October Barometer of financial markets outlook

Our business cycle analysis points to some deceleration in global economic activity.

The US economy is beginning to show signs of a slowdown after a period of exceptional resilience where it recorded above-potential growth in seven out of the last eight quarters.

In the coming months, consumption – which represents well over half of US GDP – should ease, especially in services, which will lead to a broader slowdown.

Conditions in the labour market – now the Fed’s main focus – are consistent with a GDP growth rate of some 2 per cent annualised, which is around the long-term potential. 

We see the European economy weakening further. Falling energy prices have failed to encourage more investment. Net exports – so far an engine of growth – are now at risk as China, a major destination for European goods and services, struggles to recover. We are more positive on the UK, which is benefiting from a strong services and industrial sector. The Bank of England is expected to cut interest rates twice this year, which should brighten economic prospects further. 

Japan is the only major developed economy that we expect to grow above trend in 2025, thanks largely to buoyant consumption. This will allow the Bank of Japan to continue to tighten monetary policy.

In the emerging world, China’s growth remains anaemic with third-quarter GDP seen at 0.4 per cent on an annualised basis, in stark contrast to the 4-5 per cent clip seen in the first two quarters of this year. The People’s Bank of China’s latest, bigger-than-expected monetary easing package should improve sentiment more effectively if it is accompanied by equally muscular fiscal measures.

However, economic activity in the rest of emerging markets is encouraging. Developing countries should capitalise on a recovery in global trade as the region is twice as sensitive to a pick up in world trade growth than developed economies.

Our liquidity indicators support being overweight equity. With central banks in countries accounting for more than two thirds of world GDP now cutting interest rates, monetary conditions are loosening in a way that should underpin riskier asset classes. 

We expect the Fed to reduce interest rates five more times – a considerable easing but fewer cuts than the market is currently pricing in. We expect the European Central Bank to catch up with  its counterparts and cut interest rates at every meeting to reach a terminal rate of 2 per cent.

Our valuation models show bonds are becoming very expensive. The likelihood of a soft landing for the US economy make the pace of easing currently priced by the market too aggressive. Equities remain expensive, but their valuations are not in bubble territory.

Our technical indicator shows equities are likely to be supported into end-2024 thanks to seasonality, the tendency for stocks  to perform well in the final few months of the year.

Momentum is also positive, with the US attracting the bulk of equity portfolio inflows. Japanese equities also saw good inflows but primarily from domestic investors as foreigners cut their holdings.

In fixed income, emerging hard currency bonds started to attract flows as the Fed cut interest rates.

Notwithstanding Beijing’s latest efforts to lift the country out of its economic malaise with a number of fiscal and monetary measures, we prefer the rest of emerging markets to China. For one thing, China’s problems run deep and need structural change rather than the sort of short-term fixes being offered.  While domestic equities have reacted strongly to recent monetary measures, the sustainability of the rally depends on the implementation and follow-through from the authorities. Furthermore, going into the home stretch of the US election cycle we avoid adding exposure to assets most directly impacted by increased tariffs and trade uncertainty.

In developed markets, we remain overweight Japanese stocks. Japan's corporate earnings are showing better momentum than elsewhere and its stock market remains attractively valued. What is more, improvements in corporate governance changes should enhance return on equity. Any further yen appreciation, meanwhile, is likely to be moderate, which should limit currency risks both for firms and investors. Next year, the Japanese economy is expected to grow some 1.4 per cent, double its potential.  

We maintain exposure to Swiss stocks - the market is rich wtih companies trading at very attractive valuations and offering stable earnings; we are also attracted by the market’s defensive qualities: it offers a hedge against our central scenario of a soft-landing.

Separately, we downgrade communication services to neutral from overweight. The sector has outperformed the rest of the market by 23 percentage points, year to date, powered by US tech firms. But the  rally now risks running out of steam.  Corporate earnings are no longer a tailwind, valuations are neutral at best, and technicals have turned negative. We remain overweight financials, which we expect to benefit from a steeper yield curve as the Fed cuts rates further, and hopes of  deregulation. Bank earnings are also strong. We remain overweight utilities, which we value for their defensive characteristics, stable earnings and attractive valuations. We remain underweight real estate - although the sector should eventually benefit from lower interest rates, it remains expensive and demand for office buildings has yet to rebound.

In the currency markets, we are neutral on the dollar versus almost all major developed market currencies as a closely-fought US election clouds the near-term outlook for the greenback.

One exception is the euro, which we downgrade to underweight in the face of a marked slowdown in the currency bloc’s economic momentum (next year, we now expect growth of just 1.3 per cent, down from 1.5 per cent a month ago). The ECB has remained hawkish even as it has cut interest rates. But we believe the central bank will soon turn dovish as inflation continues to ease resulting in further rate cuts that could place downward pressure on the euro.

We retain our overweight in gold, which continues to set new record highs despite increasingly stretched valuations and positioning (with net longs now at their highest since 2017). Rate cuts from the Fed – as well as the ECB and the Bank of England – reduce the opportunity cost of holding a non-yielding asset like gold, serving as a catalyst for a pickup in financial demand through ETF flows. While gold appears tactically overbought, we'd use any pullback to add to our strategic allocation.

Within sectors, consumer discretionary stocks gained 7 per cent on the month, boosted by a more benign outlook for the global economy. Energy stocks, on the other hand, slumped 3.5 per cent as oil prices continued to fall, in part on strong inventories data – oil is down more than 7 per cent on the year so far.

The monetary measures on both sides of the Pacific were good news for bonds as well. Global bonds were up some 1 per cent on the month, with emerging market local currency bonds doing particularly well, gaining more than 3 per cent, while emerging markets hard currency bonds are now up by just above 8.5 per cent on the year. Corporate debt rose across the board, emerging and developed, high yield and investment grade, gaining between 1 and 1.7 per cent on the month.

Currencies picked up ground against the dollar, which lost almost 1 per cent on the month, with non-oil commodity currencies like the Brazilian real and Australian dollar doing particularly well. Gold prices picked up another 5 per cent to register a 27.5 per cent gain on the year so far.

^{Information, opinions and estimates contained in this document reflect a judgement at the original date of publication and are subject to risks and uncertainties that could cause actual results to differ materially from those presented herein.}