Quarterly Market Outlook: Q3 2024

Our Quarterly Report focuses on the dynamics of the labor market in assessing the macro scenario of a cycle that continues to surprise investors and analysts. Our analysis indicates a low probability of recession, which is compatible with moderate interest rate cuts. However, this scenario will depend on a difficult balance between labor supply and demand. This scenario will depend on the dynamics of the two key variables in the labor market: the balance between labor supply and demand, which will reflect the level of economic activity, and wage pressures, which will determine the behavior of services inflation. In 2024, central banks will lower rates, although in a much more moderate way, as we are at a point of full employment and the urgency of cuts is decreased.

In the context of the current economic climate, investors have a wide range of investment options at their disposal, which represents the most balanced range observed in recent decades. The potential for building balanced portfolios is high, given the ability to combine fourbasicingredients: the real risk-free rate (short-term government bonds), protectionagainst adverse shocks (long duration and low volatility bonds), cyclicalearningsrecovery (European equities) and narratives oftechnologicaldisruption (U.S. equity market). This range of options allows each investor to tailor portfolios to his or her specific risk/return needs.

01. This cylce is supported by the labor market

The moderate economic slowdown has been cushioned by fiscal stimulus and the strength of the labor market, despite the rise in interest rates. Once theexcesssavingsaccumulatedduringthepandemichavebeenexhausted, householdconsumptiondependsto a largeextentonthefundamentalsderivedfromthe labor market: real income and employmentlevels. Nearly 30 months after adjustment following large interest rate hikes seems to be completed without excessive job destruction, but the final verdict will depend on labor market dynamics.

Business confidence is a good indicator of future growth. A reading above 50 signals economic expansion. The strength of the labor market is becoming more important as a key factor supporting consumption now that the excess savings from the pandemic have been exhausted.

Business confidence (PMI composite ofmanufacturing and services) and Bloomberg economicgrowthforecasts 2024 

02. Back to square one

The labor market has returned to its pre-pandemic equilibrium, with the major imbalances in supply and demand for jobs no longer present. If confirmed, this trend would lead central banks to move toward more neutral monetary policy coordinates. Interest rate cuts are coming, but expectations for monetary easing are moderating.

The progress is not broad-based, but rather based on better readings in goods, transport and energy, while price pressures in services remain elevated. The charts below show the slowprogress in wagemoderation in boththeUnitedStates and the euro area, whichisstillcloseto 4% in both regions. The correlation between the trend in this variable and the unfilled job vacancy rate is very high, so a significantreduction in wagepressureswillonly be achievediftheimbalancesbetween labor supply and demand are furtherreduced.

Wagegrowth and vacancies

03. Optimal environment for building balanced investment portfolios

The global macroeconomic environment is not optimal (core inflation is still far from central banks' targets and the cyclical recovery is still in its infancy), but it is improving compared to previous quarters.

The potential for building balanced portfolios is high, given the ability to combine fourbasicingredients: the real risk-free rate (short-term government bonds), protectionagainst adverse shocks (long duration and low volatility bonds), cyclicalearningsrecovery (European equities) and narratives oftechnologicaldisruption (U.S. equity market). This range of options allows each investor to tailor portfolios to his or her specific risk/return needs.

Correlationoflongtermequityreturns and corporateearnings

Without concentrating bets or chasing returns

In our central scenario for the upcoming quarters, investors could benefit from the combined positive impact of monetary policy easing and cyclical earnings recovery. Although these effects will probably be moderate, their combination is unusual and could contribute positively to the returns of both fixed income and equity portfolios. Therefore, werecommendthatinvestorsmaintain a neutral assetallocationwithoutexcessiveconcentration in any sector orgeography.

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