I have moved my view on European equities from underweight to neutral. There are signs that economic momentum has bottomed out and the disinflation trend is more reliable than in the US, giving the ECB more of a clear path to cut rates. Earnings have been more lackluster, with earnings revisions the worst among the major regions I monitor. A turn in earnings momentum and/or breadth would give me more confidence to turn positive on this inexpensive market.
I have moderately underweight views on China and EM ex-China. China’s headwinds are more structural, with factors such as internal deleveraging and geopolitical uncertainty limiting the potential for the market to outperform over a 12-month horizon. The policy response remains tepid or reactive as the government is unwilling to deploy the full policy toolbox to stem deflation, all of which has left private-sector confidence suppressed.
EM ex-China is a more positive story, with robust macro momentum in India and other parts of Asia and structural reform in South Korea. The AI ramp-up’s impact on semiconductor demand should be positive for the region. I need stronger conviction on the global cyclical expansion and a meaningful decline in the US dollar before I can move away from an underweight view here, which is more tactical than that on China.
At the sector level, I have an overweight view on energy, financials, and consumer discretionary, and an underweight view on health care, industrials, and materials. Consumer discretionary is my largest overweight view, with interest rates and macro fundamentals now supportive (e.g., real disposable incomes are rising) and valuations providing a tailwind. The materials sector is our largest underweight view, with sentiment, trend, and valuations all serving as headwinds.
Commodities: Has gold lost its shine?
Based on my outlook for gold and oil, I have moved from an overweight view on commodities to a neutral view. Gold has been a strong performer in recent months, but I see limited potential for further price appreciation. Central banks and other investors have been building gold allocations this year after weak sentiment in 2023, and more recent gains have been driven by an expectation of lower real yields later in 2024. With heightened geopolitical risks priced in, I think a lot of the positive case has already played out.
One of the main drivers of my positive view on oil in recent quarters has been an expectation of constrained supply from OPEC. While this expectation hasn’t changed, growth in non-OPEC supply from the US and Latin America is weighing on my outlook. I believe geopolitical risk in the Middle East limits the downside risk to oil prices somewhat, but overall I am less constructive than I have been.
Commercial real estate: Pockets of concern, but not yet a systemic issue
To borrow an expression from sports, we are still in the “early innings” of the commercial real estate (CRE) story, but so far the large US insurers appear to have been relatively insulated from major negative credit events.
While data from Fitch Ratings suggests the US life insurance industry has material exposure to CRE and the losses that are forecast in CRE for the coming years are not insignificant (office property in particular), I think insurer credit ratings are unlikely to be impacted given their portfolio skew toward the higher-quality parts of the CRE market (e.g., 90% of total exposure is in the top two risk weightings per the NAIC’s risk-based capital calculations1). There is still more potential bad news to come, given the higher capitalization rates and lower occupancy that office properties have experienced post-pandemic, but insurers seem prepared to weather the storm and have been increasing their mortgage loss reserves accordingly (Figure 3).