November Barometer of financial markets outlook

Our stance is influenced partly by our business cycle indicators, which paint an encouraging picture for the world’s two largest economies.

In the US, economic conditions remain healthy, as evidenced by recent data showing GDP grew at a robust 2.8 per cent annualised pace in the third quarter. The engine powering the US continues to be consumer spending, which is proving more sustainable than we had envisaged earlier in the year.

Although we expect US GDP growth to slow over the coming months, we see a gentle decline that will be accompanied by a steady fall in inflation. Put differently, the stars appear to be aligning for a ‘soft landing’: a scenario that sees the US avoiding a recession and inflation falling at a pace that allows the Fed to reduce borrowing costs further in the coming months.

China, meanwhile, looks to have moved onto a more stable economic footing. With the Fed having cut interest rates in September, Chinese authorities were able to set in motion a large monetary stimulus plan amounting to some RMB2 trillion, or 1.6 per cent of GDP, to shore up an economy flirting with debt deflation. But we believe this is just one part of the recovery plan China’s government has in mind. In the coming months we expect a fiscal stimulus package of a similar magnitude, or some 1.5 per cent of GDP, which could be transformative for China’s near term economic prospects, as well as those for emerging economies more broadly. The fiscal package would, to some extent, counter any increase in US tariffs on Chinese goods exports.

Conditions in Europe are less favourable, however. The outlook for both consumer spending and industrial activity remains weak, which suggests the European Central Bank (ECB) will need to cut interest rates aggressively, by more, potentially, than the market currently discounts. 

Our liquidity gauges indicate conditions are broadly positive for riskier asset classes. With some two thirds of the world’s major central banks now cutting interest rates, and China having recently added to the supply of monetary stimulus, it would appear that stocks’ price-earnings multiples can hold at current levels if not inch a bit higher.

That doesn’t necessarily apply to stocks in Europe, however. Here, the credit squeeze resulting from continued quantitative tightening from the ECB could soon worsen once France and Germany begin implementing the sharp public spending cuts they have recently committed to.

The valuation metrics we monitor show that equities have in aggregate become more expensive. The recent rallies enjoyed by Chinese and emerging market stocks mean both look less compelling on valuation grounds. Even so, they remain among the cheapest equity markets on our scorecard. In fixed income and currency markets, meanwhile, European bonds now look very expensive, as does the US dollar.

Recent technical developments support our overweight position in equities. Seasonal factors are positive as stocks tend to do well heading into the year end, while investment inflows into equities among private investors are healthy; share buybacks, meanwhile, can be expected to remain strong.

A Trump win would also be good for US equities, which already benefit from the most positive corporate earnings expectations of all major equity markets (see Fig. 3). He’s likely to push for further tax cuts, though they probably won’t be as sizeable as the previous time round. And with consumer balance sheets remaining healthy, companies are likely to sustain their profit margins, even if some of Trump’s anti-immigration and anti-trade measures push up costs. However, a win by the Democrats wouldn’t necessarily be bad for the equity market, either. 

On sectors, we maintain our barbell strategy with an overweight in both the more cylical financials sector and defensive utilities. Financial companies are benefiting from solid net income margins, low default rates and an expected improvement in loan demand. And adjusted for earnings growth, banks remain the cheapest among global industry sectors. Utilities companies, meanwhile, have the best momentum among defensive sectors and they have an attractive dividend yield of some 4 per cent. 

Elsewhere, we downgrade Japanese equities to neutral from overweight on an increase in political risk. The country’s recent snap election saw the powerful Liberal Democratic Party (LDP) lose control of the lower house of parliament and the dominance it’s held over national politics since the mid-1950s. Valuations for the market are neutral after its outperformance of the past few years while monetary policy is tightening and economic growth momentum remains weak. We also doubt that the yen can weaken much more from here – removing a vital support for local stocks.

However, we continue to use gold as a hedge against inflation and any politically-driven instability a Trump victory might generate. That’s notwithstanding the precious metal’s storming performance this year, which might otherwise be a temptation to take profits.

While a growing number of commentators have expressed concern about corporate bond valuations, we are more sanguine and so remain neutral on European and US credit, both high yield and investment grade. Despite tight credit spreads, company balance sheets are healthy – as are those of consumers, particularly in the US – and default rates are low and falling. Research shows that expected returns on credit are highly correlated with yield, allowing investors to overlook default rates, even in the high yield market.

Meanwhile, we remain overweight emerging market debt, with a preference for local currency debt. China’s stimulus should be supportive of other emerging economies, particularly in the region, especially if China’s imports rise in line with GDP growth and external tourism picks up – it’s still only 60 per cent of pre-Covid levels. EM currencies look cheap and EM real rates, especially in Latin America, are very attractive.

In sovereign debt, we remain neutral most developed government bonds. The picture is slightly muddled for US Treasury bonds: solid growth and the rising probability of a Trump sweep are clear negatives, but the recent rise in term premia – the risk component of bond returns – and the significant reduction in implied Fed rate cuts till end of 2025 are important offests. Net-net that doesn’t give a strong signal in either direction, while valuation suggests the bonds are broadly fair value after yields moved sharply higher over recent weeks reflecting the strength of the economy and Trump’s strength in the polls (see Fig. 4).

US equity markets fell but overall fared better than Europe thanks to healthy earnings dynamics. Of the S&P 500 companies that have already reported third quarter results, 77 per cent have beaten analysts’ earnings forecasts, according to LSEG I/B/E/S data.

Positive earnings surprises came from financial and communications services, which were two best performing sectors in October. Financials also benefited from expectations of less stringent regulation in the event of a Trump election victory.

In bond markets, UK gilts lost some 3 per cent in October, in local currency terms, as investors braced for bumper government debt issuance to help finance increased public spending on health and education.

Yields on 10-year Treasuries hit their highest levels since mid-July, as a run of positive data from the US consumer sector prompted a scaling back in expectations of future rate cuts. This was also good news for the US dollar, which set three-month highs versus a basket of currencies.

Gold gained 4.1 per cent, cashing in on its status as a defensive, safe haven asset. Oil, meanwhile, added 1.7 per cent in the face of tensions in the Middle East.

^{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.}