One could be forgiven for being confused by the market right now. From a geopolitical standpoint we are deep in the weeds of the US Election, and at the same time the Middle East seems to be plunging into a mess, with Iran lobbing missiles into Israel, which in turn promises tit-for-tat retaliation. Oil prices have spiked therefore as fears of a widening Middle Eastern war intensify.
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Despite this, the Federal Reserve (Fed) decision to cut U.S. rates by 50 basis points and signal an ongoing cutting cycle marks an important shift in the economic landscape. From a single-minded focus on bringing down inflation, we now see a clear Fed emphasis on its dual mandate, and specifically on maintaining a strong labour market. Corporate confidence, which is fragile despite strong cash flow and decent balance sheets, has scope to improve as rates fall. Consumer activity has moderated but remains robust even as unemployment has ticked up from its lows. Overall, we anticipate growth moderating to a trend-like pace of roughly 2% in the next two to three quarters, and inflation returning to target by mid-2025.
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The U.S. non-farm payrolls report last Friday has confirmed, again, that the U.S. economy is moving away, not toward a recession, with the unemployment rate having fallen anew. There is no sign that the U.S. economy is falling apart, and we are doubtful the Fed will cut as deeply as what is priced in by the markets. The labour market has cooled, but so far there is nothing that seems to be ominous and indicates an incoming recession.
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Importantly, investors need to consider that the two largest economies in the world are now easing policy. History suggests we should expect a global cyclical recovery, consequently which should support risk assets, if history is a guide.
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China’s government is signalling a commitment to creating a reflationary environment, which may be the only way out of its contraction that does not involve a deeper recession. This was brought about by a joint announcement by The People’s Bank of China (PBoC), the securities regulator (China Securities Regulatory Commission) and the financial regulator (National Financial Regulatory Administration) on a series of economic stimulus measures, as well as the earlier than expected Politburo meeting that prioritised growth, housing, jobs and social welfare. For now, the package appears to be a serious commitment to reflation. Albeit follow up fiscal stimulus in the first instance has underwhelmed.

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Since the package was announced Chinese equities have risen by 10%-30%, which pushed most categories into substantial Year to Date (YTD) gain territory. Even so, valuations are still at the low end of the last 10 years. We have had two periods of market rally since 2022. The first one was in 4Q 2022 as China came out of the pandemic lock down. The second was in 2Q 2024, again on recovery expectations. Both episodes ended with the market going back to worrying about China’s economic outlook. Beijing has taken similar policy steps in the past two years. However, these occurred in isolation with limited economic effect. One thing which is different this time is that the latest effort is coordinated by the various ministries and regulators, which demonstrates a sense of urgency to boost momentum, whether in the housing market, domestic consumption, or the stock market.
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In our view, the pass through of China’s nominal GDP growth into the earnings is incredibly low versus other emerging and developed economies. Australian investors are already highly exposed to the Chinese economic outlook via domestic resources exposures.

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In sum, our conviction in a return to trend-like growth, and an extension of the cycle, is growing. We anticipate moderately positive returns from risk assets as the Fed gradually eases policy but expect to see any dips in risk assets bought quite quickly. Risks to the global economy continue to emanate from weakness in the goods cycle, but for now we believe that the consumer remains robust enough to support activity. Upside risks to our view may have been pushed out to 2025, but with the Fed in play we also believe that the economy, and markets, have solid foundations.
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The biggest threat to the bull market is the escalating conflicts in the Middle East, but it is hard to assess the exact impact on financial markets at this stage. By and large, much will depend on how long these conflicts last and how high oil prices can go. Oil affects inflation and economic activities slowly and as things stand now, the economic impact of the Iran-Israel conflict is limited. However, if the war widens, pushing oil prices to $95-$100, both bonds and stocks will have to adjust downward, probably significantly, to account for rising inflation or stagflation risk.