News headlines have been volatile this year with many geopolitical issues, economic worries, and, most recently, President Biden exiting his re-election campaign.  Nevertheless, the stock market has done well and continued to “climb the wall of worry.”  This reality serves as a good reminder that ignoring most news headlines and political noise is typically the best investment strategy.

Since the start of the year, we have maintained a positive outlook and positioning, especially with U.S. large-cap stocks. That is because of our view that AI-related investments, onshoring, and cooling inflation will benefit earnings for these types of companies the most. 

Despite some choppiness, the data tells us this scenario is playing out as expected. With manufacturing surveys softening and business confidence muted, markets may begin to over-discount a sharper slowdown. Nevertheless, we continue to believe that the pace of economic growth is moderating at a goldilocks pace, and inflation is cooling sufficiently to allow the Federal Reserve (Fed) to begin easing before the end of the year.  We expect U.S. growth to be close to trend at about 2.0% by the fourth quarter and inflation to continue cooling toward the Fed’s 2% target by mid-2025.  This should be a good environment to support our view on equities overall and offer a positive environment for bonds.

Outside the U.S., the European economy is expanding once again, activity in China is stabilizing, and the global goods cycle is showing more signs of life. As U.S. growth moderates while other regions improve, global growth looks set to be well-supported and more broadly based. This should continue to help U.S. large-cap earnings as well.

There are two key risks to our core view: stickier inflation or an excessive slowdown in activity. Despite the modest uptick in inflation early in 1Q24, recent measures show a cooler trend, and resets in one-off items, such as auto insurance, have likely run their course. On the activity front, economic growth has cooled at a nice pace and remains underpinned by resilient labor markets.  For the economy to rebalance and inflation to cool further, a moderation in growth is necessary but we do not think this means recession. Still, we are alert to the risk that slowing data gets disproportionately extrapolated. Such an event could offer attractive entry points to stocks; thus, we maintain some capacity to add on dips and extend our overweight positioning.

Equities came through the first quarter earnings season smoothly. Despite cautious forward guidance, earnings themselves were strong enough to drive upgrades to forecasts. Our base case of trend-like nominal growth should support earnings growth north of 10% this year, which should support stocks overall.

Our economic cycle indicators for the U.S. economy are evenly split between mid- and late-cycle. Historically, such phases are associated with positive returns for U.S. stocks. We see limited potential for valuation expansion but feel confident that earnings growth can drive returns as mentioned. We view large-cap tech earnings as resilient and see scope for an upside in cyclical earnings as the goods cycle evolves and inventories are restocked. 

Regionally, we continue to favor the U.S. over international. Within sectors, we favor communication services, tech, industrials, financials, and energy, with staples and materials being our least preferred.

Slower but positive nominal growth also provides a good environment for credit within fixed income, and we have a positive tilt to both U.S. high yield (HY) and investment grade (IG) credit across our portfolios. We are mindful of refinancing needs that will build over the next 18 months. However, evidence from the primary market suggests robust demand, and key credit metrics such as leverage and coverage ratios remain broadly healthy. From the borrowers’ side, refinancings are hardly a surprise and can be well managed in a period of decent growth. 

We expect the Fed to begin easing rates before the end of the year, most likely starting with a 0.25% cut in September and totaling around 0.75-1% by mid-2025. Given this, we see only a limited risk of recession, thereby supporting equities and offering a potentially compelling environment for bonds overall.  

John Meynard Keynes once quipped, “When the facts change, I change my mind.”  For now, the facts have not changed enough with economic and corporate data for us to change our minds in favoring stocks over bonds, U.S. over international, large-cap over small-cap, growth over value.  As facts around Fed policy, earnings, and the economy continue to evolve, we may change our minds and change our positioning.  But for now, we maintain our positive equity positioning moving into the back half of the year while also positioning to capitalize on positive bond market performance if the Fed cuts interest rates.