Our standard probability approach suggests that the probability of US core CPI falling below 3% in 2024 - let alone down to 2% - is effectively zero. We think the central point of the forecast range should be between 3.5-4.0%. There parts of the US economy which are exhibiting disinflationary trends, but the cost of shelter, especially Owners’ Equivalent Rent, is likely to remain elevated for several quarters. The Fed needs a major policy rethink about how it manages market expectations on the outlook for core CPI, and on how it addresses the rising cost of home ownership in its overall policy mix.

US Equities have been overbought for the last nine weeks, but there have been three longer streaks than this since 2000. Late March is one of two seasonal peaks for expected returns on the S&P 500. Q2 normally produces sub-par but positive returns and the greatest risk of negative returns only comes in Q3. Seasonality also suggests that Treasuries can be weak in Q2, which would fit very nicely with a narrative of only two rate cuts from the Fed in 2024. So even if equities are due some profit-taking, we are reluctant to switch into Treasuries, until they have corrected. We do expect some change in sector leadership, but not a wholesale switch into the laggards. Relative strength and sector persistence data both suggest that leadership will rotate around the top five groups: Financials, Industrials, Technology, Communications and Consumer Discretionary.

Our new EM equity model replaces the global country model and is designed to give us greater visibility on this asset class. We show that our normal process outperforms the benchmark in absolute and risk-adjusted terms. The average annual outperformance since inception is 2.9% and this is achieved despite the model’s volatility being lower than the index. It has outperformed the index in 20 out of 28 years and has good persistence of recommendation. The average stay in the top and bottom five (out of 25 countries) is about 18 weeks. India is the top-ranking country at the moment and close to maximum overweight, while China is at the bottom and close to maximum underweight.

In our view, Japanese equities cannot outperform on a sustained basis, until Japanese investors start to rebuild exposure to their domestic equity market – something they haven’t for over 25 years. We agree that there have been significant moves to make local companies more investor-friendly, but our models suggest that US equities are still outperforming on a common-currency, risk-adjusted basis. When we run our standard process, but in yen terms, we find that Japanese equities are #2 behind the US. There are some sectors where Japan is preferred, but they are small in comparison to the ones where it isn’t. We like Japan on a tactical basis, but there is nothing to suggest that Japanese investors are about to fundamentally restructure their portfolios.

We have several indicators which suggest that Eurozone Equities could be about to generate a positive surprise. Our euro-denominated asset allocation model has upgraded global equities to overweight, chiefly because of some emerging weakness in German bunds. It is now more bullish on global equities than its dollar-denominated counterpart. Our global equity models still have the US as an overweight and the Eurozone as a neutral. There is only limited upside for the US but a lot more for the Eurozone, which has a much stronger uptrend and a better leading indicator. The positive mood is not yet supported by survey or hard economic data, but markets always move before this is published. We urge investors to keep an open mind about Europe, particularly Germany and the Eurozone.

Our models do not currently identify much opportunity for generating outperformance by switching between asset classes and most of our equity sector models are reducing their recommended active weight. We still think that above average exposure to cash and short-dated bonds is a good idea. However, they may be some opportunities for switching between equity regions, which will be affected by changing perceptions of political risk as we move through the year. The important thing is to stay nimble and remember that other people have opinions too. One example of this is in EM Equities, where India vs China is now priced for perfection, which doesn’t reflect the fact that India has a general election in April or May.

US investors have enjoyed a year’s worth of returns in seven weeks. This has been a rally of everything – except oil. Even real estate has had its moment in the sun. US Equities are approaching overbought territory and will probably get there by the end of December. US Treasuries – long and short – will get there in January, at the current rate of progress. But US and European credit is already there. There has to be some sort of reaction to recent strength. We expect credit markets to weaken first, which will be used to justify the recession narrative, which will then impact equities. Government bonds may continue their rally for a while, but we think the big theme for the year will be the US budget deficit. Round 1 is in January, the next one is in Q4. Bond vigilantes are not dead, just sleeping.

Healthcare has been underperforming all year. We are underweight in the US and Japan and may soon be forced to downgrade in Europe as well. There are a number of possible explanations, ranging from the industry specific to macro-economic, and from portfolio construction to US politics. None of them, on their own, is particularly convincing, but in combination they form a powerful cocktail. Our models are telling us there is a problem, but we are not sure what it is.

Our top-down models are now overweight fixed income, so maybe it is time to work out exactly which categories we want to own and why. We have always liked the yield to volatility ratio, chiefly because it is a good lead indicator of the Sharpe ratio, which an asset will deliver. It contains more information than a study of spreads relative to benchmark, and avoids the underlying assumption that these are somehow mean-reverting. High Yield scores very well on this metric and has done for most of the last two years, which is why we have it as the only category in our fixed income model, where we are overweight relative to benchmark.