“Navigating Market Rebounds and Rate Cuts Amid Global Economic Shifts”

Marco

Turning to recent market performance, we have witnessed a significant rebound across major asset classes which has resulted in positive month-to-date returns. In the equities space, our preference continues to lean towards US Large Cap stocks, driven by more robust earnings forecasts in the US compared to other regions. This sentiment is corroborated by the substantial equity ETF inflows, particularly in the Large Cap and Technology sectors during early August. Conversely, Small Cap stocks have experienced outflows, likely as investors take profits following softer-than-expected US economic data. Outside the US, we are maintaining allocations in developed markets such as Japan and Europe, recognising the diversification benefits they offer. However, we remain neutral on both regions, with a close watch on the monetary policy decisions from the BoJ and ECB.

In the fixed income space, we continue to advocate for locking in yields on core bonds, such as US Treasuries and Investment Grade Corporate Bonds in anticipation of a September Fed rate cut. Over the past two months, short-term rates have declined more rapidly than long-term rates and last week’s record-high fixed income ETF inflows for 2024 highlights the narrow window for investors to secure attractive yields.

Within the US equity market, the increasing expectations for rate cuts is likely to provide a tailwind for cyclical sectors. Our strategic asset allocation remains guided by long-term megatrends, including advances in artificial intelligence, technological innovation, and the rising healthcare demands driven by an aging global population. While the US stock rally has broadened from Technology into other sectors such as Financials, Consumer Staples, and Utilities, we maintain an overweight position in Technology, Communication Services, and Health Care. These sectors have demonstrated superior earnings growth against their 20-year averages, which has been a primary driver of their outperformance. Within the technology sector, the Semiconductor sub-sector continues to attract significant investor interest, particularly as the potential of AI remains a focal point of market attention.

In conclusion, while our strategic asset allocation has remained largely consistent throughout the year, the recent market pullback presents a timely opportunity for investors to reassess their portfolios. This period allows for a recalibration of risk appetite and a consideration of further diversification across asset classes to navigate the evolving market landscape.

Bonds

The Fed is now more focused on the labour market in determining the pace of cuts, given there is enough accumulation of evidence on the inflation side that it can be more confident about a smooth path back to target. Therefore, the market should be less sensitive to inflation prints from here. On labour market conditions, there is heightened focus on the scenario that continued cooling could transition to a more serious deterioration. The FOMC will very likely cut 25 bp at the September meeting, but if there is an unemployment uptick, markets could price in a greater likelihood of 50 bp cut(s) and the FOMC probably would not push back on this. Over the next several weeks, yields are unlikely to rise materially from current levels. Expect asymmetry is towards softer payroll prints which can cause yields to drop further, while in the event of a strong print yields will likely not rise by as much. We are inclined to increase duration of bond portfolios.

US PCE Inflation Improving, Unemployment Worsening

In Thailand, new Prime Minister Paetongtarn Shinawatra – who succeeded PM Srettha after he was removed from office for violation related to appointment of an unqualified person in his Cabinet – will reassess the ruling party’s plan to hand $14 billion in cash payments to citizens, to ensure compliance with fiscal discipline legislation. The latest development brings risks of delay to the fiscal stimulus and thus drag on economic growth. Given Thailand’s low economic growth rates – GDP grew 2.5% in 2022, 1.9% in 2023, 2.6% expected in 2024 – this increases overall macroeconomic risks for the country while Thailand IG spreads at 127 bp currently appear rich. In comparison, Southeast Asian peer Malaysia is experiencing more favourable growth dynamics and political stability. Malaysia GDP grew 8.7% in 2022, 3.7% in 2023, 4.5% expected in 2024. Malaysia IG spreads at 81 bp for the A rated sector and 139 bp for BBB rated sector are wider than the Asia average for their respective rating buckets. We are inclined to switch from positions in Thailand to the better fundamentals and more favourable valuations of Malaysia credits.

In Macau, concerns on regulatory tightening have re-emerged for the gaming sector. Macau legislators seek to criminalize unlicensed money exchange activities, a common way for mainland patrons to circumvent China’s capital controls. Despite these concerns, the gross gaming revenue (GGR) impact of criminalizing unlicensed money exchanges may not be as significant as some may fear, provided that legal local pawn/jewellery shops are not banned. Meanwhile, Macau July GGR increased 11.6% year-on-year, 5.1% month-on-month to MOP 18.6 billion ($2.31 billion). The latest monthly figure took Macau’s GGR for the first 7 months this year to MOP 132.35 billion, up 36.7% on the prior-year period, and represents 76.1% of the GGR in the first 7 months of 2019. At current GGR levels, the gaming operators are all generating strong free cash flows. In the event of regulatory tightening, more credit differentiation could emerge. We are inclined to position in the lower leverage Macau gaming operators as they would be better placed to absorb any potential impact from the legislative changes.

Equities

The current market sentiment is pricing in a 25-basis point rate cut at the upcoming September Fed meeting. We believe this anticipated shift towards monetary policy easing will act as a tailwind for U.S. equities. While the market has largely anticipated this rate cut, leading to partial pricing in of its benefits, we do not believe the positive impact has been fully realized. Should the Fed successfully lower rates in a manner that facilitates a soft landing, avoiding a recession, it could create favourable conditions for corporate profit growth. In our view, this scenario could further support the continuation of the current run through the remainder of the year.

Historically, following the initial Fed rate cuts, U.S. equities have generally performed positively in the subsequent months and even over the next one to two years. This positive performance is often driven by the broader economic benefits of lower borrowing costs, which tend to support stock market valuations. While exceptions to this pattern include periods like the dot-com bubble and the global financial crisis, the current environment differs notably from those past scenarios.

Given these historical trends, we expect the current market rally to persist. However, we also anticipate some volatility in the aftermath of the initial rate cut, potentially stemming from weaker economic data, geopolitical uncertainties, or factors related to the U.S. presidential elections.

For equity markets to sustain their upward trajectory, corporate earnings will be crucial. Data indicates that the primary sources of earnings growth—revenue, margins, and share count—have been largely driven by margin expansion over the past year. As we advance further into the current cycle, companies’ ability to sustain or protect these margins will be vital for continued earnings growth in the quarters ahead. Analyzing earnings across sectors from two key perspectives—year-over-year earnings growth for both quarterly and full-year 2024 and 2025, as well as the sustainable growth rate (ROE multiplied by the retention ratio)—highlights that the consumer discretionary, technology, and communication services sectors are particularly well-positioned. These sectors present a favourable outlook, making them worthy of close consideration for investors seeking growth opportunities.