Last week we highlighted heightened risk of a short-term reversal in global and US equity markets as they looked overcrowded. This week, the US equity rally stalled after hitting record highs and government bond yields slumped (bonds rose). The catalysts: Fed pushing back against expectations of a March rate cut, renewed concerns about US small banks’ exposure to property sector and disappointing revenue guidance from some technology sector leaders. Our investor diversity indicators still signal a high risk of reversal in global, US and European equities, as well as DM HY bonds.
Given this, while we maintain an Overweight stance on equities, including US equities, we have opted to trim our excessive exposure as a result of the rally since we published our Outlook 2024 in mid-December to bring them back closer to the target Foundation allocations. We continue to be Overweight on global and US equities, though to a lesser extent than in December. The direction of markets near term will likely hinge on tonight’s US job market report, upcoming US service sector business confidence indicator (ISM), Fed policymaker commentary and developments in the Red Sea.
Fed cut likely in Q2: The takeaway from the first Fed policy meeting of the year was clear: while policymakers see the ongoing disinflation conducive to initiating rate cuts later this year, they would prefer further data confirmation before acting. We continue to anticipate the first 25bps rate cut in May or June, followed by another 100bps of cuts in H2, contingent upon signs of significant growth slowdown and confirmation of inflation approaching the Fed’s 2% target by Q2.
US technology sector earnings mixed: This was a crucial week for US Q4 earnings, given that five of the so-called “Magnificent Seven” megacap companies which have been driving US earnings and stocks over the past year were due to report Q4 23 earnings. The earnings turned out to be a mixed bag. While Alphabet and Apple disappointed with their revenue guidance, Microsoft met expectations, and Amazon and Meta gave strong guidance. Overall, S&P500 companies which have reported so far have beaten earnings estimates by 6%. However, the consensus has lowered 2024 earnings estimates to 10.1%, from 11.1% at the start of the year.
Watching US job market report: US non-farm payrolls data tonight holds the key in determining the potential for a more protracted pullback in risk assets. The build-up to this data has been mixed – while US job openings rose more than expected and hiring rate ticked up, the job openings rate was unchanged, and the quits rate fell. Alternative sources of job openings data from Indeed and Linkup suggest to a deteriorating job market. Additionally, US private sector job creation (ADP) fell below estimates. Overall, the job market continues to cool. Two key indicators from the non-farm payrolls will be in particular focus – total number of hours worked, which is on a downtrend, and the rate of permanent job losers – as these are early warning indicators of a sharp deterioration in the job market. Also, ISM Services PMI data next week (especially new orders sub-indices) will also provide an update on the resilience of this key economic sector.
Investment implications: Against the above backdrop, we have marginally reduced risk in our foundation asset allocations. While we maintain an Overweight position on equities, including US equities, we have trimmed excessive exposure to equities as a result of the rally since we published our Outlook 2024 in mid-December to bring them back closer to the target allocations. Concurrently, we have redirected proceeds from trimming equities to fund our allocations to DM government bonds which continue to offer attractive yields. In our opportunistic allocations, we have added US short-duration inflation protected bonds to hedge against any revival of inflation as a result of any escalation in the Red Sea, or geopolitical tensions elsewhere.
