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Wells Fargo’s Asset Allocation Strategy for H2 2024

Published 07/05/2024, 11:10 AM
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Investing.com - As the year reaches its halfway mark, Wells Fargo considers it an appropriate time to revisit its economic and market outlook for 2024 and recalibrate expectations for the next 18 months.

Midyear Outlook Recap for Investors

The promise of artificial intelligence (AI), Federal Reserve rate cuts, declining inflation, and the resumption of durable earnings growth fueled a hard pivot to positive momentum to open the year, analysts at the U.S. bank said, in a note dated June 17.

Inflation has moved steadily downward from 9.1% in June 2022 but has remained stuck between 3% and 4%. This has resulted in the market projecting higher long-term interest rates for longer, compared with the expectation of as many as six or seven rate cuts coming into 2024.

The effect of government stimulus packages and a ballooning federal budget deficit was apparent on asset prices as large amounts of liquidity were pumped into the economy, leading to all-time highs in the S&P 500 Index, as well as bitcoin, and gold.

That said, there remain areas of tensions. There is a new war in the Middle East and a lingering one in Eastern Europe. Growth has slowed in China, dragging down Emerging Market Equities, and the U.S. dollar has remained stronger.

Which Equities Should Perform Well This Year?

There is ample evidence at midyear that, after a few years of narrow growth concentrated within a few key sectors, the potential for more robust growth is broadening.

“It will be important for this trend to continue over the next 18 months,” Wells Fargo noted.

Many of the frictions that weighed on company earnings for the past two years are likely to dissipate over the next 18 months - positive economic growth should drive sales while cost control should help anchor profit margins.

“Our view is that the incipient earnings recovery we expect this year will continue in 2025. This should allow equity prices to be driven primarily by earnings growth rather than price/earnings (P/E) multiple expansion,” analysts at the U.S. bank said.

As it stands the bank prefers U.S. Large Cap Equities (favorable) over U.S. Mid Cap Equities (neutral) and U.S. Small Cap Equities (most unfavorable), as well as Developed Market ex-U.S. Equities (neutral) over Emerging Market Equities (unfavorable).

Alternative Investment Opportunities

Inflation and interest rates remain the key narratives driving markets, Wells Fargo noted. While investors have priced in fewer rate cuts in 2024, a strong labor market and pockets of stickier inflation have many questioning whether the Fed may hold rates steady for the foreseeable future.

“We believe Long/Short Credit and Arbitrage strategies should likely benefit from their defensive characteristics during economic slowdowns. Moreover, we expect credit dispersion to remain elevated given the uncertainties in interest-rate policy and economic growth, which we believe should bode well for Relative Value strategies,” the U.S. bank added.

The bank added stronger, more stable trends in commodities and currencies, as well as elevated cross-asset volatility, to be tailwinds for Macro strategies.

“Additionally, Macro strategies have historically been the least correlated to global risk assets, which we believe can be additive to portfolios as the cycle matures,” Wells Fargo said.

Interest Rate Forecast

The path of U.S. interest rates will be a key factor in the second half of the year, and Wells Fargo expects the Fed to remain vigilant for the remainder of the year and into 2025, carefully calibrating monetary policy in an effort to avoid tilting the economy into a recession by being overly restrictive.

“Our current view is that the Fed will attempt to cut rates twice before year end; however, we believe the probability for the federal funds rate to remain on hold at current levels is increasing as inflation remains sticky,” said the U.S. bank. “Also, we expect one rate cut in 2025.”

The bank expects short-term U.S. Treasury rates to move lower in tandem with the decline in the Fed’s policy interest rate, but given the expected economic growth and inflation levels over the next two years, thinks it would be difficult for long-term rates to fall below 4% level.

“We are keeping our year-end 2024 10-year and 30-year U.S. Treasury yield targets unchanged, but we do envision slightly lower long-term yields next year if the Fed continues to cut rates as we expect,” Wells Fargo said, with its 10-year U.S. Treasury yield target at 4.00%–4.50% and the 30-year U.S. Treasury yield target at 4.25%–4.75% by year-end 2025.

Investment Portfolio Idea for the Second Half of 2024

Given these circumstances, Wells Fargo suggested investors should consider long/short equity strategies. These can provide diversification in an equity portfolio by utilizing both long and short exposures to the asset class.

While they can provide diversification, investors should expect higher tracking error to traditional benchmarks from these strategies, and prudent use through controlled allocations is recommended.

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By diversifying portfolios, investors can mitigate risk and maintain consistent returns, even in turbulent markets. If you’re looking for stock watch lists and trading ideas based around different themes - from our Top Dividend Stocks list to Cybersecurity Stocks, our Discover Stocks page should be your first call.

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