A resilient US economy (owing to consumption and wealth effects) and strong earnings expectations for the year are driving the recent upside in equities and increase in yields. Now, the big questions are whether this can continue given the already strong market movements, and whether these earnings expectations are credible?
The late-cycle environment continues to play out
“We acknowledge the trend strength in risk assets, but high valuations are preventing us from massively shifting our risk gear upwards from a structural perspective.”
On the economic front, the past strength led us to forecast a less ugly US slowdown, therefore extending the late-cycle environment. Nonetheless, we do not see this as a beginning of a new cycle, and expect a slowdown around the middle of the year, and continued disinflation. The factors listed below will be crucial to understand the direction of the economy and markets:
- US labour market. A moderation in demand is likely, led by a shift to higher savings, lower consumption and weak labour markets (stress in SMEs* employing a large part of the labour force), along with subdued investment.
- Monetary policy divergences, with inflation in focus. While the BoJ raised rates after 17 years, the Fed and the ECB are looking to cut rates but would like to be sure on the future direction of inflation first.
- US elections and geopolitics. Volatility may rise, as we enter a more active campaign phase. Geopolitics and the risks of high debt globally may provide long-term support to gold.
- Emerging markets’ (EM) resilience. We slightly upgraded our growth forecasts in EM, mainly due to Asia and India, on strong domestic demand and exports. However, our growth expectations for China do not change.
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