New year, new highs

Equity markets have commenced 2024 in the same way 2023 concluded: strongly. Several indices have registered record highs, and the soft-landing narrative has gathered further momentum. Following the positive start to the year, with data suggesting the US economy remains on solid ground and rate cuts a distant prospect, the risk/reward trade-off continues to favour fixed income. Our Chief Investment Office explains further.

Our view

The new year has so far been a positive one for most equity investors. The ASX, S&P 500 and Nasdaq 100 have registered new all-time highs and even the Nikkei is fast approaching its previous peak – one not seen for more than three decades. Indeed, just over one month into 2024 and the year-end indices targets set by some investment banks at the end of 2023 have already been met.

Bonds haven’t fared quite as well. Where markets were initially pricing for as many as seven rate cuts from the US Federal Reserve (Fed) as early as March, economic data and hawkish Fedspeak have since pushed back on this prospect. As noted in our 2024 Global Market Outlook, this pricing seemed aggressive. Indeed, jobs numbers, ISM readings and US GDP figures released over the initial stages of the year suggest the Fed is unlikely to be in any rush to ease policy.

Aside from a small wobble towards the end of January, developed market equities have seemed largely unfazed by the prospect of a ‘higher for longer’ rate environment; never mind further trouble across China’s beleaguered property market and potential supply shocks from ongoing warfare in the Middle East. In the case of the latter, the latest ISM services prices index jumped 7.3pts to 64pts, indicating that costs are rising at a faster pace, likely due to higher shipping costs.

Alongside the increased potential for a soft landing, the US earnings season has also been supportive for equities. While not overly strong, the misses have yet to prove catastrophic and perhaps most importantly several of the ‘Magnificent Seven’ including Microsoft, Apple, Meta and Alphabet have delivered positive EPS surprises. Nonetheless, both the percentage of S&P 500 companies reporting positive earnings surprises and the size of those surprises remain below average.

Given the strength of the US economy to date, we didn’t expect this reporting season to produce too many negative surprises. Rather, we look towards the Q1 and more likely Q2 earnings seasons as a potential starting point for more material misses. Of course, if the US economy remains on solid footing this could be delayed further and the ‘goldilocks’ fairy tale may continue. Even so, we are inclined to believe that the longer financial conditions remain restrictive the harder it will be for consumers to continue absorbing higher prices; eventually we expect this to weigh on corporate earnings as a result. And while the Fed has likely finished its tightening cycle, the latest Senior Loan Officer Opinion Survey shows US banks reported stricter credit standards over the final quarter of last year, indicating credit conditions for corporates remain tight.

Nonetheless, the continued rise in equity markets has been pleasing to see and given the current market exuberance it is possible this momentum could continue for some time.

However, we were already cautious prior to the year commencing, and there has been no new economic data to assuage our concerns that equities have possibly run too hard relative to fundamentals. Furthermore, while January has historically been a strong month for equities, February has traditionally been the opposite. In fact, it is the second worst month on average for S&P 500 returns. Providing us some comfort is the fact that neither investor sentiment nor positioning are at extremes, potentially providing some cushion if a risk-off environment materialises.

Conversely, even though yields have risen strongly over the start of the year (something previously noted as possible given the sharp retracement over November and December), continuing disinflation, and the likelihood that central banks have finished tightening, should provide some ceiling for yields – that is, unless inflation reaccelerates.

So, while we cannot rule out better investment returns from equities in the near-term, given the strong start to the year and the current yield available on risk-free assets, we are confident that bonds should provide better risk-adjusted returns for investors over the period ahead.

February has historically been the second weakest month for the S&P 500

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Source: S&P Global, Macrobond, ANZ CIO

What this means for our diversified portfolios

This month we remain positioned defensively across portfolios with an overweight to global fixed income, including investment grade credit and sovereign bonds. Similarly, we hold a mild overweight to domestic fixed income.

Across risk assets, we are positioned with an underweight overall. Here, global high yield remains our least preferred exposure across portfolios. Rather we maintain a bias for high quality assets. We are at benchmark to developed market shares and are mildly underweight Australian shares. Following underperformance in January our position in emerging market equities has drifted to a mild underweight and we maintain this position for now.

Our defensive positioning is premised on the belief that wealth is created through long-term compounding of returns. Ensuring one can remain invested throughout the full market cycle is critical to achieving this. During periods of uncertainty and where asset prices have disconnected from market fundamentals, we seek to position portfolios so they can broadly participate in market rallies while maintaining a defensive bias to provide downside protection in the event of a significant pullback. We will continue to look for opportunities to tactically tilt portfolios to protect capital and take advantage of opportunities as they present over the period ahead.