By Naomi Rovnick
LONDON (Reuters) - Big investors are tearing up market playbooks for 2024 based on timing an expected recession and interest rate cuts, as the world economy proves surprisingly resilient.
They are turning lukewarm on government bonds and away from big tech shares to bargain-hunt for stocks in sectors long hit by fears of a downturn that has yet to materialise.
A blazing bond rally that began in October has stalled as strong data including last week's U.S. jobs numbers shake expectations for rapid monetary policy easing.
And while red hot stock markets remain vulnerable to any collapse in rate cut bets, some money managers believe sustained economic growth will buoy up small-cap shares, banks and cyclicals and could sweep cautious money back into equities.
"The surprise this year is probably that (economic) growth comes in once again," said Evan Brown, head of multi-asset strategy and portfolio manager at UBS Asset Management.
Brown favours mid-sized U.S. stocks outside big tech and European banks. He prefers stocks to bonds.
Market gospel has long been that with borrowing costs at a 22-year high in the U.S and a record peak in the euro zone, businesses would struggle and unemployment rise, prompting central banks to quickly ease policy.
And the growth outlook has undoubtedly weakened: the World Bank on Tuesday forecast the global economy is heading for its worst half-decade performance in 30 years, while Germany - Europe's biggest economy - is having a bumpy start to the year.
But with U.S. employment strong and consumer sentiment in Europe improving, the outlook is less dire than feared.
The U.S. economy confounded expectations to grow 2.4% last year and is seen expanding 1.2% in 2024, a Reuters poll showed, while the euro zone is expected to have grown 0.5% in 2023.
"The footprints of money will guide you into the (stock) market instead of waiting on the sidelines worrying about this recession we never had and might not have for some time," said Ken Mahoney, president of Mahoney Asset Management.
Pictet Wealth Management CIO Cesar Perez Ruiz said that with economic data holding up, low-valued businesses worldwide would become takeover targets. He was tempted to hunt for such bargains in the UK's mid-cap FTSE 250 index, he said.
Money markets now predict roughly 140 basis points of U.S. rate cuts this year, compared with 150 bps in December, a revision that has boosted the dollar.
"We are expecting a soft (economic) landing rather than an outright recession and the Fed to be much more conservative in cutting rates than the consensus believes," Federated Hermes chief equity strategist Philip Orlando said.
BOND BLUES
Benchmark 10-year U.S. Treasury yields are trading at around 4%, down from 5% in October. Germany's 10-year Bund yield fell below 1.9% in December, capping its best quarterly performance since 2012, before rebounding to about 2.2%.
Pictet's Perez Ruiz said his last trade before going on holiday in late December was to sell some of his 10-year Bunds because rate-cut euphoria was exaggerated. He has a neutral stance on U.S. Treasuries.
Euro area inflation rebounded to 2.9% in December.
Economists forecast data on Thursday will show a core measure of U.S. inflation moderated to 3.8% in December.
Some analysts say that is still too high for significant monetary easing, especially as Red Sea supply disruptions threaten another global inflation spike.
Jason Da Silva, global investment strategy director at London-based Arbuthnot Latham, said he would need more evidence of inflation nearing 2% before turning bullish on Treasuries.
STOCKS TO SURVIVE?
The debate for stocks is whether they survive a no-recession scenario that pulls rate-cut bets right back.
Global shares, up 20% last year, rallied most in November to December as U.S. inflation moderated and the Fed signalled rate hikes were done.
"If the economy does hold up better than expected, then that risks creating disappointment since the rate cuts priced might not happen," Deutsche Bank (ETR:DBKGn) said.
UBS's Brown argued, however, that a no-recession outcome would drive stocks higher as market gains broadened.
Last year's equity rally was powered by the "Magnificent Seven" group of U.S. tech stocks, including Microsoft (NASDAQ:MSFT) and Nvidia, which boomed on bets of long-term growth from artificial intelligence.
Brown expects better performance this year from U.S. mid-sized stocks in cyclical industries like materials, industrials and finance.
He said European and U.S. banks would benefit from "resilient growth, healthy earnings and elevated, but not surging, interest rates".
On one measure, produced by Citi, global equity investors have entered a so-called stock-pickers' market - where the macro-economic outlook is not driving pricing - for the first time since 2019.
Federated's Orlando tipped value stocks - those defined as inexpensive versus their book value or dividend payouts and now mostly in financial, consumer and healthcare sectors - over tech.
"Investors will be attracted to the low P-E (price to earnings) multiples and high dividend yields of these stocks that, frankly, were left for dead last year," he said.