Cornelian Risk Managed Funds

There are some mixed signals developing that concern the outlook for the US economy. The beginning of the year saw optimism that even though economic growth was accelerating, the Federal Reserve would be able to start cutting rates meaningfully as inflation was about to subside. However, inflation proved to be stickier than anticipated and this stayed the Federal Reserve’s hand.

Nonetheless, interest rates adjusted for inflation are restrictive and quantitative tightening is ongoing. Following the latest employment data, which have been interpreted to show an unequivocal downturn in the labour market, bond market investors have been swift to price in an increased number of interest rate cuts this year. The risk that they perceive is that the slackening labour market is a harbinger of a ‘hard’ economic landing and recession. The Federal Reserve’s Chair, Jerome Powell, has recently acknowledged growing labour market headwinds and has stated that interest rate cuts are on their way.

Policymakers have responded to the volatility in markets with soothing words and actions. As a result, the recent volatility observed within investment markets should start to be viewed as more of a long overdue shakeout rather than anything more sinister. After all, whilst banks are almost certainly going to have to provision for materially higher levels of bad debt (versus the current benign levels), their balance sheets are strong and the sector can absorb a lot of bad news without threatening the foundations of the financial system.

Once a sustained rate cut narrative starts to build, mid- and small-sized stocks have a chance to shine provided the prospects for a genuine hard landing remain low.

Whilst the market volatility has been disconcerting for some, we judge the outlook for risk assets to be attractive. However, an increased level of volatility will have to be tolerated.

Following a period of disappointing performance, we are particularly excited about the prospects for mid-sized and smaller companies given attractive valuations as well as the returns on offer via less economically sensitive, well capitalised commercial property and infrastructure assets, which are likely to benefit materially from the perception of reduced financing costs to come.

Elsewhere, in Europe the consumer is beginning to perk up but the Chinese economy remains moribund relative to its own history. Chinese consumer price inflation has been close to zero for over 12 months and the yield on long dated Chinese debt is plumbing new lows. The economy is sagging under the weight of the property market bust and the redirection of foreign direct investment away from China. The Chinese authorities appear either unwilling or unable to instigate the measures necessary to draw a line under the economy’s property problems and move the narrative on to recovery. Going forward, China’s contribution to global growth is likely to remain relatively subdued.

The two wild cards to the above are (i) the prospects for an Artificial Intelligence (AI) related productivity surge (which would, undoubtedly, drive asset prices forward) and (ii) further fiscal incontinence (which could have the power to derail markets).

Whilst the hype around AI enablers (such as Nvidia) has got out of hand and a retrenchment concerning their outlook is likely to occur, we do believe that there are many companies which will benefit from the adoption of AI-related technologies, and this is not remotely priced into their valuations.

Concerning populism and fiscal incontinence, one has to suppose that leaders current and future will have learned the lessons from Liz Truss’s premiership and will conclude that the risks of introducing unconventional fiscal policies are not worth it, but we shall only know this in time. As a result, government bond investors may temper their enthusiasm for longer dated bonds until they can get a handle on revised fiscal policy frameworks, and this could act as a headwind.