As the first quarter of 2024 draws to a close, global equity markets have delivered remarkable gains. Our latest 2024 Q2 Market Outlook also focused on what’s next for the market. Subsequently, we have received many questions from our users. In this article, we’ve compiled the nine most pressing questions and share our view:
- Will there be a stock market correction in the second half of the year? What stage is the manufacturing industry in?
- What about bonds? Should I go for long-term or short-term bonds? How will rate cuts affect the bond market?
- What’s a good mix of stocks and bonds now? Is it better to have more stocks or bonds in my portfolio right now?
- Stocks are looking pricey. What's a good time to enter the stock market?
- Is the Fed poised for rate cuts? What circumstances might prompt a new round of tightening?
- Has the market already priced in rate cut expectations? How will rate cuts affect the stock and bond market?
- How can we tell if rate cuts are preemptive or reactive to recessionary pressures?
- Where are we in terms of the dollar cycle? What’s your outlook for the dollar?
- What’s your take on the Japanese yen? Will the BoJ further hike rates? Will that impact the global economy?
Q1: Will there be a stock market correction in the second half of the year? What stage is the manufacturing industry in?
The global stock market has been on an upward trajectory for nearly 1.5 years since rebounding from its lows in Q4 2022. Meanwhile, having bottomed out in 1H 2023, the global manufacturing industry has entered what we call the “passive destocking” phase (where inventory naturally clears out with demand picking up), the first of the two phases of the upswing cycle of the manufacturing industry. Over the past few months, as the global economy began to show signs of recovery, the gap between new orders and inventory in the manufacturing sector for various economies turned positive one by one, indicating the global manufacturing sector has shifted into the “active restocking” phase in 1H2024, which is the second phase of the upswing cycle where manufacturers actively restock with demand further picking up.
Drawing from historical patterns, the transition of the manufacturing cycle into the second phase of the upswing cycle is usually accompanied by stock market rallies, as highlighted by green shading in the chart below. This is also why we have been bullish on the stock market for the first half of the year. Looking ahead, investors should monitor whether the manufacturing sector is entering the “passive restocking” phase, where inventory builds up and the MM Manufacturing Cycle Index enters a plateau phase. In this context, though the stock market still has the potential to reach new highs, volatility is also expected to increase, as suggested by the dotted line circles.
Q2: What about bonds? Should I go for long-term or short-term bonds? How will rate cuts affect the bond market?
In contrast to anticipating seven rate cuts (pricing in potential recession risks in the US), following the March FOMC meeting, market expectations for rate cuts this year have finally converged with the three-cut projection suggested in the latest dot plot, and currently the market is even trimming expectations to just two rate cuts for the year.
In the bond market, yields on 3-month, 2-year, and 10-year US Treasuries currently stand at around 5.4%, 4.6%, and 4.2% respectively. That is, yields on bonds with maturities longer than a year have already partially priced in the anticipated rate cuts for the year.
The actual rate cuts, which will be precautionary cuts in nature, are more likely to be reflected in declines in short-term bond yields. Meanwhile, longer-term bond yields are expected to remain relatively steady as long as there are no clear signs of economic downturns. That is, yield curve normalization will mainly be driven by downward movements of short-term yields.
Overall, during a rate cut cycle, investors can consider including both long- and short-term bonds in their portfolios. It’s important to note that, in the context of precautionary rate cuts (vs. rate cuts reactive to recessionary pressures), returns on bond investment, long-term and short-term bonds alike, will mainly be driven by interest payments, while short-term bonds offer more room for capital gains as the yield curve normalizes.
Q3: What’s a good mix of stocks and bonds now? Is it better to have more stocks or bonds in my portfolio right now?
Economic fundamentals play a crucial role in determining allocation between stocks and bonds. Bonds tend to perform well during recessions or crises, where central banks aggressively cut interest rates and implement QE to stabilize the market. In this environment, bonds often yield strong capital gains and act as an effective hedge against stock market downturns, making it a rare time when bonds outperform stocks. Conversely, against the backdrop of preemptive rate cuts and a stable economy, bonds offer steady interest payment but may pale against the excess returns stocks deliver. In a nutshell, allocation to bonds hinges on which rate cut scenario we are in, with a higher allocation favored in the former scenario and lower weighting for the latter.
Overall, we still recommend higher allocation to stocks as economic expansion persists, where bond investments serve the purpose of steady income generation and risk hedging. Weighting wise, given the current interest rate environment (which no longer resembles the ultra-low levels during the pandemic), allocation to bonds for income-generating purpose can be increased (e.g., from the 80/20 stock-bond mix during past economic expansions to a 70/30 portfolio). From there, we can continue to monitor economic growth and shift towards bonds when growth dips below long-term averages or slows down rapidly or enters recessionary territory.
Q4: Stocks are looking pricey. What's a good time to enter the stock market?
The ongoing stock market rebound has progressed from last year's consolidation and recovery phase with mixed market sentiment on the economic outlook, to a phase where strengthening fundamentals are broadly reflected in companies’ financial results.
For those with shorter-term investment horizons, as mentioned above, since the manufacturing cycle just entered the “active restocking” phase, we believe the bull market can still enjoy at least 1-2 quarters of tailwinds.
