Brightening prospects in the US

Joe began by highlighting indicators suggesting the economic background is improving—in the US, at least. He cited, for example, a sharp fall in recession indicators, improvements in ISM manufacturing and services data, and advances in the housing market and the stock market. The last of these has reached new highs. Meanwhile, credit conditions are comfortable, and business and consumer confidence is brightening. However, the situation is less favorable elsewhere, with indicators pointing to sub-trend global growth.

The key question around inflation is whether it can return to a sustainable 2% level. Joe doesn’t believe this is possible without an accompanying recession. While central banks haven’t won the war against inflation, they have triumphed in the battle of inflation expectations. However, Joe is concerned about the outlook for the next one to three years, given continuing challenges on the supply side, in areas such as housing and commodities. Climate change and extreme weather events, as well as rising geopolitical uncertainty, present challenges to the supply of some commodities.

The drive towards economic resilience comes at a cost

Security concerns in a wide range of areas —national defense, cyberspace, energy, and food—could also have an inflationary impact, since they are having an effect on the way global and national economies are structured. The trend of “friendshoring,” for example, is helping to fuel inflation since it generally involves moving production away from the lowest-cost producer to the second-lowest or even third-lowest-cost producer.

At the same time, labor costs are rising around the world. Indeed, the US is the only major economy that’s made significant progress on unit labor costs, a key driver of inflation. In the US, unit labor costs have fallen to around 2%, but in Canada, the UK and the eurozone they are running at 6% plus, or three times their inflation target. Consequently, rate cuts do not appear likely in these countries or even in the US, although the latter is best placed to act and could cut rates first.

However, if progress is maintained, rate cuts could take place globally from the second quarter onwards. That should prove positive for equities and risk assets in general, given that equities almost always rise during an easing cycle.

Concerns over market liquidity

Financial stress has been easing over the last year or so, a trend that been very supportive of risk assets, says Joe. However he was “a little concerned” about market liquidity as reserves fall and the Federal Reserve's (the “Fed”) balance sheet unwinds. This has yet to affect bank lending, but Joe believes that will happen going forward into the second quarter. Allied with US tax payments in April and other factors, the draining of liquidity could cause a market correction.

Another risk, according to Joe, is that central banks may find it harder to ease monetary policy as the year progresses, as the inflationary threats outlined earlier come into play. That, says Joe, could lead to a real Fed funds rate of around 3% and a real European deposit rate of around 2%, which would have a restrictive impact on lending, the cost of capital and economic activity.

Dollar risk is another concern, adds Joe. He explains that a weak dollar could stop the Fed from cutting rates as much as it would like, due to fear of the impact on imported prices. In addition, the US is projected to incur a budget deficit of 5% to 6% of GDP over the next 10 years. Yet neither the Republicans nor the Democrats, according to Joe, appear concerned—even though the deficit could fuel inflation and cause a drop in the appetite for US debt if the US economy were to accelerate and the decline in inflation were to be arrested.

Fixed-income prospects

Joe said he had some concerns about the bond market, given the uncertain outlook for growth, inflation, and interest rates, and he might reduce exposure to fixed income.

Credit markets in general are at or near all-time highs around the world. The withdrawal of bank lending should also prove positive for private credit, and investors should be able to find good opportunities in this sector. However, Joe notes that the volume of flows into the sector could reduce returns, while defaults are likely to rise as the cost of capital reprices.

Turning to commercial real estate, the sector’s growing problems are well known. However, distressed sales remain “minuscule” compared to where they should be, and the market is not as appealing as bonds and equities. Joe believes the market may be bottoming out and there could be opportunities for long-term investors in instruments such as REITs.

Current positioning

There is an underweight in Japan, and if rates—and consequently yields—decline in the other advanced economies, the case for that underweight will increase. Overweight positions in equities and fixed income globally appear reasonable given current conditions. Joe believes the dollar was overvalued In terms of stocks, Joe believes it is difficult “to bet against the US,” while monetary and fiscal support by Beijing could drive China’s economy and global growth.

The “friendshoring” winners

During the Q&A session that followed the presentation, Joe was asked to name the winners in terms of economic resilience. He responded that the winners were to be found in Asia outside of China. Tremendous growth was taking place in countries such as India, Vietnam and Indonesia, all of which are benefiting from the movement of supply chains. Mexico  also benefits  from this trend.

Joe was also asked whether he was worried about having an overweight in equities, given current valuations. He responded that he wasn’t concerned, since companies such as Nvidia are driving the market higher and are continuing to deliver, as evidenced by the company’s recent results.

Asked for his view on commodities, Joe responded that oil supplies appear tight, and OPEC is doing “a good job” of reining in output. Longer term, consumers appear to be having doubts about buying electric vehicles, which could slow the movement away from oil and other fossil fuels. At the same time, demand for transport is increasing in areas such as India and Southeast Asia, which should also underpin stable oil prices.

US election doubts

Responding to a question about the US election, Joe said the election hasn't been decided yet. He added that one concern over another Trump administration involved possible senior staff appointments. Joe explained that during the first Trump administration, he had extremely high confidence in Trump’s economic appointees, including Steve Mnuchin and Gary Cohn, the architects of the Trump tax cuts. However, the names put forward as possible senior economic officials in a future Trump administration included people who advocate trade protectionism.

Joe added that he was concerned that Trump’s plans for higher defense spending would prove inflationary, while Europe would also likely increase defense spending as a result of a Trump election victory.

Asked about the view that market returns going forward are unlikely to match those seen over the past 20 years, Joe agreed that returns were likely to be lower. However, he added that they would be positive, and that all asset classes were going to become a little bit more competitive with each other. Moreover, as the population ages, the desire for income will increase, providing a floor underneath income assets.

Perspectives on Personal Investing

Finally, Naji asked Joe two personal-oriented questions. The first was what major lesson Joe had learned from 30 years of investing. Joe responded that the main rules he follows are “to let your profits run and cut your losses short.” The continuing strength of AI stocks underlines the wisdom of the first tenet, said Joe. He pointed out that while a year ago, investors might have thought it was time to take profits from AI, the continuing strength of the sector shows that this is clearly not the case.

Secondly, Joe was asked what advice he would give to newcomers to investing. Joe said that he would recommend they connect with a financial professional who can provide guidance. That’s because “if you don’t invest wisely in the early stages you will have to catch up later in life and that can be a hard lesson to learn”.