Despite clear indicators that the global economy is in the late stages of the economic cycle, markets appear to not be pricing in much of a slowdown in the near future.
Stretched valuations, coupled with the uncertain trajectory of economic growth, have prompted the Investec global investment strategy group to maintain its long-term risk score in negative territory at minus 1, recommending a mild risk-off position.
A range of factors contribute to this outlook, with the outlook for the US labour market being a primary concern. As expected, the European Central Bank (ECB) cut rates by 25 basis points (bps) due to concerns about euro area growth in the near term. The ECB downwardly revised its June predictions and now expects the eurozone economy to grow by 0.8% in 2024, rising to 1.3% in 2025 and 1.5% in 2026, with risks to economic growth tilted to the downside.
Concerns remain regarding a weaker contribution from domestic demand over the coming quarters, lower demand for euro area exports due to a weaker global economy or an escalation in trade tensions between major economies, or stronger-than-expected lagged effects of monetary policy tightening.
While quarter-on-quarter GDP data from Japan surprised to the downside, coming in at 0.7% versus the 0.8% consensus, July inflation remained steady for the third consecutive month, leaving limited scope for the Bank of Japan to hike interest rates any time soon.
The market is only pricing in one 25 bps increase by July next year, with low growth levels suggesting there is limited scope for hiking rates more aggressively.
The Chinese outlook also remains weak. The three-month average of total social finance — the key leading indicator for the Chinese economy — was down 10% year on year in August.
While export growth remains robust at 9% year on year, inventory stockpiling in developed markets in anticipation of higher tariffs is a possible driver.
With inflation moderating in the US, the Fed is likely to continue to cut rates. US inflation came in at 2.5% in August, down from 2.9% and in line with consensus. Monthly inflation was 0.2% for the second month in a row. If monthly inflation remains in line with the 20-year median going forward, US inflation will reach 2.3% in February 2025.
However, monthly inflation would need to fall at 0.1% a month or lower to get headline inflation to 2% by January, which is unlikely. The current base case suggests inflation will remain above 2% for the next six months.
While this remains outside the Fed’s target range, unpacking the data shows that when housing inflation is stripped out, inflation dropped to 1.2% from 1.8%. Despite the turning point in the interest rate cycle, the current consensus forecast for US GDP growth next year is 1.7%, which is low by US standards, with global growth at 3.1%, and may prove optimistic.
There is also uncertainty surrounding the US election outcome and its affect on the US economy. Kamala Harris has a marginal lead in the polls, but it is too soon to rule out a Donald Trump victory after he overcame a 1.8-point deficit in the polls to win in 2016.
In addition, money supply growth remains weak due to a combination of factors that are likely to create an uncomfortable environment for risk assets. According to Bloomberg data, the S&P 500 is trading at a price-earnings ratio well above the 10- year median. Similarly, the index dividend yield is well below the 10-year average.
If we assume the price-earnings multiple heads towards normal and earnings grow in line with trend, the expected annualised return for the S&P 500 over the next five years is about 5%. Realising a materially higher return seems unlikely given where we are in the cycle.
Under the same normalisation assumptions, the expected annual return for the JSE is 15%. SA’s consumer price inflation numbers are likely to reach 3% in October based on Investec modelling.
The Bank’s decision to cut hopefully marks the start of a set of interest rate cuts.
• Holdsworth is chief investment strategist at Investec Wealth & Investment International.
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