Rudi's View | Sep 12 2024
By Rudi Filapek-Vandyck, Editor
Global economic growth is slowing and, if forward-looking indicators can be relied upon, momentum remains poised for further weakness, possibly into the final quarter of 2024 and beyond.
How is an investor best to respond?
One strategy update that attracted a lot of attention this week stems from UBS advocating Australian banks over resources stocks. Are bank shares expensive? Yes, they are. Are resources share prices 'cheap'? Yes, they have underperformed a lot this year. But UBS clearly takes the view economic growth is not ready yet to bounce back and thus more weakness may well be in store for BHP Group ((BHP)) and its peers.
The strategy modeling at Citi, oriented more globally than UBS's ASX-centric view, draws a different conclusion which may also be guided by the fact Citi's in-house conviction remains for an economic recession to announce itself later this year in the land of Harris versus Trump.
Reduce your exposure to risk assets, is conclusion number one from the Citi modeling, which translates into reduced exposure to equities and to credit. Underneath those recommendations, however, things become a lot less straightforward, or so it seems. For starters, Citi's model advocates portfolios should move Overweight commodities, but not energy, through oversized positions in precious metals and base metals.
In terms of equities, US and UK markets are preferred, while Citi shuns Emerging Markets. There's no specific mentioning of Australia, but one can probably safely assume the ASX sits in the same basket as Hong Kong, Singapore, et cetera.
In case that economic recession does arrive, alongside rate cuts from central banks, an Overweight exposure to government bonds seems but appropriate, Citi's modeling shows. It goes without saying, share markets are priced for a soft landing, and will receive some kind of a shock if/when Citi's forecast for economic recession proves correct.
As I wrote myself earlier this week: plenty of expert voices around that believe Citi's prediction will not materialise.
As it happens, the FNArena inbox received a missive from Ninety One this morning stating the above mentioned risk has already well and truly been priced in for Emerging Markets assets and with the Federal Reserve about to embark on loosening US monetary policy, the USD should start weakening and this, historically, tends to bode well for Emerging Market equities.
No doubt, Citi would counter-argue economic recession is likely to strengthen the greenback (reduced risk appetite favours safe havens) so maybe the best conclusion to draw is this debate remains unresolved still, just like the US presidential election.
Ninety One also argues Emerging Markets enjoy structural tailwinds, robust earnings growth, compelling valuations and the USD is currently trading near a twenty-year high.
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Strategists at Morgan Stanley see too many contradictions in today's markets, and this almost guarantees a big pick-up in volatility as sometime, somehow those contradictions need to be brought back in line.
The current set-up is US bond markets are positioned for many more rate cuts than is feasible under a soft landing scenario, i.e. the bond market agrees with Citi there is likely an economic recession on the horizon.
US equities, on the other hand, are carried by analysts forecasting 13% profit growth over the next six quarters; twice the normal rate.
Economic growth is slowing, Morgan Stanley points out, let's have no doubt about that, and the US labour market is cooling. Assuming the bond market is too cautious and slow economic growth remains the most likely outcome, not negative economic growth, this still leaves the strategists with the incling that current growth forecasts seem too high.
Their advice: balance portfolios between defensives and cyclicals, growth and value, large caps and small caps, and apply maximum diversification. Share market momentum is anticipated to move away from the Mag7.
Taking a global view, Morgan Stanley's Best Ideas for portfolios are US financials, energy, healthcare, Japan, real assets and infrastructure investments. The strategists are ultra-cautious on small caps with rates still high, economic momentum weakening and US consumers being squeezed.
Peers at UBS highlight the conundrum as follows: when the bond yield curve dis-inverts this benefits small cap companies as they mostly bear floating debt, but then worsening economic conditions present themselves as a serious headwind.
Morgan Stanley sees the S&P500 range-trading between 4700-6100 with a June-2025 target of 5400. Similar as at Citi, fixed income is the most preferred exposure. Goldman Sachs is more optimistic, targeting 5400 for the S&P500 in three months, 5600 in six months and 5700 this time next year.
For Australia, Morgan Stanley's forecast is for slight improvement in economic momentum, but still below-trend, and nothing spectacular. Morgan Stanley's mid-2025 target for the ASX200 is set at 8100, with a bull case scenario of 8701 and a bear case alternative of 5631.
Prime problem for the local bourse is hardly a pulse in terms of earnings growth while the forward-multiple is 17.3x, well above the long term average of 14.7x and the 10-year average of 15.9x. Equity valuations are also deemed "expensive" relative to the historical relationship with bond yields.
The average dividend yield for the ASX200 is circa 3.6% versus the historical average of 4.5% since 2000. It is Morgan Stanley's view local share prices have disconnected from underlying forward earnings.
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