Q4 Global Market Outlook 2024: U.S. Soft Landing: Is It Possible?

The UK economy is finally showing signs of life after being stagnant since the end of COVID-19 lockdowns. Consumer and business confidence are rising, while declining inflation has enabled the Bank of England to begin easing.

The different growth trajectories over the past couple of years mean the U.S. is out of sync with the economic cycles in Europe and the UK. This makes it likely that Europe and the UK. can continue to recover if the U.S. experiences a soft landing. A U.S. recession, however, would flow through to the rest of world given the impacts on global trade and confidence.

Japan’s economic performance remains patchy. Gross domestic product (GDP) growth is weak and household spending is under pressure from rising prices, but business confidence is rising. The Bank of Japan seems determined to swim against the global central bank trend and raise interest rates further. This risks a repeat of the policy mistakes made over the past 30 years of tightening monetary policy before long-term expectations for sustained 2% inflation became entrenched.

China’s outlook has taken a turn for the worse as the property-market problems remain unresolved, credit growth slows, and consumer confidence hovers near record lows. Large scale stimulus measures haven’t arrived and until the government decides to act, it is difficult to see a meaningful rebound in economic growth.

Former Fed chairman Alan Greenspan was dubbed “the maestro” for his skillful handling of monetary policy during the 1990s. Investors are hoping that Fed Chair Jay Powell’s timing of interest-rate adjustments is just as adept (or lucky). The economic data says soft landing, but as Oasis declared in the title of their 1994 debut album, it’s Definitely Maybe.

U.S. Elections and Their Impact on Markets

We are into the home stretch of the U.S. election cycle with very competitive races for president and control of Congress.

The democratic system of government in the U.S. which features checks and balances across the executive, legislative and judicial branches, makes it hard for individuals and political parties to enact sweeping change. As a result, and over many decades, the impact of politics on U.S. markets has been limited. U.S. stocks, for example, have trended higher no matter which political party held office. And diversified, 60/40 portfolios have delivered positive returns in most presidential-election years—something we expect is on track again in 2024. Long-term investors are advised to keep it simple and stick to their strategic plan.

However, there are a few risks that we are monitoring going into the November elections. First, tariffs. They are not as consequential as many investors believe. Paul Krugman—who won a Nobel Prize in economics for his contributions to trade theory—often says the dirty little secret of international trade economics is that moderate tariff rates do not have large growth effects. A 10% percent across-the-board tariff on all U.S. trading partners is probably fine. The U.S. has already been in a limited trade war since 2018 and it hasn’t been a systemic event for markets yet. However, 60% tariffs on all imports from China would be consequential.

Second, corporate taxes. Democratic presidential candidate Kamala Harris is proposing to increase the corporate tax rate from 21% to 28%, while Republican Donald Trump is proposing to decrease it to 15%. Corporate tax changes of this magnitude either way could impact S&P 500® earnings-per-share growth by 5-10 percentage points. Importantly, taxation law is the purview of the legislature and therefore hinges on whether the November vote delivers a wave election with one party winning both the presidency and control of Congress. Prediction markets2 suggest a gridlocked, split-party Congress is just as likely as a wave outcome.

Third, the fiscal trajectory of the United States. Both major political parties have run unsustainably large fiscal deficits in recent years. If this persisted in a wave election scenario, U.S. Treasury yields could move higher—particularly if the U.S. economy remains resilient into a period of fiscal largesse.

Fourth, challenges to Fed independence. Former Fed chairman Alan Greenspan once noted he had never met a U.S. president who didn’t want lower interest rates. Jay Powell’s term as Chair of the Federal Reserve is up for renewal in May 2026. An appointment that calls into question the independence of the central bank risks de-anchoring inflation expectations and steepening the Treasury yield curve. While this is an important risk scenario for the medium-term, the confirmation process in the Senate and the fact that there are excellent candidates on the Board of Governors already—appointed by both the Trump and Biden administrations—push back on the likelihood of a more disruptive Fed chair.

“Diversified, 60/40 portfolios have delivered positive returns in most presidential-election years—something we expect is on track again in 2024.”

