Investment managers discuss the macroeconomic outlook and highlight a cautious stance in their investment outlook, exacerbated by the Middle East conflict.

Pictet Asset Management said on Friday that the conflict in the Middle East threatens to further destabilise the global economy and financial markets. “Yet another reason to be cautious – we remain neutral in stocks and overweight in bonds,” Pictet AM said in a note.

“The conflict has come at a point when economies in both developed and emerging markets are looking vulnerable. Increasing geopolitical tensions, market volatility and weak earnings have dampened investor sentiment,” the asset manager said.

The US is, in their view, at the cusp of slowing significantly as US Federal Reserve rate hikes of the past year feed through to consumers. And, although the Chinese economy looks as though it has troughed, sentiment there remains depressed, Pictet added. Elsewhere, Europe’s resurgence is slow in coming. “As a consequence, we remain neutral in equities. Valuations for stocks may be more palatable following the market’s recent pull-back and corporate earnings look resilient for now, but muted economic growth means there’s no compelling case to buy. Our defensive stance is reinforced by our overweight in bonds,” Pictet said.

“With bonds offering the most attractive yields for many years – they hit 5 per cent on 10-year US Treasuries, while real yields are at multi-decade highs and a likely slowdown in both growth and inflation – we continue to hold an overweight in fixed income,” Pictet said. 

Pictet continues to prefer quality stocks – companies with high profitability, good earnings visibility, and low leverage – and defensive stocks, it retains its overweight in consumer staples and the Swiss market.

“Japan remains the one bright spot in the developed world: we see it as the only major developed economy growing above potential in 2024,” Pictet continued. “Consumer spending is strong, while governance reforms across the corporate sector are helping attract foreign capital. We expect the Japanese market to deliver earnings growth of just over 8 per cent through this year and next, the highest of any region globally,” the asset manager added. 

Nevertheless, Pictet remains underweight in Japanese government bonds. Inflation is still rising in the world’s third largest economy, which is also experiencing strong growth. This suggests that the Bank of Japan will have no choice but to exit what is an increasingly unsustainable easy monetary policy by raising interest rates in the coming months, Pictet said. In credit, it is underweight in US high yield bonds. Gold is likely to benefit from falling US real rates and a weaker dollar through the year ahead, in Pictet’s view. While its resilience so far and the sharp ascent in the wake of the Israel-Hamas conflict has made valuation challenging, Pictet remains overweight.

Despite the gloomy economic outlook, Pictet's overweight stance on emerging economies remains unchanged for now. “These markets have better growth prospects than developed markets. We retain our increased exposure to energy, a defensive move in the light of heightened geopolitical tensions,” the firm said. In the US, Pictet expects GDP growth to fall behind its peers in 2024.

Anthony Willis, investment manager at Columbia Threadneedle Investments multi-manager team, also highlighted how the economic data is on a weakening trajectory. “The main factor seen as helping consumer resilience is the pent-up savings and transfer payments from the time of the pandemic. Across western economies, consumers have been able to draw down on these excess savings over the past 12 months and this has substantially cushioned the impact from the rising cost of living,” Willis continued. A key factor, in his view, is that consumption will weaken over the coming months, with the data showing that these savings are close to being exhausted.

“The aggressive rate hiking cycles seen in the UK, US and eurozone are also yet to fully impact on economies and there is enough evidence in the leading economic data to suggest that the coming quarters will see a decline in economic momentum, which in some economies, could be enough to push growth into negative territory for two quarters, thus meeting the recession’ definition,” Willis said.  

Sonja Laud, chief investment officer at Legal & General Investment Management, believes that investors should brace themselves for a recession in the US and Europe. Despite the warning lights, Laud said recession still hasn’t arrived. “We’ve been wrong on the timing and now expect the US recession to land in the first half of 2024,” she continued. See more here. 

Laud is not alone in her views. Amundi Asset Management expects a mild US recession in the first half of 2024, and has a cautious investment outlook. See more here. Latest figures from the EU’s statistics agency Eurostat also put the eurozone’s economy shrinking by 0.1 per cent between July and September, sparking speculation that the euro area may fall into a technical recession in the second half of 2023. See here. 

Central banks think it is a difficult time, Willis said. Their forecasts suggest that inflation will remain a challenge for some time and, as such, have suggested that interest rates will remain at current levels for an extended period.

“As we gaze into the future, we do see the economic headwinds increasing and are also cognisant that if we do escape a recession and fall into the soft landing zone, that may well mean interest rates need to stay elevated for even longer to ensure inflation is defeated,” he said. “While it may mean some short-term pain, the clearing event of an economic and earnings recession, which brings about interest rate cuts, may well prove to be a more positive reset than a prolonged period of sluggish growth, higher inflation and elevated interest rates,” Willis continued.

He has a relatively cautious view of the world but, as always, needs to balance macroeconomic fundamentals with a view of whether that news is in the price. Given the very sanguine, near complacent, market mood over the past few weeks, Willis does think that volatility will pick up, but he believes that is no bad thing for the opportunistic and stock picking managers he seeks to invest in.