3Q 2024 Strategic Investment Outlook

What You Need to Know

Our latest quarterly note considers the interaction of tactical and strategic views. One complication for investors is that there has been a significant muddying of the waters between cyclical and structural inflation, even though the forces at work have been very different.

We think it is easier to form a strategic market outlook than a tactical one at this stage, but one has to have an explicit view—our tactical view is that the equity market will be higher at year end, albeit with a lot more volatility than we have seen of late. It should be noted though that the US election now appears less close with the probability of a Trump win now distinctly higher.

It is simply too painful for investors to stand in the way of the growth-momentum trade, but even within that context, investors also need to have value-like positions as part of a prudential allocation. We highlight the Energy sector and post-election UK as two examples of this positioning.

So far, 2024 has witnessed very significant shifts in investor expectations. The point of this note is to consider what this means for portfolio allocations—especially where tactical views impact longer-term strategic positioning.

The lack of concern about equity valuation that we encounter is concerning. However, despite strong inflows, other metrics of sentiment are not indicating an overextension. We acknowledge that doubts about such sentiment metrics will be legion when performance is so concentrated. It is probably easier to express a medium- to long-term view than a tactical one at this stage. That longer-term view is positive for global equities and we are long-term overweight, but with the major caveat that we expect those returns to be muted compared with recent and long-run history. Valuations, strong inflows and the observation that (weighted) momentum factors are now above all previous peaks mean that volatility should be tactically higher than we have seen recently. The tactical view is much harder to form, but our view is that the equity market will be up, not down, from now until the end of the year—albeit with a lower return and significantly higher realized volatility.

The latest events around the US election including the attempted assassination of Trump have had a perhaps surprisingly muted impact on markets, but we think there is a logic to it. As far as betting markets are concerned at least, the US election is no longer a close race. Trump was already priced as the most likely candidate to win and over last weekend the odds moved even more in his favor. Given Trump is seen at the margin as being more friendly for equities (potential for cutting of regulation and marginally looser fiscal policy) this has been reflected in slightly higher equity expectations. We have made the point before that European risk assets probably lose out in a Trump presidency (increased trade tension while defense spending needs to rise more quickly).

We have gone from an expectation of six Federal Reserve rate cuts at the beginning of the year to one now (and also a non-zero probability of a rate increase), which has been offset by the avoidance of a recession. The equity market has seemingly not cared about the nuances of this dynamic, rallying through it. It is not totally obvious that the extra earnings make up for the discount rate not being as low as was expected, yet investors seem sanguine about this. In our client conversations, they seem less concerned about equity market valuations now than they were six months ago. The concentration of market leadership makes this situation even more challenging: Are historical metrics of sentiment even valid in a market where a handful of stocks are what has really mattered? What are investors to make of all this?

We suggest a few angles that are important for portfolio allocation:

• The interplay of cyclical and structural inflation is now even more muddied. 
• What is the case for equities now? How does the tailwind of a “no-landing” scenario stack up against the loss of support from potential rate cuts?
• Large buying of US equities (by both investors and corporations) implies that we are back to the “TINA” (There Is No Alternative) narrative again. 
• We think the recent evolution (higher valuations and inflation), further embeds the view that investors should expect lower strategic returns, especially in real terms (the only terms that count!), as well as higher realized volatility.
• Stock-bond correlation has remained positive, highlighting the need to seek diversification elsewhere.
• The US, UK and French elections all have very different implications for markets. The US faces possibly the most consequential election in years. The surprise French election result, while likely a relief for investors, points to a period of uncertainty. The UK, meanwhile, has moved from a period of somewhat chaotic politics to a potentially more stable state.
• Tactically it is too hard to stand against the growth-momentum trade. Even if it looks extended, taking an opposing tactical position is too painful. Having said that, investors also need value trades in place in the interest of prudence. We suggest two value examples in this note. One is the UK, to some degree the most-hated equity market. That election is almost the opposite of the one in the US, in that we think it is almost inconsequential, given the closeness of fiscal positions laid out before the vote. But it might possibly be a catalyst. The other value trade we highlight is the energy sector. We show that the sector is buying back more than 2% of its stock per year, has been the most out of favor and offers an attractive free-cash-flow (FCF) yield in a market that is short of valuation opportunities. We discuss potential catalysts.

Additional Contributors

Harjaspreet Mand, Maureen Hughes and Robertas Stancikas