Iain Anderson, Co-Head: Investments at Sygnia
We are approaching a major regime change: the start of US interest rate cuts. BCA Research indicates that the US bond market is likely to enter a phase of bull steepenings, which occur when bond yields decrease as interest rates are cut. Interest rate cuts cause the short end of the yield curve to go down more than the long end, causing the yield curve to steepen. Bull steepening generally happens toward the end of an economic cycle. Bonds are the best asset class in this environment, outperforming equities. At a sector level, defensive sectors such as Consumer Staples and Healthcare outperform, while Technology generally does poorly.
We feel appropriately positioned, having reduced our overweight to FANG.AI stocks and maintained our overweight position in Consumer Staples and Healthcare. We have reduced our equity overweight position, however, we remain overweight equity and neutral bonds. This may seem at odds with the research, but while we agree that interest rates will be cut, we are less convinced that bond yields will fall significantly, as we are not close to the end of the economic cycle. US growth is slowing, but it is unlikely to slow into a recession this year – it is more likely to turn from the narrow growth of technology stocks to a more broad-based growth. Inflation will continue to slow but is likely to take longer than expected.
In addition, preliminary global PMIs are holding steady, suggesting a resilient economy, and manufacturing continues to slide as services rebound. Goods or product inflation are already negative, and lower manufacturing activity will be a headwind for Europe, Japan and emerging markets. Meanwhile, higher services spend will support the US on a relative basis and may push up wage inflation.
We maintain our neutral position to South Africa, which is off the lows but still has a long way to go. We are still burning diesel in open cycle gas turbines, though no longer at peak rates. Rail and port volumes have improved, but have a long way to go to recover to previous levels. Headline CPI for July eased faster than expected and surprised positively, cementing the case for a September rate cut of 25 bps. Interest rate cuts will benefit the consumer, but real rates are still high. Only 1% of cuts are expected over the next year, compared to 2% in the US.
Geopolitical risks remain high, with tensions in the Middle East and Russia/Ukraine escalating. Supply chains could easily be disrupted, which would push up inflation.
ENDS
