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Our key mid-year takeaways
1. Higher for longer, but the trend’s your friend
The final leg of the inflation fight was always going to be a challenge, with sticky inflation and central banks struggling to determine where the long term ‘neutral rate’ is.
However, globally there are some hints that central banks have enough confidence to commence easing – even if some cuts are considered ‘hawkish’. The Swiss National Bank eased in March and again in June, followed by Sweden, Canada, and Europe.
The market is currently implying close to two easings in the US by the end of 2024, with the first easing priced in for November. In Australia, the market sees around 50% chance of another hike this year, with cuts not considered likely until the end of 2025.
Bond volatility remains elevated compared to most other asset classes. US Treasury liquidity measures have returned to levels not seen since 2010, whilst stock and bond correlations remain positive after being mostly negative between 2000 and mid-2021.
2. Modest reacceleration in growth to support risk assets
Despite the highest US interest rates since 2001, global growth has remained unexpectedly resilient. In line with the general post-COVID experience, global growth has been underpinned by the US. In addition to large budget deficits, the main drivers of strong US growth over the past 18 months have included strong consumer spending and investments in manufacturing capacity.
We expect this resilience to continue into 2025. Indeed, with a number of central banks beginning to ease monetary policy and a manufacturing upswing seemingly imminent, global growth will likely speed up a bit into next year.
While valuations in US equity markets are relatively high, we expect broadening economic growth and lower interest rates will help push equity prices higher in both Australia and international markets.
3. US equity valuations are stretched, but conditions are supportive
We acknowledge that US stocks are expensive, but that doesn’t necessarily mean that returns for the year ahead will be negative.
The US equity market is currently trading on a 12-month forward P/E multiple of around 21x. However, our analysis shows the market has previously traded on higher multiples while still producing strong returns in the following year, particularly when accompanied by a pickup in growth from lower interest rates.
Pivots in the earnings cycle are difficult to price and the market has rallied on the prospects of lower rates and stronger growth. Of course, a key driver of US earnings in this cycle is the AI revolution and its positive longer-term outlook. However, the positive economic backdrop also helps.
We think only a recession could change the direction of the market and this seems unlikely given the prospect for lower rates before the year’s end.
4. Geopolitical risks remain high
Escalating trade tensions are probably the biggest downside risk to our outlook. In recent years, governments have been striving to ‘de-risk’ global trade and protect domestic industries. We see no real respite from this thematic, which is inflationary at the margin.
This should continue to be digestible for financial markets – absent a sudden step change.
However, in this context, we highlight heightened potential risks around election outcomes. For example, candidate Trump has stated he would increase US tariffs on all imports from China to 60% and apply a 10% tariff to all other imports – changes which would have wide ranging implications.
Similarly, international policy settings from the Biden administration could become less risk averse as we exit election year.
Nonetheless, overall, a number of key global trade dependencies (including food and manufacturing) suggest there are also many constructive paths forward.
5. A positive, but underwhelming, Australian equity market
The Australian equity market has underperformed the US since the end of the pandemic, apart from 2022 and mid-2023 when global central banks were aggressively raising interest rates.
Global investors currently have a strong appetite for the IT growth story, but our local market has only a small tech sector. The Aussie market is seen as being more leveraged to our domestic economy via the banks and consumer discretionary sectors, with miners providing exposure to China and global growth.
While domestic growth is likely to be weak in Q2, we expect a rebound to commence for Q3, reflecting tax cuts and real wages growth. Despite these green shoots, the combination of delayed rate cuts and an uneven recovery in China means the market is likely to remain relatively unattractive in the short term.
However, it is not all bad news. Chinese steel production and the demand for iron ore has been propped up by auto production - albeit we expect iron ore to weaken by the end of 2025. However, with tax cuts on the way, there doesn’t seem to be many downside risks to domestic economic growth in the near term.
6. Supply issues are keeping the Australian housing market tight
House prices have remained immune to high mortgage rates but construction has been falling. The negative impact on prices from higher debt servicing costs and reduced borrowing capacity is being more than offset by a range of factors including strong net migration (which is a major driver of tightness in the rental market).
A tight rental market, lower household mobility and strong net overseas migration are all limiting the supply of properties listed for sale.
In addition to higher mortgage rates, increased construction costs have led to a fall in building approvals which indicates that construction activity has even further to fall. This will be a drag on GDP growth for the remainder of 2024.
The net result of these supply-side factors combined with high mortgage rates has been a period of uneven price rises around the country over the past year. While it is not unusual to have differences in price growth, it is unusual for the lead capital city markets of Sydney and Melbourne to take a backseat for an extended period. Brisbane, Adelaide, and Perth are seeing strong double digit price growth, while in Melbourne, Canberra, Darwin and Hobart prices are steady. Sydney, along with regional areas, is experiencing price growth broadly in line with income growth.
7. US commercial real estate to bottom by end of the year
Despite continued challenges, transacted US commercial property prices have actually increased 1% so far this year, according to the Green Street Commercial Property Price Index. This follows a collapse of 21% from the March 2022 peak.
Our forecast of economic resilience and central bank monetary policy easing should provide a supportive backdrop for the beleaguered commercial property sector to finally bottom.
Despite the easing cyclical headwinds, some real estate sub-sectors (such as office) will continue to be weighed down by structural headwinds.
Global listed REITs are trading at ~20% discounts to NTA, but stabilised asset values will set the stage for the sector to potentially rally once rate cuts begin.
8. Gold: keeping its shine
Our commodity analysts have again raised their gold price forecasts and now expect the spot price to reach a quarter average peak of US$2,500/oz in 1H25, with single point highs comfortably above this.
Underpinning this view is investors' willingness to tolerate an increased opportunity cost of holding gold due to the deteriorating fiscal outlooks of major advanced economies. Specifically, this boosts the appeal of gold’s lack of credit and counterparty risk.
Although this has been predominantly a US centric view, with the country forecast to run a budget deficit of 7%, rising uncertainty around the French fiscal outlook beyond the upcoming parliamentary elections is now drawing attention too.
Ahead of this, however, November’s US Presidential election presents a potentially greater upside catalyst. Additionally, global central bank purchases should remain an ongoing cushion for the gold market but, in our view, are unlikely to be the driver of any sharp moves higher.
9. Diversification remains the only free lunch
Be alert: the historical relationships between several important asset class and macro variables has changed. In 2021, the correlation between stock and bond returns turned positive, which is a significant shift compared to the negative correlations that generally persisted for the prior twenty years.
That negative correlation was particularly beneficial in an asset allocation context as it meant adding bonds to a portfolio provided some measure of ‘insurance’ or ‘cushion’ against stock market downturns.
Against these dynamic forces, diversification is more important than ever to protect portfolios from short-term performance whiplash, and we caution against chasing momentum or reaching for yield.
While we think equities will likely end the year higher, we also look to maintain exposures to less correlated strategies such as unlisted infrastructure, private markets (senior secured private credit and private equity) and hedge funds in order to diversify return streams and protect against tail risks.
