The News and Our Views

Erik L. Knutzen, CFA, CAIA, Chief Investment Officer—Multi-Asset

January was packed with news—and much of it supported our views for the year ahead.

January proved to be an eventful start to 2024.

The decline in bond yields and policy rate expectations that closed 2023 underwent a sharp reversal, but that failed to dampen sentiment in equity markets. The situation in the Middle East grew still more precarious. China’s real estate crisis returned to the headlines—and so did the stresses within U.S. regional banks. Through it all, U.S. and European growth proved resilient and inflation continued to cool.

We think the past month confirmed many themes in our first-quarter Asset Allocation Committee Outlook. Following a frenetic week or two of key data releases and events, we offer a catch-up on where things stand and how they relate to our current views.

Soft Landing Outlook

Through late 2023, lower market expectations for the path of central bank policy rates tended to correlate with higher levels in equity markets, and vice versa.

January broke that trend. Last week the S&P 500 Index breached 4,900 for the first time and the STOXX Europe 600 surged back toward its own all-time high. Meanwhile, a March rate cut from the U.S. Federal Reserve has gone from fully priced in at the end of last year to less than 20% following Friday’s U.S. payrolls release.

That may be because economic data increasingly suggest a soft landing, and investors have begun to focus on the growth outlook rather than the inflation threat.

Over the past 11 days, the International Monetary Fund raised its global growth forecast for 2024, U.S. fourth-quarter GDP growth smashed economists’ expectations, the U.S. Manufacturing Purchasing Managers’ Index, payrolls and job openings all surprised on the upside, the Conference Board’s U.S. Consumer Confidence Index reached a two-year high, and we found out that even the sluggish eurozone had avoided recession. At the same time, key U.S. and eurozone inflation indicators were shown to be edging back to target.

Central Bank News

On top of all these economic data and forecasts, we’ve heard the latest from the major central banks.

The pullback in Fed rate-cut expectations was amplified by Fed Chairman Jerome Powell’s cautious messaging on Wednesday, which strongly suggested that the central bank would not be confident enough to cut in March. The Bank of England delivered a similar message the following day.

Market participants interpreted the European Central Bank’s latest messaging more dovishly, moving to price for an April rate cut. After several months in which the ECB has generally been regarded as more hawkish than the Fed, this month perhaps marks the start of convergence.

Meanwhile, the Bank of Japan’s latest Summary of Opinions included discussions about ending its eight-year period of negative rates.

The First ‘Risk-Off’ Day of 2024

Last week also gave us two reminders of the critical importance of the path of rates.

The first came from the U.S. Treasury, which lowered its borrowing estimates for the first half of the year substantially more than investors had anticipated. As concerns over government debt sustainability have grown, these announcements have becoming increasingly market-moving; like last November’s, this one was met with some relief.

Less happily, shares in New York Community Bancorp, which bought the failed Signature Bank last year, opened almost 50% down on Wednesday as it reported big expected losses on commercial real estate loans. Hours later, Japan’s Aozora Bank took a hit when it, too, reported losses on U.S. commercial property.

The combination of Fed caution and renewed concerns about U.S. real estate and banks made the last day of January the first genuinely “risk-off” day of 2024.

Tech Earnings, China and the Middle East

As if all that were not enough, last week brought some other major U.S. earnings reports, financial headlines out of China and a ratcheting up in Middle East tensions.

Microsoft, Alphabet, Apple, Amazon and Meta—a quarter of the S&P 500 Index—all reported. Microsoft, Alphabet and Apple narrowly beat analysts’ expectations, but their results were still greeted skeptically by investors: a reminder that when stocks are priced to perfection, even the smallest disappointment can trigger substantial price drops. Amazon and Meta fared better, although investors appeared to be most impressed by cost-cutting and capital discipline, especially Meta’s ramped-up share buybacks and first-ever dividend.

There was heightened volatility in China’s markets as troubled real estate firm Evergrande was hit with a liquidation order. As the authorities rolled out market support, the Chinese 10-year yield fell to a multidecade low.

And finally, attacks on commercial shipping and U.S. military personnel in the Middle East pushed up shipping prices, oil prices and tensions between the U.S. and Iran.

The News and Our Views

In our first-quarter Asset Allocation Committee Outlook, we anticipated a background of slowing but resilient nominal growth, declining inflation and gradually more accommodative monetary policy.

The potential for a soft economic landing and the prospect of loosening financial conditions led us to unwind our overweight view on cash in favor of short to intermediate investment grade credit, in particular. It is looking increasingly likely that the run-up in January, from the December lows, will prove to have been a good time to lock in yields.

Geopolitical tensions and the risk of a harder slowdown kept us neutral on equities overall, and full valuations made us cautious on U.S. large caps, but we are seeking opportunity in other, more reasonably valued parts of the market, especially smaller companies and Japan. We also expressed caution on China in our views on emerging markets. Japan’s market has had its best start to a year in living memory, while the mixed results from five of the “Magnificent Seven” stocks may see our equity views further justified over the coming weeks.

Finally, we reinstated our overweight view on commodities, partly as a hedge against an uptick in geopolitical risk.

In financial markets, it is often said that January sets the tone for the whole of the year ahead. Historical reality doesn’t match the claim, but, in our view, the first four weeks of 2024 have given a lot of support to our six- to 18-month outlook.