With half the year already behind us, a tapestry of divergence has emerged. Explore our Q2 report to see how the rhythm of resilient global growth, AI-driven equity gains, and anticipated central bank rate cuts are shaping the financial stage.
Download PDF VersionRisk assets got off to a flying start in 2024. This was driven by three main expectations: markets anticipated an upswing in global growth and corporate earnings; falling inflation; and finally hefty central bank cuts. Fuelled in part by AI-related enthusiasm, hopes were raised of a new and improved version of the “Goldilocks” scenario.
Yet as we edge past the halfway point of the year, things have not quite panned out as many market commentators and policymakers expected. Growth has surprised to the upside; inflation has remained tenaciously above target and job growth has proven stronger than anticipated. And investors are oscillating between pessimism on interest rates and optimism on corporate profits – all playing out against a backdrop of heightened geopolitical risk and game-changing elections in the US, France, UK and elsewhere.
• Buoyant economic data: The global economy may currently be in a soft patch, but growth and inflation have defied an anticipated global economic slowdown in 2024 to outstrip expectations across most major economies.
• Strong returns for global equities: In the second quarter, equities gained ground - albeit in a highly selective manner. Propelled by the stellar outperformance of semiconductor stocks in May and June, almost all of the second quarter’s gains came from the large-cap growth space.
• Favourable inflation trends: Inflation is proving stickier than expected, with its trajectory flattening or even reversing in some instances. Across major Western economies, disinflation seems to have taken a pause for breath on the back of a relatively sharp decline from 2022-2023 highs, especially in the US. With services inflation in particular remaining well above targets, expectations for the start of central bank rate cuts may have been delayed, but disinflation should pursue its anticipated path.
• Interest rate cuts: While disinflation is not unfolding as rapidly as anticipated, major central banks are expected to start reducing rates soon.
• Elevated geopolitical risk: The geopolitical backdrop remains riddled with risks, as underscored by recent events in the Middle East. Elsewhere, considerable risk is represented by the ongoing Russia-Ukraine war, tensions between the US and China, and the potential impact of the upcoming US election – all of which have the potential to trigger supply shocks and hit trade flows.
• Election-related uncertainty: Across the globe, 76 countries will hold elections this year, many of which have already taken place with limited impact on the market. The greatest potential impact is represented by the US and UK elections, with their potential to shift the economic and investment landscape requiring close monitoring.
• Heightened financial stress: In the wake of rapid rate hikes in 2022-2023, financial stress is elevated, and a crisis could precipitate a sudden shift in policy stance. On a positive note, recent financial accidents have been met with swift and targeted support, so the risk of a systemic financial crisis seems limited.
The global economy remains in a soft patch, fuelled by a restrictive monetary policy backdrop that translates into below-trend, but still resilient, growth.
Divergence has re-emerged as a key investment theme, with individual economies likely to experience differing growth and inflation experiences as the year unfolds.
US growth has proven fairly resilient despite high policy rates, although it is now slackening off somewhat. European growth, meanwhile, is improving from a lower starting point and should be underpinned by rate cuts that are widely expected to happen sooner than in the US.
In Japan, growth should also improve, driven by wage rises, a rebound in manufacturing output and fiscal stimulus. And in China, strengthening consumer sentiment combined with fiscal stimulus points to an environment of below-trend, but improving, growth to come.
Developments in the US are always key for global markets, but with the stage set for a historic cut in interest rates, this is even more the case than usual. The country’s economy appears to be heading for a soft landing, where central banks can dampen inflation without pushing the economy into recession.
With a slight slowdown in sight, the US Federal Reserve is widely expected to drop interest rates in December, pushing rates out of the US election and lending ongoing momentum to both bonds and equities in the months ahead. When it comes to the speed and size of rate cuts, market expectations are lower than they were at the end of 2023, with many anticipating a cut of 75bps at most. However, it is also possible that the Fed could drop rates by less than expected if the US economy performs better than anticipated (a “no landing” scenario). This would be good news for equities but could be challenging for government bond yields.
While investors hang on the Fed’s next move, markets are being boosted by a global economy that is exhibiting more resilience than during previous periods of high interest rates, with indications that the European and Chinese economies are also starting to bottom out. Robust company earnings in countries including the US and Japan should support risk assets, while any uptick in the implementation of AI could also boost productivity and lower inflation.
Meanwhile, geopolitical risk has heightened, and while the markets have so far successfully recalibrated for this – particularly in a US election year – the risk of a major black-swan event should not be ignored.
Tech stocks show no signs of pausing their stellar performance of 2023, with the Magnificent Seven (Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla) delivering an impressive 62% of the S&P 500’s 26% total return last year. In June alone, the "Magnificent Seven" were on average up 7.5%, while the rest of the index was down -0.5%.
