3rd quarter 2024
Overview
The global financial landscape experienced notable turbulence at the beginning of August, marked by a downturn and a sharp increase in market volatility. According to BlackRock, we are navigating an unprecedented post-pandemic economic environment characterized by persistent inflation, higher interest rates, lower trend growth, and high government debt. This environment marks a sharp divergence from the past decade, when central banks were able to rely on low inflation to support asset prices through accommodative policies. In contrast, the current economic regime places more emphasis on the real economy, with significant investments in infrastructure, energy systems and technological innovation.
The bond market continues to adjust to rising rates. BlackRock points out that the income cushion offered by bonds has increased and recommends quality income strategies in short-term bonds and credit.
Last quarter: country by country
BlackRock remains underweight European equities, citing concerns about economic growth, despite some attractiveness in valuations and support from European Central Bank rate cuts.
In Asia, Japan remains a country apart. BlackRock points to Japan’s stable macroeconomic outlook, boosted by subdued inflation and increased corporate pricing power. With shareholder-friendly reforms and the likelihood that the Bank of Japan will gradually normalize policy, Japanese equities are increasingly attractive, justifying an overweight. However, the weakening of the yen poses risks for international investors.
Emerging markets present a mixed picture. BlackRock is broadly neutral, noting strong growth in countries such as India and Mexico, which benefit from their intermediate position in global trade especially as the workforce shrinks in developed markets such as Europe and China. However, valuations in India are high, and China continues to face structural challenges, including weak consumer spending, an aging population, and geopolitical tensions.
Artificial intelligence and equity markets over the last quarter
Artificial intelligence is transforming the global economy on a scale reminiscent of the Industrial Revolution. BlackRock sees AI as a key driver of performance over the next six to twelve months, with big tech companies, such as Microsoft and Apple, leading the way. Their combined market capitalization now exceeds all stock market indices such as those of the United Kingdom or Germany. This reflects investors’ optimism about AI, but there are risks, especially around possible overvaluation. The future path could either lead to a productivity boom or see a handful of AI winners being overvalued.
Steve Eisman echoes this sentiment, suggesting that AI’s long-term growth potential means investors should not be divested entirely, even if recession risks arise. However, Damodaran warns against too much concentration in AI, as the industry’s rapid growth comes with the risk of overextension. BlackRock remains firmly convinced that AI will continue to create opportunities in various industries. BlackRock outlines two scenarios in which stocks could thrive: one led by a concentrated group of AI winners, even in a challenging macro environment, and the other where AI-led growth translates into broader productivity gains and sharp rate cuts.
FX
The recent appreciation of the yen, which exceeded 10% against the US dollar between July and early August, has highlighted the volatility of currency markets. BlackRock believes that the US dollar (USD) and the Swiss franc (CHF) remain overvalued, while the Japanese yen (JPY) remains undervalued. DBS Bank’s equilibrium exchange rate (DEER) model confirms this, noting that inflation, productivity, and terms-of-trade spreads all point to an undervaluation of the yen.
According to the NZZ, Swiss exporters are feeling the impact of the strong Swiss franc, and are increasingly concerned that the currency’s strength will hinder the economic recovery. Swissmem, Switzerland’s largest business association, has called on the Swiss National Bank (SNB) to take action. In contrast to 2011, the SNB still has some room for manoeuvre with interest rates to curb demand for the CHF.
World equities
The global stock market remains polarized, with the AI sector standing out. Aswath Damodaran cites Nvidia as a great example of how quickly AI winners can emerge and be rewarded by the markets. However, concentration risks, particularly among the “Magnificent 7” technology stocks, are concerning. Marc Faber predicts a shift in market leadership, with value stocks potentially taking over from growth stocks, including AI-based names. For him, the US stock market could see a substantial revaluation due to the disappointment in economic earnings and corporate earnings.
Despite these concerns, Hong Kong and China remain undervalued, according to Augur Labs. The Hang Seng Index recently reached a CAPE of 10, a level historically associated with major market lows. This hints at the potential for a rebound, making these markets attractive to long-term investors.
Conviction and inspiration for investors
In this volatile and fast-paced environment, diversification remains the cornerstone of the investment strategy. A traditional 60/40 portfolio (60% S&P 500, 40% U.S. Treasuries) has historically returned 8.5% per year since 1926, according to Bloomberg’s Nir Kaissar. While these portfolios can experience sharp downturns, they have consistently recovered and reached new highs.
For BlackRock, private markets, for example, offer access to companies that are poised to grow in this context of rapid change, although the complexity of these markets may not be suitable for all investors.
BlackRock’s overweight in Japanese equities reflects its strong conviction in this market, where corporate reforms and stable macroeconomic conditions offer attractive returns. For his part, Steve Eisman makes the case for value stocks, noting high valuations in the US and India, while Aswath Damodaran reminds us of the interconnected risks in today’s global markets.
Ray Dalio, meanwhile, suggested prioritizing gold over Bitcoin as a store of value in times of uncertainty, aligning with his broader view of managing risk in a crisis-prone world. DBS Bank maintains an overweight in Asian equities (ex-Japan) and expects Europe to remain underweight relative to the US, Japan and the UK.
In the emerging markets sector, countries such as India and Saudi Arabia present long-term opportunities amid changing global forces (even if targeted country investments through ETFs remain expensive), while Japan stands out from developed markets by transforming its businesses under the impact of inflation.
Based on a value approach to currencies and equity markets, the focus will be on Asian equities (excluding Japan), Japan and the United Kingdom for this quarter.
Sources:
- BlackRock Global Investment Outlook
- Aswath Damodaran's equity and AI market analysis
- Steve Eisman's views on AI and value investing
- DBS Research on currency markets
- Marc Faber's equity and market leadership shifts
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