Considerable uncertainty persists in US economic outlook: Candace Browning

Besides the domestic elections, uncertainty surrounding the US economic outlook and potential rate cuts has plagued domestic equities in recent weeks. CANDACE BROWNING, Bank of America’s head of global research, expects only a benign moderation in US economic activity. In an email interview with Samie Modak, Browning elaborates on the implications of US growth for financial markets. Edited excerpts:

Where do you stand on the whole debate around a soft landing versus a hard landing in the US? How much of it remains uncertain for the equity market?
 

There remains considerable uncertainty regarding the US economic outlook. Our base case is for a benign moderation in economic activity, with gross domestic product growth settling around 2 per cent in the coming quarters.

We do not foresee a stagflation scenario in the absence of a large, unexpected supply shock. The economy should be able to avoid a hard landing as long as the “Fed put” remains in play.

Hard landing risks would increase if inflation were to re-accelerate, leaving the Fed unable to cut rates even in the event of a sharp economic slowdown.

How many rate cuts can we expect this year and next? And how will they impact equities, emerging markets (EMs), and the US dollar?
 

We expect one rate cut in December 2024 and four rate cuts in 2025.

Concerning equities, lower returns in short-duration bonds should prompt a rotation from cash and Treasury bills to equity income opportunities, given that dividends are nominal.

If rates persist at higher levels, most largecap financials, energy, industrials, and materials appear well-positioned with attractive cash flow and inflation-protected income.

High yields and improving reform efforts by EM governments have attracted investment inflows. However, if the higher-for-longer scenario extends to higher forever, the risk of credit distress in EMs rises.

A slight delay in Fed cuts should not impact the dollar much, and we still expect a weaker greenback. However, prolonged delays or market expectations of another hike could lead to renewed dollar strength, particularly if other central banks are cutting.

What will be the impact of the US election on the equity market? How has it played out during past election cycles? Are there any sectors that tend to benefit?
 

Historically, election years have been the second-best year of the cycle, with the S&P 500 delivering 11 per cent returns (history since 1928), although volatility tends to rise from July to November ahead of the election.

Profits tend to matter more for S&P 500 returns than the political party in office. However, gridlock typically benefits equities (no major new policies are passed).

Themes with bipartisan support in this election cycle include maintaining defence spending, relocating tech IP out of China, and supporting reshoring and US manufacturing.

What are the other main risks at this juncture? Is the US-China trade war among them?
 

Many of the risks facing the global economy are geopolitical. From geopolitical tensions driving energy price shocks or shipping costs to more structural supply chain reallocations, these will remain key moving forward.

Trade tensions between the US and China have largely contributed to what we consider a permanent shift in the landscape. The US is substituting Chinese imports with those of other trading partners while driving the reshoring of production in strategic technologies, which could spill over as near/friendshoring in other economies.

What are your views on the EM pack and India in particular?
 

EMs have performed well despite delays in Fed rate cuts, particularly on the equities side. Additionally, EM debt has outperformed developed markets.

If the soft landing remains on track, EMs are poised to outperform over the next year as growth picks up while US growth slows.

India represents one of the top opportunities with robust growth, solid fundamentals, and openness to foreign investment. The Indian rupee has been the best-performing Asian currency this year, and we expect this trend to continue.

Are there more opportunities on the fixed-income side, given the elevated yields?
 

We are comfortable owning the 10-year Treasury here and would add to our positions if yields reached 4.5 per cent. If the Fed has finished hiking, carry trades should benefit.

Yield spreads are near a 17-year high, so we recommend relatively high cash balances, but we see some value in middle-quality bonds.

While corporate balance sheets overall are in good shape, higher-for-longer rates have taken a toll on the lowest-quality issuers.

Given the strong performance of US markets, why would capital from the US pursue opportunities elsewhere?
 

‘US exceptionalism’ has been a dominant theme in recent years, driven by US growth and innovation. US investors recognise that the dollar is strong and overseas assets are inexpensive.

The US stock market trades at 21x forward earnings, compared to just 14x for the rest of the world. A recovery in European and Asian economic growth could serve as a catalyst for US capital to flow overseas.

Is there steam left in the rally of Big Tech, artificial intelligence (AI), and chip-related names?
 

We expect the market for AI accelerator chips to double this year compared to last year and to double again by 2027.

Demand for Nvidia AI chips continues to outstrip supply. However, in software, AI benefits have generally been slower to materialise. This should change in the second half of the year, as we expect to see more evidence of AI monetisation.

Overall, the growth mix will shift away from Big Tech.