Q1 2024 – Invesco Model Portfolio Service Market Update

A Raging Bull?

Equity markets continued their impressive form in March, delivering further gains and rounding out a quite stunning first quarter. Though the loosely defined US Tech sector, particularly those associated with the A.I. theme, made the most significant contribution to Q1 returns, in March we saw a broadening of equity market participation. Of note was the resurgent Energy sector which, given its dominance in domestic markets, helped the UK bourse to enjoy both absolute and relative success. Japanese equity performance was also pretty eye-catching across the quarter, as better than expected earnings performance and robust wage gains suggested corporate reforms were continuing (or perhaps starting) to deliver on their desired impact.

It was, however, another relatively disappointing quarter for Emerging Markets, with China again crimping the aggregate asset class performance. Toward the end of January, however, investor interest did start to show signs of life, buoyed by hopes of Chinese authorities getting a little more assertive in their efforts to address the stuttering economy. Unfortunately, momentum stalled towards the end of the quarter as this response appeared to fall shy of what markets were hoping for, particularly given the scale of its housing market travails.

Have the Doves Departed?

In a converse fashion to equities, the major segments of the bond market struggled in the first quarter. On balance, the dominant theme/headwind for bonds this year has been the combination of resilient growth and stickier inflation, forcing a reappraisal of both when interest rate cuts will begin, and how many we’ll get before the year concludes. At the start of the year interest rate futures (i.e. ‘the market) were informing roughly 6 cuts were anticipated from the US Federal Reserve in 2024. As at the end of March this number was more like 3. Interestingly, ‘3 cuts’ aligns with the prevailing Federal Reserve guidance within its official policy communications (the dot plot).

What has taken many market participants by surprise, this quarter, has been the equity market’s ability to ‘shake off’ the hawkish pivot; with many previously concerned a higher for longer interest rate environment might usher in a more pernicious growth outcome. Whilst such concerns may yet prove prophetic, for now markets are taking comfort from the reason for the hawkish shift, rather than any potential consequences from it. Specifically, encouraging economic performance, driven by a resilient jobs market and robust consumer spending, has likely been a catalyst for a reduction in calls for rate cuts. Rather than balking at this development, however, equity markets appear more keenly focused on the fading prospect of an imminent recession.

Of course, investors have also shown great enthusiasm for the A.I. theme which, to date, has achieved remarkable earnings performance, dwarfing any macro-related influence. Recognising the crucial importance of company performance in driving market returns, we encourage readers to visit Invesco’s Time in the Market Podcast site on Spotify and listen to our latest two episodes: Episode 11 with Joe Dowling (of Invesco) and Episode 12 with Terry Smith (of Fundsmith). Though lots of areas are covered, A.I. earnings delivery is certainly a focus.

Shine a Light on Positioning

Returning to macro themes, however, we would also suggest that whilst investors may have been frustrated by the stickier levels of inflation, the overall trends still point lower, and continue to support a summer initiation of interest rate cuts. Markets, therefore, seem less sensitive to the marginal prints on inflation relative to expectations, so long as the trends remain in place. For now, therefore, the ‘Goldilocks’ environment of resilient growth, fading inflationary pressure, and more accommodative monetary policy, remains in place.

Indeed, such a backdrop has often been a favourable one for stock markets and encourages the Invesco MPS to persist with its current preference for equities within portfolios (where appropriate). It is important to stress, however, there are non-negligible risks to this view.

The Last Waltz?

Whilst there is good reason to believe healing supply chains, housing market travails and cracks in the labour market can prolong the disinflationary trend, hopes growth can remain positive throughout 2024 and into 2025 may yet unwind. No doubt the market has been surprised by the resilience of the economy to prior interest rate hikes, but the ‘long and variable lags’ to policy changes should remain front of mind. Whilst certain mortgage deals may allow segments of the economy to avoid the full force of interest rate hikes, not every consumer will be in such a fortuitous position. What is more, many channels of financing, such as credit cards, overdrafts and corporate lending will be much more sensitive to interest rate changes and will continue to bite into the economy as we move through the year. Investors should brace themselves for a more volatile period ahead as markets potentially fret between extremes of soft-landing euphoria, inflation resurgence and recession.

Yet, even in recession, we would argue all may not be lost for equity investors. Of most comfort would be the hope any such recession wouldn’t be as severe as more recent episodes. This more benign view hinges upon the apparent absence of major economic imbalances i.e. corporations and households don’t (in aggregate) appear to be facing quite such daunting refinancings challenges (except maybe UK mortgage holders) as in prior economic cycles. We should also remind ourselves that having moved off the zero bound, there are now some interest rates to cut! Such policy options might prevent a more pernicious downturn and prove sufficient to reignite economic and investor enthusiasm.

The Chinese Casino

As noted earlier, the Emerging Market asset class continues to be thwarted by the disappointments of the Chinese economy, with sentiment waxing and waning on hopes of more stimulus from its leadership. Pinning an investment strategy to such hopes looks a touch thoughtless, not least given the opacity of some Chinese data, however, we acknowledge policy makers’ increased efforts of late. We also observe valuations of Chinese (and broad Emerging Market) equities, reflect considerable pessimism about the outlook. This setup offers a reasonable level of asymmetry, in which policy that delivers amelioration might offer some relief to markets, and potentially more if stimulus is more emphatic. Of course, geopolitics and erratic decision making could undermine this claim of Emerging Market asymmetry, but the risk reward has encouraged the Invesco MPS to move a little further in this direction mid-quarter.

Market Direction

Recognising how uncertain the outlook remains, however, as well as our philosophical belief in the need for humility when investing, MPS portfolios strive to seek appropriate levels of diversification to meet the investment challenges ahead. Relative to stocks for example, high quality corporate and government bonds might offer a more defensive return profile in the face of less encouraging growth outcomes, particularly given the increase in yields observed over recent months. Alternative asset classes also assist Invesco in its efforts to help diversify portfolios in a more troubling period for stock markets.

Stay safe, stay well, and please get in touch if you wish to discuss any part of the Invesco MPS strategy further.