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HSBC Perspectives Q2 2024

Willem Sels

Global Chief Investment Officer, HSBC Global Private Banking and Wealth

Favourable macro and structural drivers support the outlook for equities and bonds

As we enter the second quarter, we see a brighter outlook with the Fed rate cuts just around the corner and markets being quite realistic about the timing and pace of those cuts. Moreover, fears of a global recession have faded and US earnings growth has consistently been surprising on the upside.

What does this mean for investors?

Bond investors were delighted to see the strong rally in late 2023 as rates peaked, and the rally should resume in expectation of falling rates in the coming months. At this juncture, with bond yields still elevated, we see a good opportunity to lock in current yields by extending bond duration. Tight credit spreads and market uncertainties around economic growth and geopolitical risks mean that our preference for quality bonds stays firmly in place.

The most significant change we made during Q1 is our more positive view on equities. This is backed by improved earnings and margins thanks to falling costs and expected rate cuts, which encourages more corporates and households to spend and invest. In the US, we expect to see solid earnings growth exceeding 10% in 2024, well above its long-term average of 7%, while earning growth in Asia ex-Japan is expected to be double that of the US.

As China’s stimulus measures will take some time to boost actual economic performance, we stick with our geographical diversification in the region, capturing the rise of ‘AI’ in Asia. AI in this context isn’t artificial intelligence but refers to ASEAN and India, due to their strong fundamentals and domestic drivers. We’re also positive on South Korea on growing demand for memory chips globally, and we’ve recently upgraded Japan thanks to its corporate reforms and the end of its deflationary period. These opportunities led us to raise our global equity allocation to overweight in Q1 by adding in particular to US and Japanese equities.

Our optimism for equities also lies in the rising structural trends that have reshaped the world in which we live. The use of generative AI (artificial intelligence), robots and innovative technologies promises to be a game changer to all aspects of life, boosting not only technology but also healthcare, communications and other industries that benefit from increased productivity and new product development. Both the US and Asia enjoy strong consumption power supported by wage growth and accumulated savings, and lower interest rates will help fuel the momentum further. The trends of nearshoring of industry and North America’s re-industrialisation are also accretive to job creation and manufacturing in the US.

Sustainable investing is closely connected with all of these themes. After two years of rising interest rates, the return to policy easing should unlock more spending from companies and governments on the path to a low-emission world. Renewable energy and biodiversity will be top priorities.

Finding the right balance between exploiting opportunities and focusing on quality

In conclusion, we see a number of positive drivers for investors, but our complex world also demands careful attention to risks, including a busy election calendar. While everyone’s eyes will be on the US election in November, historical data seem to be in favour of US equities during an election year. As usual, our four investment themes aim to find the right balance between risks and opportunities, with a focus on quality holding the key.

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Investment themes

Bonds tend to do well after rates peak as investors seek to get ahead of the coming wave of central bank easing, which helps explain the strong rally in late 2023. As we’re approaching the first rate cut, with the Fed and the European Central Bank expected to move in June and the Bank of England soon after, bond prices should rise further. Locking in still attractive yields before it’s too late is the right thing to do. This can be achieved by putting cash to work in bonds and extending bond duration.

No matter where we sit in the interest rate cycle, bonds play a key role in any portfolio because they provide diversification and predictable income streams. Within the bond market, we focus on quality as global growth is lower than usual and geopolitical risks remain elevated. While Treasury yields remain high, credit spreads haven’t widened sufficiently to compensate for even a small pickup in defaults. This makes it hard to justify taking on extra risk, supporting our preference for investment grade over high yield bonds.

Indian local currency bonds are another bright spot due to their low correlation with other bonds and attractive yields. India’s bond market allows investors to tap into the country’s strong growth momentum and is enjoying strong inflows following the inclusion of Indian bonds in EM bond indices.

