Talking Heads – La valutazione dei punti di svolta nell'outlook azionario

This is an edited audio transcript of the Talking Heads podcast episode: Assessing turning points in the equity outlook

Andrew Craig: Hello, and welcome to the BNP Paribas Asset Management Talking Heads podcast. Every week, Talking Heads will bring you in-depth insights and analysis on the topics that really matter to investors. In this episode, we’ll be discussing the outlook for developed equity markets. I’m Andy Craig, Co-head of the Investment Insight Centre, and I’m joined today by Daniel Morris, who besides being Co-head of the Investment Insight Centre,  is our Chief Market Strategist. Welcome, Daniel, and thanks for joining me.

Daniel Morris: My pleasure, thanks, Andy.

AC: This week we’ve published our outlook for equities in the fourth quarter. The title we gave the publication is ‘It’s the economy’ – it focuses on what we see as the main factors likely to influence the performance of equity markets in the coming months.

So, let’s go through those topics and start with the US Federal Reserve, which in September cut its benchmark interest rate by 50 basis points, the first reduction in official rates in four years. How do you see this affecting equity markets?

DM: Well, in the title you mentioned – ‘It’s the economy’ – there’s a word that follows that in a famous quote from a political strategist during a previous US election. His point was [that] when you’re talking to citizens and who they should vote for, he said “it’s the economy, stupid” that matters. The idea was that you need to really focus on that – it’s what really matters to people.

When we then put that in the context of the Fed cutting interest rates, you see a lot of people trying to predict what the Fed is going to do and when – “Is it going to be [a] 25 basis point [cut] at the next [policy] meeting or 50?” and so on. Certainly that matters, particularly if you are a short-term fixed income portfolio manager. But I think for most investors, that’s of secondary importance. The really important thing is the economy. Think about the last five cutting cycles that we’ve had in the US since the 1980s. We use that as a benchmark to evaluate how different asset classes, different markets, might react when you have the Fed cutting rates.

What we have done is look at those five cutting cycles and then evaluate how equities performed in different sectors, different styles, different parts of fixed income. And what you find is that it’s not the fact that the Fed is cutting interest rates that’s the most important thing; It’s whether or not the economy was growing or was in a recession.

In fact, in those five cutting cycles, the US economy ended up going into a recession in four out of [them]. But even that doesn’t necessarily give us the whole answer, because it [also] mattered when that [recession] took place.

In two of the cycles, the US economy entered a recession within two or three months, and there you saw a very clear outperformance for fixed income relative to equities as you would expect – slow growth, negative growth and interest rates falling because of that slow growth.

In the other three instances, though, when in one case you actually did have a soft landing – which is what we’re expecting for this cycle – or in the other two, where the recession did eventually occur, equities did better than fixed income for the most part, credit outperformed government bonds, and in general, risk assets, as you would expect, outperformed defensive assets because you had an expanding economy.

The bottom line is you really want to be focusing on the indicators of how robust US economic growth is – looking at purchasing managers’ indices and non-farm payrolls as we have, because that’s going to be the key driver of corporate profits.

AC: The other major event that we have coming up is the US presidential election on 5 November. What do you think investors should be thinking about in terms of the potential ramifications for markets in the short term?

DM: Honestly, I think the election is not so important for the markets. I say that because we have all seen the polls [and] the headlines saying the race is extremely close. [I think] what that means is investors aren’t going to be trying to position themselves for a particular outcome given the odds seem to be more or less 50:50. I want to highlight that as important as it is who turns out to be president from a market point of view, it’s going to be more important what happens in the US Congress: do you end up having single party control or do you have divided government?

The reason that matters is because when you have single party control in Congress and also the same party controlling the presidency, there’s often scope to do quite significant things that affect the economy and markets.

Think of Obamacare. Democrats had full control. [or] Trump’s tax cuts – that was  when the Republicans had control. Even the Inflation Reduction Act it was [when] the Democrats [were in] control.

Let’s assume that you get a divided Congress, Democrats controlling one part, Republicans the other. The assumption is you’re going to have gridlock.

Now, markets aren’t necessarily so bothered by gridlock. Nonetheless, depending on which party wins the presidency, we can look at the different proposals from the two candidates.

The thing I want people to keep in mind is that, broadly, we anticipate a soft landing in the US, meaning US growth is going to continue to be positive this year and next year, even if it is at a slightly slower rate. [That] should still be a positive environment for equities, even if inevitably there’s going to be some differences at a sector level depending on who wins.

AC: If we just look at what’s been happening recently, in the first week of October, we saw a spectacular rally in China’s equity market. How do you see this playing out? What do you think are the implications for the medium-term outlook?

DM: Well, first, perhaps a comment about what’s happened over the last couple of weeks. At one point, the MSCI China index was up [by more than] 30%, which is spectacular. [But] I think what was more interesting than the returns for the Chinese equity market is what you saw for other equity markets.

Let’s not forget, China is the second largest economy in the world and, at least before the pandemic, we focused much more on what was happening in China than in the US, which is a mature developed economy [that is] not really able to grow all that quickly.

We look to China to drive demand globally. You would think with a 30% increase in Chinese equities that it would suggest something pretty major is going on in the Chinese economy and therefore that should have a global impact.

What you saw, though, if you looked at the equity markets for countries that are relatively exposed to China –  like Europe, like Japan – they didn’t really move all that much in the first couple days after the initial announcement of the stimulus, when you had Chinese equities up [by] about 15% at that point, European equities were up [by] almost 4%, Japan [by] a bit more.

So, a decent bump, but maybe not quite as big as you might expect given the reaction domestically. What’s interesting is that subsequently even those relatively small gains have faded. As you had Chinese equities to continuing to go up, other markets pulled back.

I think there’s a couple of messages in that relative performance. I think this outsized return for Chinese equities compared to other markets does suggest that those returns were at least partly driven by positioning.

By that I mean you had, for example, hedge funds that were short Chinese equities and then once you have the rally, they faced what’s called a short squeeze. They had to buy equities to cover the short positions. And that buying, in and of itself, pushes markets up even further so that the rally you’ve had in Chinese equities then maybe [becomes] more of a technically driven rally as opposed to a massive change in the fundamental outlook. Do investors think that valuations have improved by 15% because of this announcement or that you’ve increased your earnings expectations by 15%? Certainly, things are better, but probably not quite to that degree.

And what about the medium term? The country still faces challenges. The property market is still depressed. Confidence is low. We think there is going to need to be yet more measures from [Beijing] before those issues are fully addressed.

AC: Thank you very much, Daniel, for joining me.

DM: My pleasure.