As for investments with medium- or long-term horizons, timing considerations can focus on identifying the turning point of the current economic upcycle, based on the cycle investing principle of “buy at economic lows and sell during economic booms.” In this case, Taiwan’s export data can be useful—Taiwanese export growth typically leads reversals in the MSCI ACWI by 8~12 months. Investors can monitor for signs of slowing export momentum in the second half of the year as bases become higher.
Q5: Is the Fed poised for rate cuts? What circumstances might prompt a new round of tightening?
Based on the traditional Taylor rule formula, with core PCE inflation down to around 2.8% and unemployment rate at around 3.9%, currently there is already room for three rate cuts. Prescribed federal funds rates based on other models the Fed uses are also below the current interest rate level, indicating the Fed is now in a position to cut rates, though still waiting for clearer data signals before taking action.
As for possibility of returning to rate hikes, based on the Taylor rule, this risk would only emerge if core PCE inflation reverses to an upward trend and approaches the 4% mark, which would trigger talks of rate hikes again. This is why we have maintained the view that the Fed’s forward guidance to manage market expectations on the timing of rate cuts would have minimal impact on the market. Meanwhile, with the Cleveland Fed’s Inflation Nowcast still forecasting a continued decline in core PCE inflation, the risk of rate hikes making a comeback remains low.
Q6: Has the market already priced in rate cut expectations? Respectively, how will rate cuts affect the stock and bond market?
For the bond market, currently the yield curve is still inverted, with the 10-year Treasury yield at 4.4%, suggesting long-term bonds have very likely already priced in the anticipated three rate cuts for the year depicted in the Fed’s dot plot. Similarly, at 4.6%, the 2-year yield has also fallen within the range of 4.5~4.75%, which is indicative of three rate cuts. In contrast, yields on Treasury bills with a maturity of one year or less are still in the range of 5.25~5.50%, and their pricing will gradually adjust only after an actual rate cut happens.
For the stock market, judging from the fact that the S&P 500's P/E ratio is already above the five-year average, some of the rate cut expectations have likely been priced in. That said, we suggest taking a longer-term view of the rate cut cycle. The dot plot suggests we may be in for more rate cuts in the next two years, with the potential for three cuts each. Moreover, besides interest rates, economic fundamentals and corporate earnings also influence valuations. Therefore, as long as the Fed maintains its course of rate cuts without signaling a return to rate hikes, the impact on stock valuation will likely remain limited.
Q7: How can we tell if rate cuts are preemptive or reactive to recessionary pressures?
Economic fundamentals provide a good frame of reference. For instance, the latest US nonfarm payrolls, which saw a gain of 275,000 jobs, and the real PCE growth at 2.37% are both above long-term averages, indicating a robust economy.
Against this backdrop, the Fed still plans for three rate cuts this year taking other factors into consideration, including the fact that the real interest rate (policy rate minus inflation) is close to 3%, and events like the looming corporate debt maturity wall and price declines in commercial real estate. This shows the upcoming rate cuts are more precautionary than reactive.
We can also look at the pace and magnitude of rate cuts. Preemptive cuts are usually more gradual and sporadic, while recessionary cuts tend to be more aggressive.
Q8: Where are we in terms of the dollar cycle? What’s your outlook for the dollar?
Historically, the US dollar goes through a cycle roughly every 16~18 years, with each weakening phase accompanied by the rise of new economic powers (such as the Asian Tigers in the 1990s, the Eurozone’s formation in 2000, and the emergence of BRICS economies) and ending with crises with these economies (such as the Asian Financial Crisis, the Eurozone debt crisis, and the emerging market crisis of 2015).
We initially thought that the COVID-19 pandemic would mark the peak of the upswing phase of the current dollar cycle. However, the loose monetary policies that followed caused the currency to fluctuate within a range instead. On top of that, a new economic power challenging US dominance remains absent. Thus, the future course of the dollar cycle is still unclear.
We do expect the dollar cycle to shorten, mainly driven by the alternating alternating strengths of the service and manufacturing sectors. During upswings in the manufacturing sector, foreign economies thrive while the US dollar weakens. Conversely, during expansions in the service sector, the US economy tends to outperform others, leading to a stronger US dollar, until another economy emerges as a challenger.
Q9: What’s your take on the Japanese yen? Will the BoJ further hike rates? Will that impact the global economy?
Following the ending of eight years of negative interest rates by the Bank of Japan (BoJ) in March, our take has been that there is no reason for the BoJ to engage in consecutive or substantial rate hikes. The central bank’s stance is turning neutral rather than hawkish. Thus, the Japanese yen hasn't shown much signs of appreciation. We expect the Yen to remain volatile in the short term and to stabilize after the Fed and other central banks initiate rate cuts.
Additionally, the BoJ has historically lagged behind in the global rate hike cycle, so there has been an observation that when the BoJ starts hiking rates, the global economy is bound for a recession. But there isn’t a strong or logical causal relationship between the two. Instead, we believe history is less likely to repeat itself this time. The key difference from the past is that the economy is back on track of growth this time, with the probability of a global recession declining. This is markedly different from the circumstances during the dot-com bubble in 2000 and the real estate bubble in 2008.
Conclusion
As always, close monitoring of economic data and macro trends remains crucial to navigate the evolving market landscape and fine-tune investment strategy. For more analysis and insights on market directions, check out our 2024 Q2 Market Outlook report.
This is the end of the full article.
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