Jack Manley of J.P. Morgan Asset Management reflects on the economic surprises of 2024 and what lies ahead
This article was produced in partnership with Canada Life Investment Management.
As we reach the midpoint of 2024, it's a good time to reassess the market landscape and prepare for the remainder of the year. Reflecting on the first half of the year, Jack Manley, Global Market Strategist at J.P. Morgan Asset Management in Canada, highlights the unexpected resilience of the U.S. economy.
“For most U.S. equity investors, the theme for the start of 2024 has been unexpected economic resilience,” he notes. This resilience has shaped global markets and impacted various asset classes, particularly with shifting expectations around U.S. Federal Reserve (Fed) rate cuts. Initially, markets anticipated significant rate cuts, but these expectations have drastically changed due to stronger-than-anticipated economic indicators.
“We started this year with the futures market pricing in about 175 basis points of cuts by the Fed by the end of 2024. That's dropped down to about 25 basis points,” Manley explains.
This shift has led to a stronger U.S. dollar, on the back of strong U.S. Gross Domestic Product (GDP) growth. Furthermore, while the first quarter GDP print was revised down to 1.3%, the weakness in U.S. growth was driven by disappointing numbers in inventories and trade, which aren’t particularly concerning when considering the underlying strength of the consumer.
Manley finds that as expectations for the first rate cut have been pushed out, several things have happened. The U.S. dollar has strengthened significantly, which has been detrimental for investors in overseas markets. For instance, Japan's equity market returned significantly more than the S&P 500 in local currency terms, but U.S. dollar returns were cut by about two-thirds due to currency exchange rates. This pattern has affected other regions too, including European, U.K., and Chinese markets.
Volatility in bond and equity markets
There has also been notable volatility in bond markets, especially high-quality ones, as the timing of the first rate cut remains uncertain in the U.S. Manley asserts, “It’s the second year in a row now that we’ve been saying that bonds are back, and yet it's the second year in a row where bonds don't really seem to be back. So far this year, a lot of bonds are losing you money.”
Additionally, shifting rate expectations have introduced volatility even in the U.S. equity market, which has long led global markets in terms of sustainable performance. Much of this is due to the market’s growth orientation, particularly its exposure to technology and artificial intelligence. Growth equity is more interest rate-sensitive than value equity because it relies on long-term earnings growth. Thus, changes in rate expectations have significantly impacted earnings expectations for some companies.
On the flipside, the Bank of Canada is entering cutting mode, just recently lowering the overnight policy rate from 5% to 4.75% with more cuts expected later. Falling interest rates could help Canadian bond holders as values start to rise, making Canadian fixed income more attractive. However, with U.S. rates remaining higher, investors chasing income may be tempted to allocate there instead.
Consumer behaviour
Amidst the volatility, Manley emphasized the importance of the consumer, given the robust U.S. labor market and resilient consumption patterns. He says, “If we're banking on the consumer continuing to be resilient, we see some interesting dynamics. The U.S. is experiencing demographic challenges resulting in a very tight labor market. If people are employed and confident in their job security, and wage growth continues to beat inflation as it has for about a year, these factors should help keep consumer spending robust.”
If consumers continue spending, then consumer-driven components of the equity market should, in theory, do well. However, there are cracks in the armor: credit card and auto loan delinquencies are ticking up, people are starting to repay student loans after a long moratorium, and prices and the cost of living are higher.
In theory, this situation should favor staples over discretionary items because even in tough times, people won't stop buying essentials like toothpaste or toilet paper. Staples are always resilient during consumption downturns. Yet, we also see consumers still spending on discretionary items, though they're opting for lower-quality options.
Illustrating the point, Manley says, “For example, a friend of mine who works in corporate strategy at a large liquor company mentioned that while people still buy alcohol, they aren't choosing top-shelf brands anymore. They're buying a $50 bottle of tequila instead of a $200 bottle. They haven't cut out these items entirely; they're just adjusting their spending habits.”
Sector performance
Manley is a long-term tech enthusiast. He believes it's hard to argue that technology will be less important in 10 years, given the exponential growth in its significance over the last 10 years.
Artificial intelligence (AI) is the current hot topic. While Manley thinks it's unlikely to revolutionize our lives overnight, he points out how many things we take for granted now that were science fiction 15 years ago. Even if AI doesn't meet all its hype, he believes there will always be something innovative and exciting that could drive portfolio returns over the next 10 to 15 years. Manley is a long-term secular tech advocate, and AI is a significant part of that.
The global market strategist also likes financials and believes they are undervalued. He thinks the risk associated with last year's regional banking crisis was overblown. Even with the potential risks from commercial real estate this year, he sees these as specific to individual banks and not something that will wipe out the entire industry.
He says, “I also like the net interest margin story, because unless you are banking at a credit union or a small regional bank or a handful of online institutions, the Fed funds rate is close to 5.5% right now but you're clipping 2 basis points – if you're lucky – on your savings account. Meanwhile, banks can create a 30-year mortgage and charge 7.5% or issue a credit card with a 25% annual percentage rate. There is still a great net interest margin story there, even when rates do start to move lower. Financials haven’t worked for a while, but I am optimistic about that part of the market.”
Manley advises avoiding long-duration bets in portfolios and to remain dispassionate about political influences on the market. Additionally, he highlights the need to be cautious and not make any “big bets on anything, because clearly the data keep changing.”
Manley advises against going all-in on duration due to the small but possible chance the Fed doesn't cut rates this year. Similarly, he warns against fully committing to value stocks, given the potential for AI to continue surprising to the upside and driving growth. When it comes to allocations, Manley recommends a balanced, “boring”, middle-of-the-road approach.
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