Note Précis Apr. 21 2024: Capital Markets Sketch Change

Note Précis Apr. 21 2024: Q2/2024 – Capital Markets Sketch Change – In late April 2024, exogenous and internal facets underscore that capital markets have started to sketch change. It will likely be abrupt and rocky. Amid a massive election period and tepid global growth, outright physical and trade wars exist. A missed opportunity worldwide has been that of reducing fiscal lax. Diversification in asset allocation is called for, including cash and precious metals. Quality parameters such as valuation count across equities. Federal Reserve and other central bank positioning as well as currency developments have us maintaining short to medium term in Fixed Income. Capital market risk premiums exist not because of precise knowledge but instead to compensate for known and unknown knowns. It is akin to overengineering in physical projects such as buildings, bridges and the like.

In exuberance over monetary largesse, compression of risk spreads in credit markets and elevation of equity valuation emerged on expectations of a central bank put. Amid a massive global election period and tepid 3% annual global GDP growth, the political temptations remain large for largesse and protectionism. Despite capital market contradictions and a prolonged lag, noteworthy are the rise of precious metals such as gold and of the U.S. dollar against not just the Chinese Yuan but also the likes of the Euro, Yen, Canadian dollar and Australian dollar. Capital markets have overstepped in attempts to incorporate expectations of several rate cuts such as in Fed Funds. Instead as corroborated by current data as well as a reading of experiences of monetary policy of the 1980s, major central banks appear espousing a steady stance.

Equity markets are at the cusp of releases and discussions of results. Momentum markets benefitted from a disposition to celebrate last consensus beats rather than valuation. Also contributing have been quantitative ease and concept euphoria in social media, climate change and most recently, artificial intelligence purveyors. Long term consensus estimates call for 10% + annual earnings growth in S&P 500 operating earnings. In 3% global annual GDP growth, steady interest rates and rising costs such as for energy, we would expect earnings potential to be closer to 5% per annum. Companies have been expressing caution and cutting expenses. At present valuations, volatility is likely to expand.

Momentum has dominated equities since the apex of the credit crisis in 2008. Hypotheses have emerged that not only productivity but also increased efficiency in capital markets would support lower than historical risk premiums. Still and even if ECB rates of 4% were used as benchmark and certainly versus U.S. Fed Funds of 5 ½%, equity risk premiums seem low. A minimalist administered rate argument did not work in Japan from the 1990s/2000s. We expect equity risk premium increases to percolate through geographic market, sector and individual security segmentation by market capitalization. Rather than value versus growth, preferences are likely to be for quality of operations and financial strength.

Communications Services we have underweight expecting restructuring driven by prior acquisition excess and greater regulatory scrutiny such as over cyber security. Consumer Discretionary is underweight on the view that while the U.S consumer has already performed leadership, Europe and Asia remain bifurcated and weak. Consumer Staples we have marketweight on as input costs weigh in and erstwhile emerging regions remain difficult. Energy we have overweight on the basis that legacy businesses in hydrocarbons remain attractive while business strength offers opportunity for expansion into alternate energy. Financials we have as overweight in favoring strong restructuring delivery amid net interest margin and commercial real estate challenges. Healthcare is overweight for us on valuation and in comparison to operating challenges in other defensives like Consumer Staples and high valuation in other growth like Information Technology.

Industrials we have overweight in cyclicals on the basis of rising defense expenditure potential as well as more efficient infrastructure in other consumer and manufacturing businesses alike. Information Technology we have at 25% cap  for diversification amid several marquee companies have emerged with high valuations from the artificial intelligence euphoria. Materials we place as over weight on gold bullion and pressure metals for diversification amid potential currency market volatility. Seeming under estimated is  the criticality of rare metals, even base metals and food. Real Estate we place at underweight  with commercial real estate an especial challenge with industrial space being an opportunity . Utilities we place at underweight on project financing costs a potential challenge. E.o.e.