The signs that could suggest market recovery

What is your outlook for the global economy in 2024?

Hubert Aarts: For the global economy in 2024, we have to assume two things. One is what happens on the macro front and the other one, what does it mean for the stock market cycle? So, they are not synchronised. As we know, the economic data will happen next year with the slowdown of economy, a consumer slowdown because of higher mortgage rates, but also higher energy costs. And then, of course, we have the industrial side of the economy still in contraction if you look at the PMI index.

So, for next year, we assume a further continuation of weakness in economic data. But for stock markets, we should look ahead of that. 

What could drive a positive stock market with poor economic data is, of course, inflation coming down further when yields already have reacted to that, coming down from their 5% level.

And then next, we need central banks to think, “Well, okay, inflation's under control, the economy is not growing fast enough, let's cut some rates”. And we have already seen earnings downgrades for equities. So that would mean you're well set up to look at a recovery for the economy and stock markets into 2025.

When do you expect central banks to consider cuts?

The timing for central banks to start to cut rates is really data dependent. 

They've said, "Well, we look at the data." So if we assume that we'll see the continuation of inflation coming down more to trend and why would it be - because we have two important components within that; one is energy costs, so that's trending down, still continuing to trend down also because the Middle East war has not triggered higher oil price. In Europe, we've seen the gas storage is really full going into the winter. That would mean that you don't have that stress from higher gas prices. 

Then, of course, relief for the central banks to cut rates is the GDP growth slowdown. Therefore there's two incentives, inflation and GDP growth, to start to cut rates - maybe by a 100 basis points.

What are some of the emerging themes for equities?

The equity market has two drivers. One is valuation. We have seen stock markets going up, but it's driven by a very small cluster of stocks, driven by the artificial intelligence momentum. But if you look at the rest of the stock market - very easily done by looking at, let's say, a Russell 2000 in the US - that fell 20% last year and has not recovered this year, it's flat.

So, there are still very cheap equities within a broader equity market. I think that is attractive. 

If we then look at earnings growth, that has been positive in 2021-22 and this year. We expect positive next year and 2025. But what is also very important is that we have some policy drivers, some momentum behind the budget. There's the IRA bill and the European Green Deal, which are also helping many of the sectors and opportunities within the equity markets.

And there is, of course, a school of thought that says, “Well, okay, if you have a steep yield curve, that means that bond yields are ahead of the central banks, you should invest in quality growth or the growth ease sectors”. And we've seen that significantly and it would mean that we now own a flat curve. So the bond yields are a similar level as interest rates from the central banks. That would mean that cash is king and we've seen that. A lot of money has left equities and went into money market funds and bond funds.

The next stage is that you get an inverted yield curve, i.e., the bond yields are ahead of the central banks, so long end of interest rates lower, that would mean that you switch out of quality growth stocks into quality cyclical stocks, economically sensitive sectors, industrials, materials to mention a few.

Which sectors are most likely to be challenged?

The most challenged would be the sectors that have not got that earnings power, but also have on top of that, negative policies against them. So, we would look at sectors that are not in a position for the transition to a more sustainable economy, that have a carbon issue to fight with. Think about airlines, heavy trucking. Often utilities or independent power producers need to offset that high cost of capital.

And then we have the electrification of the car sector. So you have car sector stocks, producers that really need to invest more to ensure you're ready for that electrification, continuation of electric vehicles. So some areas really need to transition to a more sustainable economy, and they will feel the headwinds.

How are you positioning for this outlook?

We're celebrating 25 years this year and we've always been positioned for the companies and the stocks to a more sustainable economy. What does it mean? That means that we look at companies that provide environmental solution drivers. It could be building energy efficiency, electrification of the car sector, the transportation sector, grid upgrades, water treatment, testing, monitoring, sustainable food, reducing your food waste, making food healthier and then within the water value chain, fixing water leaks and treatment of water - think about the everlasting chemicals as a big issue.

We look at companies that provide the solutions there, but also the companies themselves behave very strongly from an environmental, social and corporate governance perspective. So those are the areas that we continue to invest in that have secular growth drivers and strong ESG credentials.

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