- Paul Eitelman, Senior Director, Chief Investment Strategist, North America

Yen Carry Trade and Japanese Currency Trends

The Japanese yen has been very cheap and oversold for some time: one of the factors driving this was the prevalence of a carry trade in the currency. A carry trade is where an investor borrows money in a currency with low interest rates and invests that money in another currency with higher yields or a higher expected return. This trade relies on a stable or depreciating currency and low volatility, given it typically involves a lot of leverage.

In late July 2024, this trade was hit by two catalysts which led to a dramatic increase in volatility. First, the Bank of Japan surprised markets by raising rates, and this led to a repricing of Japanese bond yields. Second, the U.S. July jobs report indicated a soft economy, which led to a repricing lower of U.S. bond yields.

The chart below shows this dynamic using the differential between the two-year U.S. and Japanese bond yields. The slide in rate differentials led to a large appreciation in the yen against the U.S. dollar. The impact on Japanese equities was dramatic, with the Tokyo Stock Price Index falling 20% over three days in the first week of August. A stronger yen reflects tighter domestic financial conditions and is a challenge to exporters.

We think the unwind in the Japanese yen carry trade is now largely complete. The Commodity Futures Trading Commission (CFTC), which provides positioning on futures and options on a weekly basis, shows there has been a full reversal of the short positioning, with the latest update showing traders are now slightly long the yen in aggregate.

Despite the 12% appreciation in the JPY/USD currency exchange rate since early July, the yen is still cheap. It is, however, no longer oversold. The Bank of Japan will likely be more patient in raising rates, given the volatility that followed the July rate hike and the global central bank easing cycle underway. Japanese bonds at the beginning of Q4 are the least attractive in the G103 universe, given expensive valuations.

“We think the unwind in the Japanese yen carry trade is now largely complete.”

– Alex Cousley, Director, Senior Investment Strategist

Regional snapshots

United States

The U.S. economy passed its first soft-landing test by demonstrating resilience through a risky disinflation process. Inflation has now cooled markedly, allowing the Fed to pivot to rate cuts and shift its focus to backstopping a slowing labor market. The final test is whether the Fed can cut rates back to normal levels while stabilizing the economy. Employment growth has slowed to a point that it is increasingly difficult for new workforce entrants like college graduates and immigrants to find jobs. The unemployment rate is rising as a result, but importantly without the layoffs that usually accompany an economic recession.

Fundamentals in the corporate sector look robust and should help sustain a period of low layoffs. Economy-wide corporate profits improved in the second quarter and industry consensus earnings growth estimates for the third quarter show that resilience continuing with expectations for a broadening out from the mega caps. That is not a corporate landscape that would usually catalyze a layoff cycle, but the situation commands a laser focus on initial jobless claims and other similar measures for signs of an inflection toward recession. Treasury yields have fallen sharply in recent months and now sit on top of our estimate of fair value. We closed our tactical overweight to duration with many of our portfolio strategies taking profits on the positioning in recent months. Equities are priced for the soft landing we expect, which leaves the risk of a material drawdown if the landing is harder. We continue to emphasize diversification in U.S. portfolios.

Eurozone

The gradual pickup in bank lending and rising household incomes are providing a tailwind for eurozone economies. The growth improvement is being led by Spain, Italy and France. Germany continues to struggle due to its trade reliance on China, and because its important auto sector has fallen behind in the global shift to electric vehicles.

Moderating inflation has allowed the European Central Bank (ECB) to ease policy twice since June and at least one more 25-bps rate cut seems likely by the end of the year. The main risk to the eurozone expansion is a deeper downturn in the U.S. economy. Barring this, the recovery looks set to continue into 2025.

European stocks are attractively valued and should perform well if earnings recover in line with the economy. The EUR/USD exchange rate is deeply undervalued relative to its purchasing power parity valuation and has upside if, as seems likely, the Fed cuts interest rates by more than the ECB.

Economic Recovery in Europe and the United Kingdom

The improvement in the UK economy is becoming more sustained with consumer and business confidence moving higher and house prices beginning to recover. Inflation is declining in line with both the eurozone and U.S., but the cautious tone from the Bank of England suggests a slower pace of rate cuts than for other central banks.

The recently elected Labour Party government led by Keir Starmer will deliver its first major fiscal statement at the end of October. The new government will want to make politically unpopular decisions on taxes and spending early in its term, creating the risk of fiscal tightening through 2025.