These stellar returns underscored the exponential growth rate of technology and the related impact on earnings. At the same time, unrelenting excitement around the ascendancy of generative AI is predicted to significantly boost productivity and contribute billions to the global economy.
• The US stock market put in a strong showing for the second quarter, underpinned by robust performance from the tech titans. AI was the driving force for Nvidia’s 36% rise over the quarter and Apple’s recovery from a lacklustre performance at the start of the year.
• Apple was buoyed by a 25% surge in the second quarter, propelled by strong iPhone sales and growth in its services business, as well as new product launches and expansion into fresh markets. Analysts continue to take a bullish stance on the stock, predicting continuing growth with the company’s upcoming product pipeline.
• Nvidia saw 36% growth during the quarter, driven by robust demand for its graphics processing units, particularly in the AI and gaming spaces. Investor confidence has also been boosted by the company’s acquisitions and partnerships, and the outlook for the stock remains positive.
• Alphabet gained 26% for the year to date, outperforming the 15% rise in the S&P 500 over the same timeframe. Looking ahead, consensus estimates for Q2 indicate revenues of $78.3 billion.
• Meta expects total revenue for the second quarter to come in at between $36.5 billion and $39 billion. This implies growth of between 14% to 20% – lower than analysts’ expectations. The stock appears to be pulling back in anticipation of slower growth and lower margins going forward.
With equity markets across Europe now touching, or approaching, record highs, equity market valuations and the health of the economy still appear to be at odds with one another.
The region is edging closer to interest rate cuts, which stand to deliver a significant boost to the European economy. Inflation has fallen significantly and is now within reach of central banks' targeted levels, putting the economy in “Goldilocks” territory. And with inflation apparently under control, rate cuts could effectively spark economic growth. However, even if the European Central Bank (ECB) cuts rates, there will be a lag effect before the impact filters through to the economy.
The outlook for the UK remains challenging, with GDP stagnating and inflation declining at a slower rate than in other developed economies. Economic activity measures are showing early signs of improvement, and the consumer seems to be in a stronger position than many expected. Inflation has been slow to fall, and services inflation remains elevated.
The Bank of England is widely expected to start cutting interest rates in the third quarter, providing some much-needed relief to the country’s economy, although the cutting cycle is likely to be gradual.
Meanwhile, with the UK looking likely to see a new Labour government on 4 July, a closer relationship with Europe could be on the cards, chipping away at some of the Brexit discount associated with UK assets, but policies are unlikely to deviate significantly from those of the incumbent Conservatives.
Unlike last year, China’s economy will not be boosted by a post-pandemic reopening, which may make its 5% GDP growth target tough to achieve, according to Russell investments.
Meanwhile, Japan is outstripping expectations in terms of economic activity and corporate profits growth, as well as in financial markets, with the Tokyo Stock Price Index (TOPIX) reflecting the country’s status as the best-performing market year-to-date.
At the start of the year, markets were expecting a raft of rate cuts from Western developed economy central banks. Today, expectations have moderated somewhat, with market pricing pointing to just a handful of cuts following stronger-than-expected inflation data in the opening quarters. The narrative on disinflation and policy has been remarkably volatile this year so far, with markets appearing to be near the bottom of the range of anticipated rate cuts in the US, eurozone, and UK.
Continued progress on inflation should exert fresh downward pressure on the policy path, causing real policy rates to rise and helping instigate rate cuts from the Fed, ECB, and BoE. In Europe, relatively weaker growth should see the region move sooner to cut rates.
In the US, slower progress on inflation should point to relatively fewer rate cuts from the Fed, helping to keep the dollar expensive until rate cuts happen. And in Japan, where inflation is higher, further rate hikes are slated for the rest of this year.
The outlook for the equity markets appears constrained by overbought sentiment, high valuation multiples, and optimistic earnings growth expectations. Non-U.S. developed market equities continue to trade at a steep discount to U.S. equities, but there is substantial uncertainty around the ability of these markets to generate differentiated earnings.
In fixed income, government bonds may offer attractive value for investors, as yields are still trading well above expected inflation.
The U.S. dollar currently looks expensive, pointing to the potential for it to decline over the medium term. However, the chance of a global recession in 2024 could generate further upside for the dollar in the short term as investors are drawn to the relative safety of US assets.
The outlook for the global economy remains unclear, with uncertainties that could trigger further market turbulence. Against this challenging backdrop of economic, environmental, and geopolitical risks, maintaining a well-diversified portfolio is set to be more important than ever in managing ongoing volatility.
CEO