We overweight longer duration (7-10 years) developed market government bonds including US Treasuries, while maintaining a medium duration preference (5-7 years) for investment grade bonds, preferably in US dollars.
In Asia, we prefer selected banks, Indonesian quasi-sovereign bonds, Macau gaming and Chinese IT, media and telecom. Indian local currency bonds remain attractive for diversification and yield enhancement.

We’ve become more positive on equities thanks to stronger-than-expected economic growth, strong corporate earnings growth and a favourable rate outlook. In the West, the US is the most resilient and has the strongest earnings power. Rate cuts should improve margins, which are growing steadily. US equities tend to do well not only before the first rate cut, but they have also outperformed in 15 of the past 20 presidential election years.

Asia sees divergent growth, with India and ASEAN (particularly Indonesia) leading the pack. Supply chain diversification, young demographics and strong investment flows are shared drivers for the two countries. India is also backed by its digital transformation and services exports; Indonesia benefits from rapid urbanisation and investments flowing into the EV sector. South Korea is also poised to gain from the digital transformation and a recovery in global demand for memory chips.

The latest addition to the list is Japan, where we see the reflation trend, corporate governance reforms (including higher dividend distributions) and the AI investment boom translating into structural opportunities. Monetary policy normalisation will also strengthen the yen, adding to returns for foreign investors.

We overweight US equites and diversify our Asian exposure into India, Indonesia, South Korea and Japan.
We prefer large-cap companies with leading brands, strong cash flows and manageable debt.

In the US, strong labour markets, real wage growth and falling inflation should support healthy consumer spending, which accounts for 70% of GDP.

Structurally, US leadership in technology and the wide application of generative AI and automation are opening up huge opportunities across industries. Companies at the forefront of the AI development are delivering strong earnings growth, albeit at higher valuations. Healthcare innovation is another growth driver through AI and the use of robots, as well as new product development. Both the nearshoring of industry and the North American re-industrialisation are boosting manufacturing and job creation.

The consumption story is also playing well in Asia, supported by accelerating private wealth and strong domestic spending power. Many internet leaders also benefitting from their large consumer retail operations. Asia’s leadership position in e-commerce and semiconductor manufacturing helps sustain the growth momentum.

Although we remain defensive in Europe amid sluggish economic growth, new pharmaceutical products continue to lift sales expectations there.

We maintain a cyclical tilt in the US, extending our favourites beyond technology to consumer discretionary, industrials, communications, financials and healthcare.
We remain overweight on Asian technology, consumer discretionary and staples, communications and utilities. In Europe, we prefer technology, financials, energy and healthcare.

According to the United Nations (UN), 2023 was the hottest year on record, with extreme weather events on the rise. COP28 confirmed how far the world is falling short of climate change goals. Yet amid the gloom, investments into a sustainable and more equitable world continue to grow, supported by government policies and better regulatory frameworks.

Global greenhouse gas emissions need to fall by 43% by 2030 to get the goals of the Paris Agreement back on track and keep the world on a path to net zero by 2050. Renewable energy is positively prioritised as investments in low-carbon energy topped USD1 trillion in 2023. Rate cuts should also lower capital costs, encouraging companies to raise spending on alternative energy solutions such as solar, wind, biofuels and hydrogen as well as innovative technologies to increase productivity and reduce their carbon footprints.

Biodiversity and the circular economy are also coming into sharper focus with the recognition that the rapid loss of species poses a systemic threat to the global economy. Increased regulation, the expansion and funding of the UN’s global biodiversity framework, and growing investor attention are driving companies to adapt their operations to mitigate their impact on nature. Companies that preserve biodiversity offer investors the potential to access growth, provide relative outperformance and support long-term change.

We see structural investment opportunities focused on sustainable energy such as renewables, hydrogen, storage and carbon capture.
Global agreements on biodiversity will have a meaningful impact in the food, pharmaceuticals and cosmetics industries.

