Macro Review – Q1 2024

Stable equilibrium

The most impactful decision we usually make as macro investors is whether to be over or underweight risk. To make this call you need to come to a view around what’s going to dominate in the next phase – expansionary or contractionary forces? But 10-20% of the time this isn’t true – there is a tussle between expansion and contraction and macro forces are balanced. This is where we are now. You should still expect modestly positive equity returns, albeit the expected risk/return payoff isn’t great. It’s actually far more return generative to know which market segments to allocate to.

Economically things are mixed right now and we expect them to worsen – most of the world is still processing much higher interest rates and recessions are a certainty for some economies. On the flipside, with inflation now closer to central bank targets – policy makers are much closer to being able to cut interest rates if needed. This expectation of interest rate cuts is why equity markets have rallied into weakening economics over the past 18 months. If the liquidity conditions are right (as they have been), weakening economics doesn’t necessarily imply falling equity markets.

So what’s next? In the next few months we don’t see anything that could convincingly tip the scales one way or the other. Outside of an idiosyncratic event, it’s unlikely economics weaken enough in the near term to outweigh the rate cuts that would follow. And it’s equally unlikely that inflation accelerates enough to justify materially tighter policy, albeit we do think policy makers will move more slowly than the market is currently expecting.

What’s not well understood is, the most important decision to make in times like this is which equity segments to allocate to. Headline equity returns on average annualise around 5% in balanced conditions. Positive, but much less than when conditions are expansionary. Now, there are generally opportunities to trade equities within a range (typically + /-7.5%), and we expect to do so, but being able to capture this requires a very flexible approach to asset allocation – something a lot of investors don’t have the tools for. Being more specific within an equity portfolio is generally much more compelling. There are equity segments where we expect 10-20% p.a. returns on average.

Given the backdrop of weakening economics – a theme we expect to continue for most of this year – there are two segments we think it makes sense to emphasise in equity portfolios at the moment:

High Quality – this tends to point to an overweight to the US, large cap, growth, low debt, high return on equity and low earnings cyclicality
Momentum – from both a price and earnings perspective. Both of these will tend to lead to overweights similar to the above, although with a particular focus on the Technology sector.

We believe the most valuable decision to make now is being overweight these factors.

Please contact your Agilis representative if you would like to discuss this further.

Author: Joe Andrews, CIO

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