Preparing for a Mild Recession with a Bullish Stance

6:04

Published on: Jul 23, 2024 8:00:00 AM

Our Chief Investment Officer at EasyRetire, Duane Gilbert, talks about a more bullish market outlook for 2024, with falling inflation and potential Fed rate cuts supporting equities, while maintaining conservative positions. Learn more about how the team's portfolios are positioned in the article below.

Global Markets
The US equity rally continued in June as financial markets increasingly expect the US to avoid a recession in 2024/2025 (the “soft-landing” scenario). The S&P 500 index ended the month up 3.6% in USD in June. However, US stock gains continue to be concentrated in the US large-cap tech sector, which have benefitted from AI technology and expectations for falling interest rates being brought forward. The reason why Tech stocks should benefit the most from falling interest rates is that they are “growth” stocks, and high growth becomes more valuable in a lower interest rate environment.

The magnificent seven (Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla) have rallied 47.5% Year-to-date, after rallying 107.0% in 2023. In aggregate, the S&P 500 index has rallied 26% since 1 January 2023.

Global bond yields also benefitted from expectations for US interest rate cuts being brought forward. The Bloomberg Barclay’s Global Aggregate Bond Index ended the month up 0.9%.

Chart 1: US tech stock vs US Indices

*Please note that the magnificent 7 returns are price returns and do not include dividends paid to investors.

European equities ended the month down 2.2% in USD. French equities led the decline, down 6.6%, after no single political party or alliance of parties won a clear majority in the national election. Like South Africa, France now has a hung parliament, and a coalition government will need to be formed.

Chart 2: France election results (Source: Aljazeera News)

Emerging markets ended the month up 3.9% in USD. Performance was driven by Indian Equities which ended the month up 6.9% after Prime Minister Narendra Modi was able to secure a majority win in the national election after forming a coalition government with two allies. This marks Modi's third term as Prime Minister of India.

Since March we have not seen pro-cyclical assets such as industrial metals and emerging markets ex. China rally, suggesting that the rally in developed market equities is driven by expectations for rate cuts rather than an improving growth outlook – which is concerning. In fact, there is cause for concern for US growth (and hence global growth given the central role that the US plays in global trade). The US unemployment rate is picking up sharply, while unit labour costs are declining, which is a typical precursor to a recession.

Chart 3: US unemployment rate and recessions (Source: Trading Economics)

Local Markets
Local markets had a good month as domestic focused stocks benefitted from positive sentiment towards the Government of National Unity (GNU). The Financials 15 Index ended the month up 14.5%, while the Industrial 25 Index and the Resource 10 Index, which hold companies that make more of their earnings offshore, ended the month up 1.6% and down 3.7% respectively. The Rand gained 3.0% to the dollar. However, it failed to meaningfully break the R18 to the dollar mark during the month, and closed at 18.06 to the dollar, before giving up some of its gain in July.

The JSE All Bond Composite gained a massive 5.2% for the month as sentiment toward South Africa’s fiscal position improved. Inflation linked bonds gained 3.0%. While it is pleasing to see this change in sentiment, the reality is that Government expenditure continues to expand aggressively. Government expenditure has almost doubled in the past 8 years, with interest expenditure increasing from roughly 9% to 18% as a percentage of revenue over the same period

Chart 4: National Government Expenses (Source: Stats SA)

Chart 4: South Africa Public Debt and Debt Service Costs (Source Alpine Macro)

Comments from our Chief Investment Officer, Duane Gilbert
Our market outlook for 2024 is more bullish than it was in 2023. Falling inflation will give the Federal Reserve scope to cut interest rates, which will be supportive of equity markets (and bond markets to a lesser degree). However, we should not forget that the recent interest rate hiking cycle was the most aggressive in 40 years, at a time where growth was already fragile. It is likely that the US will experience a mild recession towards the end of the year, or early 2025. A recession is also likely in Europe, and China seems likely to continue its low growth trajectory in the absence of a meaningful stimulus package from the government.

As a result, we remain conservatively positioned in our portfolios, but with a tactical overweight to defensive US equities. We have a high allocation to global bonds which provide a strong hedge during a recession.

South African equities are particularly cheap but vulnerable to a global sell-off. One needs to carefully pick companies that can grow their earnings in a low growth environment. Given the continuing decline in investor sentiment towards South Africa, we have further reduced our exposure to South African government bonds, which have been a value trap over the past year.

We prefer exposure to high-quality secured credit. We also hold a lot of cash in our portfolios. We prefer USD over ZAR. The weakness we saw in 2023 despite a supportive global backdrop is testament to how fragile the ZAR is. Our large cash position gives us the dry powder we need to take advantage of bargains that may arise from a market sell-off.

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Any opinions, news, research, reports, analyses, prices, or other information contained within this research is provided by an external contributor as general market commentary and does not constitute investment advice for the purposes of the Financial Advisory and Intermediary Services Act, 2002. First World Trader (Pty) Ltd t/a EasyEquities (“EasyEquities”) does not warrant the correctness, accuracy, timeliness, reliability or completeness of any information (i) contained within this research and (ii) received from third party data providers. You must rely solely upon your own judgment in all aspects of your investment and/or trading decisions and all investments and/or trades are made at your own risk. EasyEquities (including any of their employees) will not accept any liability for any direct or indirect loss or damage, including without limitation, any loss of profit, which may arise directly or indirectly from use of or reliance on the market commentary. The content contained within is subject to change at any time without notice.

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