RISK ASSETS SUPPORTED BY HEALTHY EARNINGS OUTLOOK
Apr 9, 2024
In its 2Q 2024 Outlook, PGIM Quantitative Solutions sees moderate economic growth and solid earnings ahead as rates stay elevated.
U.S. EQUITY MARKET RALLY CONTINUED
Following robust gains in 2023, equity markets continued their strong run in the first quarter of 2024. As in 2023, growth stocks continued to lead the way, though by a smaller margin, when growth trumped value by nearly 30%. The widening breadth of market participation is another notable market contrast relative to 2023, when the “Magnificent Seven” (M7) accounted for two-thirds of the S&P 500’s advance. So far in 2024, the M7 has contributed a still remarkable one-third of the returns to the S&P 500, but the remaining 493 stocks in the index are now contributing the majority of returns.
The Bloomberg U.S. Aggregate Bond Index has started 2024 in the red as expectations for as many as six Fed rate cuts at the beginning of the year have evolved to just three possible cuts as of March 20, leading to a year-to-date rise in yields across the curve. For the balance of 2024, the outlook for bonds remains tenuous. A return to a positively sloping yield curve will require rates to move higher on the long end of the curve, or short rates to move lower, or some combination of both. Barring a rapid deterioration in the economy, a sizeable duration rally seems unlikely in the near term, with a non-trivial risk that rates could move higher still if inflation continues to stay above the Fed’s 2% target.
Our outlook for asset outcomes for the balance of 2024 hovers in flat-to-moderately positive territory. There are overhangs from overly strong asset performance, including elevated equity valuations, moderating inflation trends, and still-subdued manufacturing activity. However, we don’t consider these factors to be a danger to absolute positive performance, but instead, just a ceiling on what could happen.
ELEVATED BUT DECLINING INFLATION
On the inflation front, expectations are for a significant decline from last year’s levels after both G7 headline and core inflation pulled back sharply from their 2023 peaks. Although these expectations are partly an extrapolation of those declining trends continuing into 2024, more recent inflation readings suggest that core inflation is turning out to be stickier. While global core goods inflation eased significantly with the removal of supply-chain bottlenecks, falling commodity prices, and weak goods demand during 2023, this decline has been fading recently amid a pickup in goods demand and firming input costs.
With inflation continuing its bumpy progress towards the Fed’s target and slower predicted growth over the rest of the year, we expect the Fed to start its easing cycle sometime toward the middle of 2024. Meanwhile, the European Central Bank (ECB), which has kept policy rates unchanged since September 2023, has also indicated in its March meeting that the first rate cut in this cycle could be in the coming months. In contrast, the Bank of Japan (BoJ) ended its ultra-loose monetary policy in March by exiting negative interest rates and yield curve control. However, even the BoJ has signalled that it won’t tighten policy any further for now given its focus on avoiding significant disturbance to the economy.
EARNINGS EXPECTATIONS REMAIN SOLID
Global earnings growth was modest in 2023, with significant declines in energy, commodity, and healthcare stocks offsetting gains in consumer discretionary and communication services holdings. In the U.S., earnings are on an improving trend.
Following modest growth in 2023, the consensus is for low-double-digit growth in both 2024 and 2025 as the economy is expected to grow at a moderate pace, with many industries having already experienced an earnings recession and a tightening of purse strings, setting the stage for margin improvement. Labor productivity has also accelerated in recent quarters. Even if current expectations are revised lower, earnings growth could still turn out moderate barring a significant economic slowdown that could be a hit to sales. Outside the U.S., expectations are for moderate developed-market growth and for a double-digit rebound in emerging markets after GDP declines over the past two years.
POSITIVE GROWTH IN EMERGING MARKETS AND JAPAN
Regionally, Japan is relatively more attractive, with still-easy monetary policy, fiscal stimulus to boost both consumer and business spending, and among the fastest earnings-growth expectations globally. The earnings outlook for emerging markets is also attractive and stands to benefit from easing Fed policy. With China remaining a drag on broad emerging markets indexes, an alternative might be to gain emerging-markets exposure ex-China. Factor-wise, PGIM Quantitative Solutions favours quality as firms are likely to remain constrained by the steep cost of capital due to still-high interest rates.
VOLATILE BUT MODERATE RETURNS FOR COMMODITIES
Commodities returns are likely to be moderate but remain volatile after a down year in 2023. While tight monetary policy and a strong dollar were negatives in 2023, year to date in 2024 commodities returns have essentially held flat. OPEC+ is expected to continue to manage supply expectations by maintaining its guidance on supply. However, there are still downside risks from sharply slower global growth and higher-for-longer interest rates.
References to specific securities and their issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities. The securities referenced may or may not be held in the portfolio at the time of publication and, if such securities are held, no representation is being made that such securities will continue to be held.
The views expressed herein are those of PGIM investment professionals at the time the comments were made, may not be reflective of their current opinions, and are subject to change without notice. Neither the information contained herein nor any opinion expressed shall be construed to constitute investment advice or an offer to sell or a solicitation to buy any securities mentioned herein. Neither PFI, its affiliates, nor their licensed sales professionals render tax or legal advice. Clients should consult with their attorney, accountant, and/or tax professional for advice concerning their particular situation. Certain information in this commentary has been obtained from sources believed to be reliable as of the date presented; however, we cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. The information contained herein is current as of the date of issuance (or such earlier date as referenced herein) and is subject to change without notice. The manager has no obligation to update any or all such information; nor do we make any express or implied warranties or representations as to the completeness or accuracy.
Any projections or forecasts presented herein are subject to change without notice. Actual data will vary and may not be reflected here. Projections and forecasts are subject to high levels of uncertainty. Accordingly, any projections or forecasts should be viewed as merely representative of a broad range of possible outcomes. Projections or forecasts are estimated based on assumptions, subject to significant revision, and may change materially as economic and market conditions change.
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