The US Federal Reserve’s decision to keep interest rates higher for longer, rather than raising or cutting rates, indicates that economic conditions have been holding up “quite strong”, as seen from recent economic data, says Yeap Jun Rong of IG Asia, the Singapore unit of IG Group.
The market strategist says that while a rate cut is the ideal situation many are looking forward to, it might mean some economic cracks. “So it’s not necessarily a bad thing to have higher-for-longer rates,” he adds.
On May 2, the US Fed kept its key lending rates at 5.25%–5.50% after the inflation numbers for March crept up to 2.7% — instead of dipping, as expected. The latest data-set has left analysts and economists speculating on a new timeline for the slashing of interest rates — after the US presidential election in November.
In the beginning of the year, many commentators predicted as many as six rate cuts. The figure dropped to three as of last month. Despite the “higher for longer” rates, which made it more attractive for investors to save and earn interest than to punt the market for potentially higher gains, there has not been a “huge crash”, says Yeap.
In a scenario where rate cuts do not occur in 2024, the market strategist believes that markets can continue to rally if two conditions are met. The first is that the Fed does not revert to rate hikes, and the second is that recessionary concerns do not appear.
Given this economic backdrop for the rest of 2024, Yeap expects financial institutions that can continue to charge a higher margin on their loans to be winners, while property players such as REITs will face higher refinancing costs, which will eat into their profits.
See also: US equities, IG, fixed income strategies, gold and copper among top investment picks: UBS
Yeap: Investors need to be on their toes for the second half of this year. Photo: IG Asia
The AI effect
See also: With Trump win boosting stocks, investors hunt for next winners
In 2023, significant momentum was built around growth sectors, notably the “Magnificent Seven” mega tech stocks, says Yeap. But going into the year’s second half, there may be some slowdown on a y-o-y basis.
This slowdown in momentum does not mean that business is bad; rather, earnings growth compared to the year before may slow a bit. The 2023 artificial intelligence (AI) hype has resulted in the valuations for many of these companies reaching “elevated” and “lofty” levels, says Yeap.
In this case, investors may look out for a key theme: whether there is any rotation from some of the growth areas in the market to value. Historically, when earnings growth starts to slow, some form of growth-to-value rotation comes into play, Yeap reasons.
He cites the recent rallying of the Hang Seng Index as an example. Beaten down for the better part of three years, Hong Kong’s benchmark market index entered a technical bull market on May 6, touching 20% above its January low, with an influx from international funds improving liquidity.
This comes as sentiment towards Chinese equities has shifted, even as consumer and property sectors remain soft. Nonetheless, the valuations of many of these stocks have dipped to a level that is now drawing foreign investors to start chasing after lower-value, high-dividend Hong Kong-listed shares. They have also been shifting away from other Asia Pacific markets like Japan or India, which have gained significantly, and where currencies are under pressure from a stronger dollar.
STI may see catch-up
Meanwhile, the Straits Times Index (STI), which “really has been lagging in performance” over the last year, may also finally begin to see a catch-up, says Yeap, who believes there is still room for growth on that end.
For more stories about where money flows, click here for Capital Section
“Looking at the FTSE STI, price-to-book at 1.09, price-to-earnings at 10.8, valuation is relatively inexpensive. It offers a 4%–5% dividend yield, which can be attractive amid a pipeline of rate cuts ahead,” says Yeap. “The STI has generally been less volatile during uncertain times (somewhat of a defensive nature), with its companies generally carrying sound balance sheets and stable cash flow.”
For investors, three broad market themes have been present since 1H2024 and will continue into 2H2024. They are the US Fed policy outlook, the US economic conditions, and geopolitical tensions, says Yeap.
He observes that the US Fed has been highly dependent on economic data to dictate its decisions going forward, and cautions investors to be a little “more reactive rather than predictive”.
“We probably also have not seen the full impact of the rate hike coming into play, so we should not be too complacent,” he adds.
In the event of a turn or significant deterioration in the US economic conditions, the market strategist says that investors will have more to watch out for.
When the US Fed eventually carries out its rate cuts, Yeap cautions that investors must look to understand its true decision. He says a routine policy move is fine, but a material change in the economy may call for greater concern. “Investors need to be on their toes for the second half of this year.”
