Aviva Investors, the global asset management business of Aviva PLC, believes that disinflation and political risk are currently the two key themes driving market movements, according to the firm’s latest quarterly House View.
Whilst the asset manager predicts that global growth will slow very slightly to around 2.7% across 2024, marking a small decrease on the 2023 figures of 3% growth, there remains little slack in most economies and labour markets continue to be tight in most emerging and developed markets. However, while this “soft landing” will be regarded by most as a relief, given a hard landing and recessions were previously considered risks or even consensus, there is a trade-off: inflation convergence to targets has been stalling, as the “last mile” is proving the toughest in many economies.
There is little doubt that interest rates have been raised to levels that constrained growth and lessened inflation pressures in all major markets. The question now is: how restrictive are those rates, and for how long they will need to be kept in such territory? The evidence is mixed, and the risk outlined in previous Aviva Investors House Views of disinflation slowing or reversing has been realised. In the U.S., underlying inflation is just below 3%, and will take another year and a half to get to 2%, in our forecast; this is similar in the Eurozone, where inflation lately reaccelerated even though growth is much weaker.
The Bank of England and the Fed should follow the ECB in cutting rates in due course, but given the dynamics described above, they will do so cautiously. Emerging market central banks have also slowed down rate cutting cycles and are constrained, to some degree, by the Fed and continued dollar strength. Japan remains an outlier: the BoJ is likely to hike rates faster than markets expect and may continue to use QE to slow yield rises even as it intervenes to limit yen depreciation.
In the Eurozone, growth continues to improve most rapidly, led by the continued strength in the periphery (Spain, Italy) and as Germany recovers from recession; GDP will pick up to about a 1.5% pace. In the U.S., the rebound after an inventory correction will probably wane, even with job creation and services remaining solid; growth should settle down towards 2% after the recent 3% above-potential pace.
In Asia, China came into the year with growth at a nearly 6% annualized pace, but front-loaded investments and exports are likely to give way to the drag from the property sector depression and weaker consumption, with growth slowing to around 5% this year and then to 4% in subsequent years.
Regarding asset allocation, Aviva Investors prefers to be overweight equities, tilted towards quality and growth markets, such as Japan and the U.S. on a country level. Their stock markets are more expensive than the UK and the Eurozone, and concentration risk is a concern, but “cheap” markets on simplistic valuations do not automatically augur value. The investment team view the current environment as neutral for government bonds generally, with their negative carry relative to cash, inverted yield curves, and positive correlation to risky assets making them poor diversifiers. The team enter Q3 with a mildy bearish tactical bias on the US dollar, due to the spate of relatively weaker US data, but expect volatility and dollar strength to resume in the run-up to the U.S. election.
Michael Grady, head of investment strategy and chief economist at Aviva Investors, said:
“We expect the next 12 months to be somewhat of a tug-of-war for markets, as the disinflation process slows, while political risks rise. On the one hand that could be supportive of risk assets while limiting the extent of rate cuts as inflation only slowly falls back to 2%. On the other hand, election outcomes that result in more isolationist policies could result in increased market volatility and a more challenging environment for risk assets.
“Looking into the early part of H2, we prefer to be moderately overweight equities, with economic and corporate fundamentals supportive. However, with the main political risk likely to come with the US elections in November, we expect a more cautious allocation may be necessary as it approaches.”