Regional market outlook

US stocks remain our main overweight in the West as we believe the country benefits from cyclical and structural resilience. A strong labour market and falling inflation benefit the consumer, while re-onshoring is positive for industrials and the US technology sector is world-leading. We’re not too concerned about high valuations because US companies are generating strong earnings and are able to expand their margins thanks to falling costs and their strong market position.

The presidential elections may create some volatility after the summer, but for now, we focus on the market’s strong fundamentals as the election is very difficult to call. We continue to like technology but also diversify into other sectors such as consumer discretionary, communication services, healthcare, industrials and financials as we see opportunities across the market.

Countries in the Eurozone and UK have either just gone through a mild recession or barely escaped one. The mild positive is that growth may have bottomed and we could see a very gradual economic pickup from here. That said, fiscal challenges in Europe, protests and strikes, energy dependence and tail risks related to geopolitical conflicts on Europe’s doorstep present risks to stock markets.

In spite of low valuations, we maintain our neutral view on the UK and our underweight view on the Eurozone until we see improved cyclical momentum. We expect the European Central Bank to cut rates in June (like the Fed) and the Bank of England to follow in Q3.

We maintain an underweight on European emerging markets, in line with the underweight on the Eurozone, since many of them suffer from the same issues.

Latin America has more favourable drivers and hence we overweight the region, including Brazil and Mexico. Rate cuts in Brazil are already helping market sentiment and downside risks to Brazil’s commodity-heavy exports have decreased as China takes steps to boost its economy. Mexico is benefitting considerably from trade with the US and is now a larger US trading partner than China. Changes to the global supply chains benefit Mexico as many US companies are actively nearshoring their production.

China’s economic growth continues to face headwinds stemming from the property market. Government support measures should help reduce the downside for the economy and the stock market, but investors will want to see stronger growth before stocks can rally sustainably. In the meantime, we continue to diversify our Asia exposure into India, Indonesia and South Korea.

Positive demographics, digitalisation and changes to the global supply chain are helping India and support the current high valuations, in our view. Following the elections in February, Indonesia should see renewed economic activity and is benefitting from the net zero transition. South Korea is well placed to tap into the strength of technology demand linked to AI.

We’re positive on Japanese stocks since a weak yen and rising inflation are helping companies generate strong earnings. But the tailwind is more structural than that: companies have been urged by the stock exchange to improve corporate governance, which is already leading to higher dividend payouts.

Rising wages are lifting consumer spending and creating a mindset that Japan has finally left its deflationary period, which is a clear positive for stocks. For bond markets, higher inflation means that the central bank will soon raise rates to zero or even positive territory, which will hurt bond returns. This could also lead to mild JPY currency strength.

Key data to watch

Source: HSBC Global Research as at 8 March 2024. Estimates and forecasts are subject to change. India inflation forecasts are fiscal year.

Source: Bloomberg, HSBC Global Private Banking as at 1a March 2024. Past performance is not a reliable indicator of future performance.

Source: LSEG, HSBC Global Private Banking as at 20 February 2024. Past performance is not a reliable indicator of future performance.

Source: FactSet, HSBC Global Private Banking as at 20 February 2024. Past performance is not a reliable indicator of future performance.

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Investment Outlook: HSBC Perspectives Q2 2024

Favourable macro and structural drivers support the outlook for equities and bonds

Investment themes

1. Lock in current yields for longer ahead of rate cuts

2. Increase equity exposure to growth leaders to boost returns

3. Ride on cyclical and structural trends to diversify sector exposure

4. Tap into sustainable growth through clean energy and biodiversity

Regional market outlook

United States

Eurozone and UK

EM EMEA and EM Latin America

Asia (ex-Japan)

Japan

Key data to watch

We expect economic growth in the West to bottom in Q1, followed by a mild acceleration

Yields of investment grade bonds look more attractive than high yield. We continue to focus on global investment grade and government bonds.

Earnings momentum is healthy, with growing margins in the US and Japan as productivity gains offset cost pressures.

US company earnings are expected to rise almost 11% in 2024, boosted by big tech earnings surprises.

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