As temperatures climb across the Middle East, investors will be welcoming the cool breeze of disinflation that we’re seeing recently. The Federal Reserve also welcomed this cooling, signaling a cut in the not-too-distant future. But sadly, there is no summer break on the horizon for markets. Artificial Intelligence (AI) momentum just keeps building. Stocks are hitting more new highs and bonds are rallying, but it’s not all straightforward — risks remain.
So how can Middle Eastern investors play it in their portfolios? Here are five actions worth considering today.
I. Continue to move out of cash
Both headline and core United States Consumer Price Index (CPI) cooled to the slowest pace we’ve seen in years recently. The key downside driver was “sticky” services, as Chair Powell’s “super core” services ex-shelter gauge actually fell (i.e., deflated) in May for the first time since 2021. A few hours later, the Fed signaled that the economy can handle higher rates for a bit longer and that the next move is still lower — shifting its projections from three cuts this year to just one while awaiting further inflation progress.
Meanwhile, the race to rate cuts is already on elsewhere. Out of 37 central banks we track, 20 are now in easing mode. This means that for the first time in over two years, more central banks are cutting rather than hiking. With most currencies across the Middle East pegged to the USD, we expect many central banks across the region to follow suit with potential cuts later in the year and into 2025.
Times are changing. Cash has played a noble role in portfolios over the last two years and is a necessary part of any lifestyle. But even if policy rates settle in a higher range than in the last cycle, the shift away from global tightening, albeit staggered, signals that today’s elevated cash yields won’t last forever.
We believe better opportunities exist today, especially for long-term investors looking to grow and compound their wealth over time.
II. Embrace equity exposure
As of July, the S&P 500 has now made 29 record highs this year. Looking back since 1950, whenever we’ve seen these many all-time highs in the first half of the year, the full year has averaged a 20 percent return. Equities across the Middle East have generally lagged behind the US market year-to-date given ongoing geopolitical uncertainty and a different market composition with less exposure to technology. However, it is important to keep in mind that this is coming off a strong year in 2023.
Today’s backdrop looks poised to continue the upside trend. The global economy is at its healthiest in decades, and inflation looks to eventually settle into a 2-3 percent range. That’s historically been one of the best eras for stocks. Inflation below 3 percent tends to support equity valuations and benefit earnings, with companies able to raise prices while also managing costs.
We’re seeing this in action: Profit margins in developed economies are near their strongest levels in decades, signaling that companies are more efficient at turning sales into profits. To boot, mega-cap firms have demonstrated exceptional earnings power despite higher rates, and it doesn’t stop there: the latest Q1 earnings season saw eight out of 11 S&P 500 sectors post profit growth, with 80 percent of companies beating expectations (well above the 10-year average).
But within that strength, investors should note dispersion beneath the surface. Currently, less than one-quarter of stocks have outperformed the S&P 500’s 15 percent year-to-date total return, near the lowest share in the past 10 years. This creates opportunities for active investment decisions. We see some of the strongest potential across sectors such as technology, industrials, consumer discretionary and healthcare, and are always on the hunt for mispricings. For instance, some of the highest-quality small- and mid-cap companies are trading at a meaningful discount to their large-cap peers.
III. Lean into credit opportunities
After the rate reset, bonds are back to being bonds. Most pockets of fixed income, outside of Treasuries, are now outyielding cash for the first time in two years. As a strong (albeit slowing) economy keeps default rates low, we think investors can pick up even greater yields by going out on the credit risk spectrum — building in strong income potential as well as insulation in the event of a downturn.
The opportunities aren’t exclusive to “traditional” credit markets though. Other pockets of the investing landscape show why it’s a good time to be a new lender. Direct lending, a segment of private credit, is offering yields around 11 percent. We think this more than compensates investors for potential default losses. Elsewhere, specialized credit investors can capitalize on the reality that not all borrowers are created equal, stepping in to help companies and their creditors renegotiate their agreements. Such “amend and extend” transactions increased tenfold between 2022 and 2023.
IV. Position for the AI revolution, but be discerning
Global markets seem to be sussing out which AI players can demonstrate real productivity gains, revenue creation, or both. That approval does not come easy — even for tech giants.
In time, we believe the potential use cases span almost every industry, and that’s not to mention the massive infrastructure needed to power it. One inquiry on ChatGPT requires up to 10x more power than a traditional web search. As we decipher the power and capabilities of AI, we believe it will be transformative, akin to the internet and the steam engine. But as in those times, too, a discerning eye is key. Some of the future winners may not even exist yet.
V. Diversify, diversify, diversify
Risks of all kinds are apparent, especially around elections and continued geopolitical turmoil. This requires investors to be alert and to insulate portfolios from destabilizing events — whether that be through diversification, or investments oriented around the changing world order.
In all, we see a strong economy in a fragile world. To us, that looks like a healthy backdrop for investors as they prepare for the second half of 2024. Amidst these market dynamics, Middle East investors must stay focused on their long-term goals. While short-term market fluctuations may tempt reactionary responses, a disciplined investment approach anchored in sound fundamentals remains paramount for their long-term goals.
By embracing diversification, reassessing cash holdings, and staying attuned to long-term objectives, investors can navigate this evolving landscape with confidence.
All market and economic data is as of June 2024 and sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.
Steven Rees is Head of Investments at JP Morgan Private Bank for Middle East, Africa & Turkey.
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