Insight Investment

In our latest global macro research paper, we explore the pivotal shift in central bank thinking from inflation to growth. As inflation trends back towards central bank targets, policymakers are now focusing on weakening labour markets and have initiated a global easing cycle.

However, each central bank is facing a slightly differing outlook and are adjusting their policies based on their unique economic situations. For instance, the People's Bank of China is in full stimulus mode, while the Bank of Japan is gradually increasing rates.

With economic data starting to stabilise and central banks easing policy, our macro regime framework has shifted to a more positive outlook for risk assets.

Although this makes us more positive on the outlook there are two key concerns.

1. Equity valuations appear expensive. The S&P 500 Index is currently trading at a historically high price-to-earnings (P/E) ratio of 24.5 times. Even when excluding the top-performing "Magnificent-7" stocks, the index still trades at a 21 times ratio, which is considered expensive in historical context. High valuations can complicate market dynamics, as they often lead to greater drawdown risks. However, historical data shows that high valuations do not always predict poor performance during easing cycles. For instance, despite high valuations, the market has seen significant gains in certain periods, such as in 1998. Conversely, during the global financial crisis (2007/08) and the COVID-19 pandemic (2019/20), high valuations were not the primary cause of market distress. Therefore, while high equity valuations present challenges, they do not necessarily preclude positive returns during rate-cutting cycles
2. The recent US election result brings significant policy uncertainty, with potential fiscal expansion and tariffs impacting both growth and inflation. The prior consensus was that a Trump victory would benefit domestic US stock markets, driven by fiscal stimulus, regulatory changes, and a pick-up in merger and acquisition activity. However, Chinese and European equities were expected to be most adversely impacted by tariffs, with Trump raising the prospect of imposing tariffs of 60% on goods imported from China and 20% on goods from the rest of the world. Most economists agree that tariffs ultimately lower growth and raise inflation. The market reaction to fiscal expansion presents one of the most immediate investment. The Committee for a Responsible Federal Budget highlighted that a Trump administration might raise debt by approximately US$7.75 trillion through 2035.

In aggregate, we believe the shift in the macro regime framework makes the short-term outlook for equities more positive, despite high valuations. However, we believe defensive strategies are necessary to mitigate risks from higher US bond yields and geopolitical uncertainties.