Macroeconomic backdrop

Headline inflation rates accelerated modestly into year end, to be followed by early indicators of strengthening economic activity in January. Central banks warned financial markets against over optimism regarding the probability of rate cuts in the first quarter. The Federal Reserve (Fed) kept rates on hold, while the European Central Bank (ECB) also voted to leave borrowing costs unchanged. ECB president Christine Lagarde acknowledged that the worst of the inflation fight was likely over and the “disinflation process was at work” but signalled that summer was the most probable timing for rate cuts.

Market update

Global equities were mixed in January, while Japanese stocks were the strongest performers, boosted by robust corporate earnings and a weaker yen. US equities were supported by a continued advance in stocks seen to benefit from artificial intelligence. European shares also moved higher, while emerging market equities were weighed down by weak returns in China. Global bonds weakened as hopes for March rate cuts faded. Corporate bonds held up better than government debt, with high yield outperforming. The US dollar appreciated over January, and while the euro weakened against the dollar, it strengthened against the Japanese yen. Oil prices rallied on concerns over disrupted supply given heightened tensions in the Middle East.

Our view

In our last update we noted that markets might be poised for a period of consolidation, following the strong gains enjoyed since late October. Whilst that may yet be the case at some point, we have become more optimistic on the prospects for market returns in the year ahead and expect any correction to be modest in nature. Market dynamics are favourable and continued strength in macro data gives comfort that markets will remain well supported in the near term.

The US economy continues to outperform expectations and corporate earnings should benefit from the resurgent US consumer. While market expectations for the timing of interest rate cuts could yet be disappointed, we view this as more of an issue for the bond market than the equity market, which is beginning to turn its attention to a soft landing. Japan should benefit from a stronger global economy, driven by the US, but should also be supported by improving domestic demand. In addition, we see a currency boost to corporate earnings, as the Japanese yen has weakened again in recent weeks.

Positive market drift has automatically moved our equity allocations higher in recent weeks. Such being the case, we look to maintain current equity exposures and even add to positions as opportunities present themselves, particularly in the US and Japanese markets.

Within fixed income, we maintain a neutral stance on longer dated bonds, although we look to add risk in emerging market debt (EMD). While we have seen a narrowing of the spread of corporate credit yields over government bond yields in recent months, EMD spreads look more attractive in a historical context. They should also be supported by solid fundamentals.

To fund opportunities we see in equities and EMD, we look to reduce our position in cash and/or alternative investments, where the potential upside appears lower.