Cleared to land?

The below is an extract from our Q4 Asset Allocation Outlook.

The US economy continues to show remarkable resilience and appears to have decent momentum heading into year end. There have been a number of headwinds, including actual hurricanes, but so far they have done little to restrain growth. As a result, there is a heavy consensus the US is on track for a soft landing.

We acknowledge the Federal Reserve’s (Fed’s) 50 basis point (bps) cut in September increases the chance of a soft landing, especially since the easing cycle has commenced as the US labour market still looks healthy. We’ll never know if the Fed would have cut as aggressively if it had seen the strong September payrolls, but concerns that the Fed might be too slow to remove some of the policy restraint have receded.

There have also been some favourable developments to national income, which suggests private sector balance sheets are in a stronger position than previously thought. The household saving rate has been revised up, hinting at a less stretched consumer. The national account measure of corporate profits has also been marked higher, closing some of the gap with the more timely company earnings. The opening of this gap has historically flagged a late cycle.

Together with broadly favourable inflation developments, despite core CPI prints firming in August and September, our recession indicators have improved.

Please remain seated

Polls suggest the US presidential election race remains extremely tight, but so far the political uncertainty does not seem to be undermining business or consumer confidence. The escalating conflict in the Middle East is another concern, but the main channel of transmission is via higher energy prices, and so far the reaction of oil has been relatively muted.

The next few months are critical as the landing comes into view. Markets have scaled back some of the Fed easing without any adverse impact on risk asset prices. However, there is still significant easing priced alongside expectations for strong earnings growth. This does not leave much room for either inflation to surprise to the upside or an ability to cope with fresh shocks and a growth disappointment.

Outside the US, demand has been subdued, but China has delivered some monetary easing and is developing a broader range of fiscal support. Together, this should at least put a floor under China’s growth even if we are not convinced the measures will be sufficient to address the country's structural challenges. Europe remains sluggish amid political uncertainty, budget pressure and Germany’s uncompetitive manufacturing sector. The UK appears to be slowing again after a better first half of the year as a tax raising budget comes into view. So, the US consumer once again remains the critical driver of global growth.

How we’re positioned

We believe the vulnerability argument we had to remain short risk in portfolios is now less valid. Inflation is trending down, and the positive growth momentum means it will likely take more than a few data points before recession fears drive markets. We express our neutral view on risk by being long equities and short credit as we believe at these tight spread levels credit has similar downside but significantly less upside than equities.

Within equities, we are enthusiastic about the prospects for non-China emerging markets (EMs). The spillover effects of any Chinese stimulus are likely to be felt in other EM nations, without the geopolitical/tariff risk that comes with allocating directly to the Middle Kingdom.

We’ve had a long-standing enthusiasm for US treasuries and reappraised that view as pricing became increasingly extreme at the front end. As policy rates fell below 3% we felt the implied 250bps of rate cuts by September 2025 without a recession would be unprecedented. It is possible, but tough to envision. Yields have subsequently moved back up in October. The case for owning duration now is that it offers good insurance value as long as the market keeps believing in the disinflation story.

For example, during August’s growth-driven market jitters, bonds demonstrated their worth by moving in the opposite direction to equities. We think that helpful correlation is set to continue with inflation worries receding.

This quarter’s articles

In his article, James considers the root causes of populist policy making, and the long-term economic implications.

In his section, Martin explores private markets, and the potential benefits for investors of new ways of accessing these assets.

In our previous quarterly update, Robert gave his verdict on the dizzying ascent of the Magnificent 7. He returns to the subject this quarter, arguing hopes of an ‘immaculate broadening out’ are misplaced.

Tim rounds out this update with his regular CAMERA feature showing our long-term return expectations across a range of assets, this time with a focus on emerging markets.

The above is an extract from our Q4 Asset Allocation Outlook.