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How central bank policy could impact your portfolio
Investment Specialist Ritu Vohora Provides a Summary
At midyear, expectations for rate cuts have been pushed out further, with far fewer anticipated, and markets have repriced accordingly. We anticipate growth in the global economy—however, while the U.S. economy remains strong, leading indicators suggest that the narrative of U.S. exceptionalism may fade. We see continued market broadening, with select equity and fixed income opportunities. Most importantly, the ongoing transition from the low rate post-global financial crisis environment to one characterized by higher interest rates may provide favorable conditions for active managers to outperform.
Key factors shaping our midyear market outlook
Higher for longer has become the consensus
Most developed market central banks are walking a tightrope amid reaccelerating inflation. The Federal Reserve is likely to make fewer cuts, while we believe the European Central Bank will cut between one and three times. We expect Japan to gradually tighten its monetary policy.
Key takeaway:
The Fed is more likely to surprise with fewer cuts than with more.
Opportunities broaden beyond the Magnificent Seven
We believe artificial intelligence will create long-term winners, but stock selection is key as performance of the mega-cap tech stocks begins to fragment. We anticipate a continued broadening of opportunities to include more companies and sectors that may have lagged in recent years. We believe that value—and possibly small-cap—stocks may begin to challenge the dominance of large-cap growth stocks.
Key takeaway:
Now may be the time to diversify into areas that have valuation support and robust fundamentals, such as value stocks.
Rising capital expenditure should benefit value sectors
In contrast to the U.S. market’s heavy exposure to growth stocks, the international market is more exposed to value-oriented sectors, including financials, materials, industrials, and energy. Supply chain diversification, infrastructure rebuild, defense spending, and the likelihood of higher energy prices should favor traditional value sectors as capital spending accelerates.
Key takeaway:
We continue to favor Japan and see select opportunities in emerging markets, such as South Korea and Vietnam.
Uncertain environment favors short duration bonds
Short-term bonds are highly valued during uncertain periods—such as the present—because they are less exposed to interest rate changes than longer-maturity bonds. They also provide the potential for higher returns than cash while being almost as liquid, which can be useful during periods of economic uncertainty.
Key takeaway:
We have a preference for short duration bonds. While credit spreads are tight, all-in yields look attractive, with the potential for price appreciation if yields move lower. Currently, we are overweight high yield and emerging market debt.
Energy stocks and commodities could help hedge against inflation
Stocks have typically dipped sharply during recessions and also weakened when inflation is at higher levels. However, energy sector stocks have historically performed quite well during periods of very high inflation. This suggests that one way to hedge against inflation risk would be to tilt portfolios toward stocks in the energy sector and other commodity-oriented equities.
Key takeaway:
Sticky inflation could inflect higher as global growth broadens. Commodity-oriented equities may offer an effective way to navigate inflation risk.
Want to Read the Full Global Market Outlook Midyear Update?
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