currently at the highest level since 2011. “Our plan is not to wait for things to break and then try to fix them”, FED Chair Powell stated during the press conference post-June FOMC meeting. The window for implementing first rate cut without “breaking” the U.S. economy is rapidly narrowing. Over the past month U.S. Treasury yields shifted lower across the curve as investors piled into fixed income funds across all duration. Fears of a U.S. recession is rising with most market participants assigning a 30-35% probability of a recession over next 12 months. However, as real interest rates are currently elevated the FED is well-equipped to manage any economic slowdown without triggering another bout of inflation.

The ECB may lower interest rate for the second time in September as core inflation stagnated at 2.9%YoY for the past three months after holding rate steady in July. The BOE delivered first 25bps rate cut of the cycle lowering policy rate down to 5%. BOE Governor, Andrew Bailey, stated inflationary pressures had “eased enough” to enable first interest rate cut. U.K’s economy has grown faster than anticipated in recent months, exiting recession post Q124 with GDP growth of 0.7%QoQ (quarter-on-quarter), double the levels recorded in France and Germany. Japan’s economy expanded by a much faster-than-expected annualized 3.1% in the Q224 backed by consumption and real wage growth. BOJ is treading carefully between trying to avoid excessive upward pressure on the JPY and controlling inflation. Dissatisfaction with costs of living has resulted in PM Fumio Kishida announcing his resignation. China’s economy continues to recover albeit gradually with 1H24 GDP growth 5%YoY in line with the state’s target. India’s 2024 GDP forecasts were downgraded to sub-7% due mainly to the contraction in government spending after a robust 8.2% growth last year.

Global Equity

To-date 93% of the companies in the S&P500 have reported earnings Q224. 79% managed to report above estimates EPS growth. Blended YoY EPS growth is 10.9% thus far with the technology sector having reported the highest EPS growth of 18.9%YoY. Although there were chatters that Q424 EPS forecasts may see downward revisions given the dampened U.S. macro outlook, full-year EPS forecasts remained steady at 10.1%YoY. Profit margins remained robust for constituents at 12.2%, which is higher than Q223 net profit margin of 11.6%. S&P500 trailing-twelve-months (TTM) P/E stands at 25.5x far above 10YR average of 21.1x. Forward P/E is also elevated at 21x relative to 10YR average of 17.9x.

Four of the companies in the Mag 7 comprising of NVIDIA, Amazon.com, Meta Platforms and Alphabet are projected to be among the top five contributors to YoY earnings growth for the S&P500 in Q224.  Once again, tech sector earnings will determine market direction and but may also add fuel to the current market broadening. However, markets are punishing companies that have reported negative earnings surprises in Q224 more severely with an average price decrease of -3.8% two days before the earnings release through two days after, a reflection of lofty valuations and heightened investors’ expectations. Presidential candidate Kamala Harris’ plan to raise U.S. corporate tax rate from 21% to 28% is a key risk to FY25 EPS forecasts.

NIKKEI225 saw selling pressure following the selloff in U.S. tech names during early August but has quickly recovered bolstered by strong Q224 GDP numbers. BOJ is set to weigh financial stability before embarking on further policy tightening.  Indian equities saw selling pressures of nearly USD1 billion in the two days following tax increases on derivatives trades and equity investment gains as foreign investors sold back in July. However, market recovery faced another setback as the SEBI chief was accused of a conflict of interest with the Adani Group. 

China Equity

Much of the good news in manufacturing comes from China’s “new three” industries: EVs, solar panels and batteries. Regardless, the CCP’s Third Plenum did not deliver any positive policy surprises which disappointed investors. This was somewhat offset by a 20bps cut in the 1YR LPR to 2.3% by the PBOC, the largest easing since 2020. Subsequently, China's government bond yields declined to an all-time low following the surprised rate cuts in July. New yuan loans in China plunged by 88%YoY to RMB260 billion in July, the lowest level in 15 years, signaling ongoing weak credit demand and sluggish domestic consumer spending. Consumption remains benign despite large excess consumers’ savings as asset prices continue to deflate.

However, low market expectations coupled with compelling valuations may result in upside surprises during H2 2024 should economic recovery picks up steam. HSI Index currently trades at 9.6x P/E below 10YR average with EPS growth forecast of 7.19%YoY and 6.7%YoY for 2024 and 2025, respectively. The mainland CSI300 Index saw slight downward EPS revisions to nevertheless decent 11.56%YoY and 12.83%YoY for 2024 and 2025, respectively. However, the property sector remains a major drag. China's new home prices in June fell 4.5%YoY, the fastest pace in nine years as property sales and investment slumped, increasing pressure on policymakers for more stimulus to prop up the sector as it struggles to find a floor. However, pre-owned homes in major cities such as Beijing and Shanghai are experiencing price gains for the first time in 2024, a positive sign.

Alternative Assets

REITs performance continues to disappoint YTD but this is quickly changing. The FED is guiding markets toward the first rate cut in September. REITs and infrastructure assets will benefit from larger investors’ allocation as Treasury yields are expected to see continued pressure across the curve from FED’s loosening pivot. As part of income investment strategies, investors will need to seek out income producing assets beyond risk-free to meet desired returns inevitably benefiting interest rate sensitive assets with stable cash flows. Gradual accumulation of REITs and infrastructure assets for income seeking investors is prudent at this juncture as total returns are set to improve significantly over next 12m.

Market is increasingly cognizant of the risks posed by the Israel-Hamas conflict which have expanded to include Iran, Pakistan, Lebanon, Syria and Iraq. Disruption to cargo and energy transportation in the Strait of Hormuz, Red Sea and Suez Canal could potentially put global economy in dire straits. Crude prices volatility has yet to translate into a sustained upward pressure on CPIs and have eased over past month as demand worries mount. Moreover, market expects a quick peace deal in both the Middle East and Ukraine should former President Trump is reelected as well as more oil and gas drilling activity in the U.S., a negative for oil prices.

Equity remains a compelling asset class with multiple compelling investment opportunities across the globe. For H224, the focus should be placed on quality stocks with reasonable valuations, REITs, infrastructure assets and investments that benefit from lower risk premiums such as small caps and emerging market equities. Momentum is finally giving way to fundamentals.  It is feasible to gradually add duration to fixed income portfolios in anticipation of lower policy interest rate across developed markets. We recommend investors to invest with a portfolio-based approach through a combination of strategic and tactical asset allocation (SAA and TAA) to optimize risk-reward under all scenarios.

Arun Pawa, IP, FM, IA, Investment Strategist 

CIMB Thai Bank (CIMBT)