Barclays tells investors to stick with global equities but hedge against potential risks

Barclays has told investors to stick with global equities after strong gains this year, but with rising risks and low volatility it’s a good time to shore up portfolios.

Barclays global chairman of research Ajay Rajadhyaksha.

Barclays has told investors to stick with global equities after strong gains in the first half of 2024.

However, with political risks rising and relatively low volatility in equity and currency markets, it’s a good time for investors to protect themselves from potential drawdowns, the British bank says.

In its global outlook, Barclays sees steady economic growth, sticky inflation and a slow easing of restrictive monetary policy by central banks providing a backdrop for further outperformance in global equities compared to government bonds again in the September quarter.

A week before month end, the global stock market is up about 2.7 per cent in US dollar terms for the June quarter after hitting a record high despite a flat performance from Chinese stocks.

Australia’s S&P/ASX 200 has fallen 1.4 per cent in local currency terms this quarter as its tech exposure is limited and a pullback in crude oil and iron ore prices has weighed on resources stocks.

The Australian dollar has risen more than 2.2 per cent with local rate cuts not expected until 2025.

Still, the S&P/ASX 200 is up about 8 per cent for the financial year. The median super fund in the growth category is heading for another solid return of about 9 per cent according to Chant West.

Amid further strong gains in mega-cap tech stocks driven by the AI boom, the MSCI All Country World Index recovered from a 5 per cent dip caused by jitters about sticky inflation which receded as US disinflation got back on track and rate cuts started in Europe and Canada. At the same time the global bond market largely tracked sideways even as corporate credit rallied and spreads tightened.

Underpinning these benign markets has been surprisingly steady global economic growth.

An underwhelming performance from China has been offset by the start of a cyclical recovery in the euro area, strong growth in India and surprisingly strong growth in the US.

After turning down into “contraction” territory in September 2022, the J.P. Morgan Global Manufacturing Purchasing Managers’ index turned up into “expansion” territory in January and hit a new two-year high in May, signalling a cyclical upturn in global manufacturing.

“Historically, rate cut cycles play out quickly and against a backdrop of high job losses and quickly slowing activity; that is not the case in any major Western economy right now,” said Barclays chairman of research, Ajay Rajadhyaksha.

“Instead, while they wait for data that confirms inflation is decisively headed towards 2 per cent, central banks are simply turning a little less restrictive at a very slow pace. Put bluntly, as summer starts, the macro backdrop is not very worrying but neither does it seem terribly exciting,” he said.

But there are plenty of concerning developments below the surface.

Ongoing wars in Europe and the Middle East, persistent worries about the US fiscal situation, and concerns outside the US that the Federal Reserve may be keeping rates too high for too long have potential to increase volatility in global markets.

Election results in Mexico, India and South Africa have caused upheavals in their local markets, and opinion polls point to a change of government in the UK and France faces parliamentary elections which could bring the National Rally to power, raising questions about European co-operation.

Trade frictions are rising, with the US and EU both imposing new tariffs on China, and attention will turn to the US Presidential election in November with trade wars possible if Donald Trump wins power again.

“Our baseline is that none of these developments will knock the global economy off course,” Mr Rajadhyaksha said.

“It does concern us that, with equities making new highs virtually every week, investors seem blasé about downside risks.”

Nowhere is this more apparent than in the option markets, with implied volatility relatively low in most major asset classes, with the rates market being a notable exception.

Ahead of Friday’s “triple witching” expiry on Friday and after a 7 per cent intraday reversal in Nvidia from a record high of $US140.50 on Thursday, the VIX index of volatility on S&P 500 futures rose 0.8 percentage points to 13.28 per cent but was still well below its long-term average of 19.5 per cent.

Mr Rajadhyaksha said this leaves him feeling “uncomfortable” when it comes to asset allocation.

“We see little upside in core fixed income, given our growth and inflation outlook and rising fiscal deficits in many economies,” he said.

“Nor do we find equities compelling, after the massive rally from last October’s lows, especially with broad indices unusually hostage to a few mega-cap US tech firms, most notably Nvidia.

“But we feel that the path of least resistance is still for equities to grind out positive returns, so we find ourselves overweight stocks over bonds for yet one more quarter.”

However, for the quarter ahead Mr Rajadhyaksha tells investors to make use of the current low levels of volatility prevailing in equities and FX markets to “buy tail risks”.

“Don’t be taken in by the (northern hemisphere) summer lull,” he said.

“The second half of the year will bring both risks and opportunities.”