UBP House View - April 2024

Key takeaways

Editorial

Buying regional laggards

The Swiss National Bank’s interest rate cut came as a surprise. Kicking off a new rate-cutting cycle, this first decrease in March by a quarter of a percentage point shows the way for other Western central banks. The global easing will lead to new investment opportunities in the broader market.

After a lacklustre performance in 2023, Swiss equities are now gaining attention, as evidenced by the SMI’s 5.34% increase over the quarter. Given that about 80% of Swiss companies’ revenues originate from outside Switzerland, their earnings are expected to rise naturally due to the depreciation of the Swiss franc and the stimulus resulting from lower rates. This context bolsters our confidence in the previously lagging market.

We also raised our conviction in the UK market, which has trailed behind in the aftermath of Brexit and during a surge of the cost of living. With inflation decelerating faster than expected, the Bank of England appears to have the greatest firepower to lower its interest rates and give a boost to its economy and domestic companies.

Lastly, we upgraded our outlook on the industrials sector as we believe equity performances will broaden. This sector shows potential for recovery, as visibility improves for cyclical end markets.

Strategy

What happens when the FED cuts rates?

Since the early 1960s, 10-year Treasury yields have, on average, fallen by 90 bps in the months after the first Fed rate cut, which, this year, we expect over the summer.

The bulk of these declines can be attributed to falling inflation-adjusted yields. However, inflation-adjusted 10-year Treasury yields have only been lower than current levels during the Fed’s post-2008 quantitative easing era. This suggests the sustained declines in yields like those seen in previous Fed easing cycles are unlikely as the Fed cuts rates in 2024.

In contrast, credit spreads have historically only widened modestly in Fed rate-cutting cycles, despite the 21st century’s default cycles. For bond investors, this means a focus on income (i.e. carry) from credit should offer more attractive return profiles than interest-rate-focused strategies seeking falling yields ahead.

For equity investors, sharp equity market sell-offs amidst systemic stress triggered the Fed’s easing cycles in 2001, 2008, and 2020. The Fed appears to be seeking to pre-empt similar risks in 2024.

US Fed Chair Powell’s recent press conference highlights a proactive policy stance designed to ease in the months ahead should the job market weaken, risking an industrial recession.

However, the surprise from the March meeting was the Fed’s plans to slow its quantitative tightening programme “soon” to pre-empt the money market stress and financial system instability as in other 21st-century cutting cycles, offering a potential “double-barrelled” policy easing beginning in the summer.

With anticipated Fed policy pivots underpinning the soft-landing narrative, equity investors can instead focus on the US soft landings of 1984 and 1994, both of which saw Fed easing cycles kick off sustained, earnings-driven bull markets as the Fed cut rates.

Thus, the next stage of the current bull market should be supported by an accelerating, Fed-driven liquidity backdrop beginning in the summer. This should broaden earnings momentum beyond the tech-led sectors that characterised the first quarter to include more cyclical sectors in the US and cyclical economies and sectors in Europe, Japan and emerging markets.

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