The FTSE100 Index of UK stocks is relatively attractive with a 12-month ahead price-to-earnings ratio of 11.5 times and a 3.7% dividend yield. UK gilts are attractively valued with a 10-year yield at 3.75%. The potential for wider interest-rate differentials gives British pound sterling upside versus the U.S. dollar.

China: Economic Outlook

China’s economy continues to be weighed down by the property market and depressed consumer confidence. Consensus GDP growth forecasts have been downgraded after the lackluster government policy response following the Plenum4 in July. Substantive policy measures are now likely to be reactive to worsening economic data rather than proactive. Chinese equities are attractively valued, and despite the soft backdrop we believe the outlook for earnings growth is reasonable. Chinese bonds have seen strong positive momentum in recent months, but we expect bond yields are nearing a floor. The yuan is likely to trade sideways, with authorities eager to avoid volatility in either direction.

Japan

Japan is on a steady footing, with reasonable growth and inflation that is returning to target. Our confidence on the direction of monetary policy has reduced following the surprise rate hike in July, but we expect the Bank of Japan will be patient and not take policy to a restrictive stance. Japanese government bonds look modestly expensive, while the yen continues to screen as very cheap. Japanese equities are trading in the realm of fair value to modestly expensive. We continue to see a tailwind from the reforms to corporate governance and an improving focus on returns to shareholders.

Canada

The average Canadian's standard of living is likely deteriorating. The fall in GDP per capita of roughly 3.5% since the second quarter of 2022 suggests as much, despite headline GDP rising 2.2% over the same timeframe. Worsening living standards and the 1.6% rise in the unemployment rate since 2023 have compelled the Bank of Canada (BoC) to cut its policy rate by 25 bps at three consecutive meetings, the first G75 central bank to do so this cycle. We believe the BoC is just getting started, and if there is further deterioration in the growth outlook or a rise in joblessness, it could require the BoC to ease more aggressively than the current measured pace. The challenging business cycle outlook means government bonds can still be a source of income but, crucially, an important portfolio diversifier in case the economy stumbles more than the industry consensus expects. Meanwhile, although Canadian equities are still favorably priced compared to U.S. equities, macro concerns also keep us cautious if economic conditions in Canada weaken further.

Australia and New Zealand

The Australian economy is likely to continue cooling. The consumer is under pressure from higher interest rates, while the mining sector is facing softer commodities prices given China’s slowdown. However, we expect a ‘narrow path’ of avoiding recession is achievable for Australia. The Reserve Bank of Australia will likely start cutting rates in the first quarter of 2025, later than the market currently expects. Australian equities have priced in a lot of good news, suggesting some asymmetry in the outlook. The Australian dollar is facing competing forces of improving interest rate differentials and a softer outlook for China, but we expect some mild upside from here.

With virtually zero economic growth since September 2022, the New Zealand economy is set for some respite now that the Reserve Bank of New Zealand (RBNZ) has begun its rate-cutting cycle. Monetary policy, however, is unlikely to become accommodative until the second half of 2025. The RBNZ board members have noted downside risks to the economy and indicated they are open to rate cuts of 50 basis points if required. We do not think that will be required, and instead expect a steady path of 25 basis-point cuts. New Zealand government bonds are close to fair value in our opinion and should provide some return upside if the economic outlook deteriorates further. We are neutral on the New Zealand dollar, with the interest rate differential expected to remain steady as the RBNZ cuts rates along with the U.S. Federal Reserve.

“European stocks are attractively valued and should perform well if earnings recover in line with the economy.”

–Andrew Pease

Asset-class preferences

Global equities have taken a breather in the second half of 2024. We have seen a rotation into value stocks at the expense of growth stocks. After a very strong first half of the year, most of the U.S. mega-cap tech stocks have lost ground since the end of June despite fundamentals remaining relatively robust. U.S. small-cap equities have outperformed in the last three months on increasing expectations of the U.S. economy achieving a soft landing and lower interest rates.

Fixed income markets have been positive as inflation has faded to the background and the focus has shifted to growth. Sovereign yields are now down for the year, and the U.S. 10-year government bond yield has fallen by 0.7% since June. Shorter-end bond yields have fallen by more, as markets have increased conviction in central bank rate cuts. Credit spreads have been volatile but remain tight.

