The global economy is proving resilient, as shown by IMF's upward revisions to growth forecasts for 2024, particularly in the US, China and emerging markets ('EM'). This positive development is due to the reduced impact of the recent crises, supported by fiscal programs and moderate impact of monetary policy. The risk of a global recession has decreased, with EM faring relatively better than advanced economies. Inflation remains a concern, prompting central banks to pursue a vigilant policy. The Fed is expected to be patient, while the ECB moved faster. EM central banks should continue their easing cycles to combat inflation.

Chart 1: Recession averted, growth accelerates

However, the positive momentum is slowing, and signs of consumer saturation are emerging, which may dampen future growth. Equity markets reached new highs in Q2, supported by robust economic fundamentals and investor confidence. Yet, there is slight saturation in equity markets due to persistent inflation limiting the Fed's ability to cut interest rates significantly. The bond market reacted to the inflationary pressure and interest rate expectations by pushing up long-term yields significantly. The yield on 10-year treasuries climbed to 4.7%. Geopolitical tensions are increasing global risks, impacting inflation and market visibility. Despite solid fundamentals, high valuations and potential volatility warrant caution and a balanced approach with alternative investments.

United States

The US economy maintained its robust momentum over the quarter amid the most aggressive rate hike cycle in decades. Q2 2024 was characterised by widespread optimism fuelled by consistent economic growth expectations and rising equity market valuations supported by strong fundamentals. The labour market remained strong and the unemployment rate has remained consistently below 4% for over two years, which has not been the case since the late 1960s. Initial jobless claims remained at historically low levels and the addition of 829,000 jobs in the first quarter underscored the broad-based nature of hiring. GDP data reflected this optimism, driven by robust consumer spending, continued growth in business investment and tailwinds from government spending. Challenges arose with regard to inflation, which remains stubbornly high. While goods prices reverted to pre-pandemic levels, service prices remained significantly elevated, exerting inflationary pressure.

Chart 2: S&P 500 earnings growth vs. ex-Magnificent 7

Market expectations for an extensive Fed easing cycle have weakened. Instead of the seven rate cuts anticipated at the end of 2023, markets now expect only two cuts for 2024. The 10-year Treasury yield rose by more than 40 basis points since the beginning of the year, reflecting the market's adjustments to changing interest rate expectations. Optimism prevailed in equity markets, with momentum stocks outperforming significantly in Q2. The Magnificent 7 contributed around 50% of the S&P 500's YTD return. The economy's resilience to forecasts of a slowdown or recession surprised many. However, economic indicators for May weakened, with real household spending falling slightly, while corporate profits came in better than expected. Bond yields fell back from their year-to-date highs as investors digested dovish Fed signals and weaker-than-expected economic data.

Europe

The second quarter of 2024 in the eurozone was characterised by a complex interplay of economic factors, monetary policy adjustments and geopolitical developments that shaped the investment landscape in the region. Economic indicators painted a nuanced picture of a slight recovery in the eurozone. While preliminary GDP estimates signalled moderate growth of 0.3% quarter-on-quarter, concerns about the sustainability of economic growth remained considering ongoing disinflationary process. The composite Purchasing Managers' Index (PMI) rose to a 12month high, indicating an improvement in economic activity, particularly in the services sector. However, challenges remain, and the manufacturing sector is showing signs of sluggishness in some areas. Inflation in the eurozone remained elevated, with headline and core inflation accelerating slightly to 2.6% and 2.9% respectively in May.

Chart 3: Decoupling of Euro Stoxx 50 and S&P 500 in June '24

The European Central Bank (ECB) cut interest rates by 25 basis points in June in response to ongoing disinflationary process and weaker than expected economic data. Market reactions to the ECB's monetary policy adjustments varied. Bond yields in the eurozone fluctuated, reflecting changing interest rate and inflation expectations. Credit default swaps on government bonds rose to multi-week highs following the announcement of the rate cut, reflecting investor concerns about the region's economic outlook. Geopolitical developments, including the European elections, contributed to market uncertainty. The EU elections were largely in line with pre-election expectations, with far-right parties making notable gains. Nevertheless, the current majority coalition has sufficient support in parliament. President Macron's decision to call an early general election in France following the strong performance of Ms. Le Pen's RN party was the most unexpected result.

China and emerging markets ('EM')

China's economy demonstrated resilient growth, with GDP rising 5.3% year-on-year (y-o-y) in Q1 2024, up from 5.2% in Q4 2023 and, exceeding market expectations (5.0%). This growth was primarily driven by robust industrial production, increased manufacturing investment, and a rebound in exports. The Lunar New Year festival also contributed to this economic uplift. Consumption patterns showed divergence; service consumption surged by 10% in Q1, while consumer goods consumption remained below pre-pandemic levels. Manufacturing and infrastructure investments demonstrated strong momentum, growing by 9.9% and 8.8% respectively, with further growth expected due to ongoing equipment renewal and accelerated government bond issuance. Export growth returned to positive territory, driven by global manufacturing recovery and strengthened regional trade collaborations. The manufacturing PMI indicated a recovery in business prospects, remaining in the expansion zone at 51.7. Foreign direct investment in China dropped 28.2% y-o-y from January to May 2024, a record decline.

Chart 4: China foreign direct investment (y-o-y)

Inflation remained low, with the annual rate steady at 0.3% in May 2024, falling short of market forecasts and reflecting a modest recovery in domestic demand. The property market faced challenges, with real estate investment declining by 9.8% y-o-y in April 2024. Despite expectations of a pickup due to a low base effect and eased liquidity for developers, long-term recovery will require sustained policy support. The People's Bank of China maintained key lending rates in May, with the 1-year loan prime rate at 3.45% and the 5-year rate at 3.95% following a cut earlier in the year. These rates, at historic lows, reflect Beijing's efforts to spur economic recovery amid mixed activity data, including sustained industrial output growth, the lowest jobless rate in five months and weak retail turnover.

Investment conclusions

The global economy proves resilient despite higher capital costs and geopolitical tensions. Inflation remains high compared to pre-COVID levels, with a mix of disinflationary and cyclical inflationary pressures. The US is experiencing low growth, while Europe is facing stagnation and China is aiming for a 5% GDP target. Despite a rapid normalisation of interest rates, there has been no recession and companies have adjusted and stabilised their profit margins. Equity valuations are high, but there are opportunities outside the US. The interest rate tightening cycle is complete, although the new inflation poses a risk of significant cuts. Credit exposure remains constructive.

Chart 5: Credit yields trump earnings yield on equities

Bonds: Monetary policy tightening has concluded globally, but banks' credit tightening measures continue to challenge corporate financing. Default rates have risen but have not spiked, making selective credit attractive. Our current tactical stance is neutral on duration, favouring US Treasuries, and overweight in credit, particularly in Scandinavian short-term HY, European loans and structured credit.

Equities: Equity valuations are deemed fair, though modest growth prospects limit the upside potential for large US equities due to elevated PE multiples.

A blended investment style is advised, along with a positive outlook for US Treasuries and short-term high-yield loans, and a mildly positive outlook for equities. In the credit market, we anticipate a modest increase in default rates, leading to slightly elevated levels. Finally, we consider current credit spreads to be reasonably valued.

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.