Europe, although it surprised in the first quarter in terms of growth, remains unattractive except for certain sectors that benefit from the current macro and geo-political context.
As far as the United States is concerned, there is an ongoing slowdown in the labor market which however remains solid. The cooling of the economy observed in the first quarter (confirmed by the PMI indices), together with stable inflation between 3% and 4%, has effectively opened the debate on a potential stagflation of the US economy. Suffice it to say that in the month of April the number of articles published on Bloomberg that mentioned the word "stagflation" increased to over 600, the highest since June 2022.
Market expectations for a Federal Reserve rate cut changed quickly, after the publication of the PCE index investors priced just one cut for 2024 while following the publication of employment data the forecasts increased to 2 cuts. For the moment, the American central bank has limited itself to acting on the reduction of assets on the balance sheet which from June will slow down to the rate of $25 billion per month from the previous $60, a larger cut than expected, i.e. $30 billion.
The move is aimed at carrying out on the one hand a gradual reduction of the balance sheet rather than at too fast a pace which in the past has led to market shocks and on the other hand at maintaining stable liquidity on the markets which is a driver for them as well as to prevent government bond yields from getting too close to sensitivity thresholds.
The thresholds identified by Morgan Stanley appear to be correct because they convince investors to abandon stocks in search of better alternatives.
Similar speech not only for the 10Y Treasury yield vs the S&P500 earnings yield but also between the 2Y Treasury and the dividend yield of the US index.
The thing to watch out for is excessive optimism from analysts who have raised earnings estimates for the first time in Q2 2024 and appear to be overly confident about forward Q4 earnings of the year in which growth is expected of 17% y/y and a broader perspective of 10% for 2024 and 2025.
These estimates seem overly optimistic because they are based on the expectation that US companies will be able to expand profit margins while revenues are assumed to grow steadily by 5%. In the post-pandemic years the expansion of margins and the maintenance of these within the context of the return of inflation was possible thanks to the federal tax benefits offered which are unlikely to be replicated.
Analysts are likely to believe that the US economy will tend to perform better than expected, which is also why 2024 is off to a positive start given conservative Q1 earnings estimates.
However, markets today seem positioned on the assumption that the cooling of the labor market could bring a rate cut closer because it helps contain a possible increase in inflation. If inflation remains stable, or even starts to fall again, with soft employment data risk assets will continue to benefit. If inflation were to rise unexpectedly due to supply chain pressures that were not factored into analysts’ estimates, and at the same time the labor market was to decline, it could result in a scenario where the Fed is unable to act in a way that aligns with the stagflation scenario.
Europe, although it surprised in the first quarter in terms of growth, remains unattractive except for certain sectors that benefit from the current macro and geo-political context (banks, defense sector, and anti-cyclical). The recovery of domestic demand could reverse the trend of economic stagnation, as previously mentioned, which has not yet given signs in this sense.
China is instead observing a return of investor interest, thanks to depressed stock valuations and an economic context that seems to be giving some stable signs of recovery.
The Asian giant currently represents an opportunity due to the deeply discounted valuations of the stock market and the economic recovery which seems more stable thanks to the support of the authorities who tend to be cautious in the use of debt to stimulate the recovery. The return of investor interest is quite evident.
However, tail risk remains the geo-political scenario given that an increase in trade tensions between Washington and Beijing and a devaluation of the Yuan aimed at stimulating Chinese exports is highly probable.
The current situation is quite uncertain as we are now feeling the impact of the increase in raw material costs. This is leading to projections of the world’s largest economy experiencing stagflation, which is considered the worst-case scenario. For the moment, the risk-asset trend should remain upward provided that the base scenario remains active, the drivers will mainly be employment and inflation data.
Investors are starting to skim the companies to bet on (i.e. "everything goes up" no longer prevails) and in a context like the current one, Value offers better opportunities than Growth also due to valuations that have reached a historically depressed point.
On the bond side, the returns offered by the short part of the curves remain attractive compared to those of the longer parts of the curves. At present it is better to invest more in the shorter segment of the curve, High Yield corporate bonds and also Emerging ones represent a good solution to increase carry. Gold and Silver, however, continue to represent a hedge against the risk of inflation. Agricultural goods should also be monitored as they could also start to rise again in terms of price due to the rise in energy prices.
|DISCLAIMER
The information and considerations in this article should not be used as the sole or primary basis for making investment decisions. The reader retains full freedom in his own investment choices and full responsibility in making them, since he alone knows his risk propensity and his time horizon. The information contained in the article is provided for informational purposes only and its disclosure does not constitute and should not be considered an offer or solicitation to public savings.|
Original article published on Money.it Italy 2024-05-20 07:10:00. Original title: Per gli USA sale il rischio stagflazione. Ecco come investire ora