What’s the outlook in equity and fixed income markets?

We use our cycle, valuation, and sentiment (CVS) framework to guide investment decision making. Our base case is for a U.S. soft landing, but recession risks remain elevated given concerns about potential lags in impact of monetary policy. Equity and credit market valuations are slightly expensive, and earnings expectations indicate the market is fully pricing a soft landing. Our sentiment indicator suggests that market psychology has become more balanced after being quite optimistic two months ago. Combining these building blocks, our CVS framework points to negative asymmetry6 in equity and credit markets and highlights the diversification role that government bonds can play in a multi-asset portfolio.

Our asset-class preferences at the beginning of Q4 2024 include:

• The tactical opportunity set in equity regions, sectors and styles is muted in our opinion. Across global equities, the value and momentum factors appear relatively cheap but are accompanied by higher economic sensitivity and poor sentiment, respectively. We prefer to maintain a balanced exposure and allow stock selection to be the key driver of portfolio outcomes.
• Government bonds are fairly valued and offer positive asymmetry if economic growth deteriorates further—however, some of the tactical opportunity has dissipated given the rally. We expect the yield curve to steepen from here, which means the gap between the 10-year bond and the two-year bond will increase. Credit spreads are pricing in a significantly lower recession risk than our own, making them unappealing.
• Real estate and listed infrastructure are both attractively priced relative to broader equities, although the valuation gap has narrowed. Listed real estate climbed more than 15% in third quarter7 as central banks began cutting interest rates. We expect that real estate and infrastructure can serve as important diversifying assets. Oil prices have fallen as concerns about weak Chinese economic growth have resurfaced. Geopolitical tensions could cause occasional spikes in oil prices, but weak demand is likely to keep prices below any level that would cause challenges for the global economy. While the prospect of interest rate cuts usually bodes well for gold, stretched valuations relative to real rates make the near-term path less certain.
• The U.S. dollar continues to look expensive, and we expect it will likely depreciate in a soft landing. The oversold reading on the Japanese yen has unwound since August given the unravelling of the yen carry trade.
• The interest rate-cutting cycle should help provide a floor under commercial real estate and may help unlock more mergers and acquisitions (M&A) opportunities. Even so, our expectation for a gradual pace of rate cuts also means that borrowing costs will still be somewhat elevated at the end of 2024. Management teams will need to focus on operational value-add. We expect the dispersion of outcomes within the private market universe will be high, in part because of ongoing macroeconomic uncertainty. This makes manager selection crucial for achieving favorable investment outcomes.

¹ John Maynard Keynes was an English economist who popularized the ‘paradox of thrift’ economic theory that personal savings are a net drag on the economy during a recession.

² A prediction market is a unique type of futures exchange that facilitates speculation on the outcome of all sorts of common events.

³ The Group of Ten (G10) consists of 11 industrialized nations that meet on an annual basis or more to consult, debate, and cooperate on international finance. The member countries are Belgium, Canada, France, Germany, Italy, Japan, the Netherlands, Sweden, Switzerland, the United Kingdom, and the United States.

⁴ China's ruling Communist Party commenced its so-called third plenum on July 15, which is a major meeting held roughly once every five years to map out the general direction of the country's long-term social and economic policies.

⁵ The Group of Seven (G7) is an intergovernmental organization made up of the world’s largest developed economies: France, Germany, Italy, Japan, the United States, the United Kingdom and Canada.

⁶ Negative symmetry refers to scenarios where the downside risk outweighs the upside potential.

⁷ As measured by the FTSE EPRA NAREIT Global Developed Index through September 10, 2024.

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IMPORTANT INFORMATION

The views in this Global Market Outlook report are subject to change at any time based upon market or other conditions and are current as of Sept. 23, 2024. While all material is deemed to be reliable, accuracy and completeness cannot be guaranteed.

Please remember that all investments carry some level of risk, including the potential loss of principal invested. They do not typically grow at an even rate of return and may experience negative growth. As with any type of portfolio structuring, attempting to reduce risk and increase return could, at certain times, unintentionally reduce returns.

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2024 Global Market Outlook – Q4 update
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