We may be approaching the point where "bad data will be bad" for risk assets.
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Focus on diversification and quality
In recent months, economic data in the U.S. has been surprisingly generally downbeat and consumers are showing some signs of fatigue (e.g. retail sales, consumer confidence, auto and credit card delinquencies), but with inflation above the Federal Reserve's (Fed) target and the economy not in crisis, the logic that "bad economic data is good data for the market" seems rather questionable to us.
Rather, we may be approaching the point where "bad data will be bad" for risk assets, with the economy potentially weakening, while inflation could remain stable and above the Fed's target. Even if the Fed were to cut rates, the long-term rate (discount rate used for risky assets) need not fall at the same pace, given the liquidity squeeze and potentially higher term premia.
There is therefore a risk that the opposite of the optimistic expectation may occur in the coming quarters: growth slows, inflation remains firm and long-term rates do not fall sharply (risk of stagflation).
We continue to believe that volatility in the long end of the rate curve will remain, amid greater fiscal pressures and high inflationary volatility that do not justify -at this stage- negative term premia. Therefore, we maintain a RF strategy with a more neutral duration (around 4 years), until we have more evidence of inflation convergence and a "friendlier" monetary and fiscal policy.
Going forward, we maintain our conviction that this year -and more so in 2025- should be positive for fixed income, with lower interest rate risks and historically attractive initial rate levels. The focus on improving quality should allow investors to build resilient portfolios without giving up upside potential.
With inflation trending lower, and with risks much more balanced or even tilted toward concerns about a more significant economic slowdown, we believe bonds will begin to exhibit more of their defensive (hedging) characteristics, we believe bonds will begin to exhibit more of their defensive (hedging) characteristics.
In equities, the outsized performance of large-cap stocks is masking weakness in other areas of the market. The Federal Reserve's early initiation of tapering and growing skepticism about the boom and the high capital expenditures of these large AI techs has led to some sector rotation out of large tech and into more interest rate sensitive sectors.
2Q24 corporate results have beaten estimates. However, despite posting year-on-year earnings per share (EPS) growth of 26% this quarter, Mag-7 shares have failed to inspire investor confidence, as prices of all stocks except Meta fell 8% on average in the 3 days following the 3 days after reporting.
The proportion of companies beating sales estimates in the U.S. has declined significantly, This, in turn, could affect margins in the second half of the year.
We are maintaining a focus on diversification and quality and a more balanced global a more balanced global strategy to address the high concentration of the U.S. market and unattractive valuations that should limit the upside. upside potential in the coming quarters.
The dismantling of the carry trade in yen, due to the Bank of Japan (BOJ) rate hike, has generated volatility in global financial markets. How much of the effects we have seen in the markets and potential impacts on financial stability may extend over time will certainly depend on the monetary policy decisions that may be taken not only by the BOJ, but also by the Federal Reserve itself. That said, all indications are that things are leaning towards the BOJ refraining from further rate hikes, since the Fed will most likely start cutting rates as of September and this could put additional pressure on the rate differentials with Japan.
If things get worse, some form of quantitative easing - coordinated by the Fed itself - can be taken to help prevent to help prevent Japanese and other investors who have fled from the carry trade from carry trade carry trades in yen from having to sell assets.
