The financial markets remained buoyant in February, with the strong performance of equities in particular continuing to set the tone. The global equity index rose by 4,7% in euros, posting a performance of more than 7% in 2024, thus enabling it to continue its momentum.
In fixed income, we are observing a correction of the somewhat extreme movements that occurred at the end of last year. Sovereign yields fell sharply in December and seemed disconnected from central banks’ desire to keep them high for a while. In February, rates continued to rise: the US 10-year yield reached 4.30% and the German yield 2,45%.
Risk appetite continues to be fuelled by the US economy, which is still surprising by its resilience. In the last quarter of 2023 as well as the current quarter, growth expectations are around 3% annualised, well above the estimated potential of 2%.
In addition to consumption still supported by employment and wages, investment in infrastructure and public spendings continues to create economic growth. Beyond the already strong current growth, the market is also anticipating potential productivity gains from artificial intelligence as it is likely to increase work efficiency in many areas. The market is therefore driven by a resilient US economy so far, and is already looking to the future with all that artificial intelligence promises.
It is natural that a parallel should be drawn with the 1990s. At that time, the US Federal Reserve (Fed) had successfully orchestrated the soft landing of the economy, which was accompanied by a period of strong growth and hopes related to the advent of the Internet era.
The current environment is very similar. As in the 1990s, we are coming out of a wave of rate hikes that helped control persistent inflation. It has now returned to around 3%, and we can expect central banks to make downward adjustments to rates, without reacting strongly, as in the case of a recession.
However, the more attractive valuation level is a definite advantage compared to the 1990s, as companies are delivering much better results today than in the Internet era. In this respect, the artificial intelligence theme is not only a source of hope: it is already delivering benefits to investors, which makes investing more rational. On the other hand, competition from rates is also less intense. With the US 10-year real rate close to 4% in the 1990s, rates increased the opportunity cost of equity investing, whereas today they are only 1,90% and are likely to fall.
In this environment, we recommend staying invested in equities, even though the performance of the last four months has been remarkable. At this stage, there seems to be some rotation already with European equities, particularly the Euro Stoxx 50 index: it brings together large quality European companies, which have caught up with their US counterparts, and small caps which outperformed large caps in February. It is essential to remain invested in the major themes driven by the Technology sector, but also to continue to position ourselves in favour of the sector rotation that we have been expecting since the beginning of the year.
In terms of sectors, we favour those such as Consumer Discretionary and Financials, which can continue to benefit from a buoyant macroeconomic environment. We therefore recommend an overweight position in the Communication Services sector as they fully benefit from the artificial intelligence theme and show significant earnings growth.
For bonds, we like the carry that the asset class delivers after years of bottoming rates. However, the capital gains expected from lower rates may be modest given that the economy is still too resilient, which may not allow central banks to reduce key rates quickly.
