While in the alpine regions of Europe the ski holidays are in full swing, in China the two-week Lunar New Year celebrations have just ended. The country recorded 474 million domestic tourism trips, which is well above the pre-pandemic level and better than feared by market observers. However, Chinese consumers have spent on average considerably less than before. This single data point chimes well with what we have heard from numerous company executives during the fourth-quarter earnings season: do not count on China for better growth prospects. How China recovers will depend on whether the Chinese authorities announce any meaningful fiscal support in the next weeks and months and will play a part in the new economic cycle.
In the US, timing is also a key focus. US inflation has recently surprised to the upside, so expectations about the timing of the first rate cuts have moved further out. We have always been on the cautious side and expect a first cut in May. In the second half of the year, when the new economic cycle kicks in, economic factors also point to a new manufacturing cycle.
A new manufacturing cycle
We recently upgraded the Automation & Robotics theme, as we see the start of a new manufacturing cycle on the horizon. On the economic front, the Japan Machine Tool Orders (JNMTO) Index, a key leading indicator, pushed through in Q4 2023, when orders were close to -20% y/y, and is now improving, with momentum in positive territory.
This is an important signal for the manufacturing sector, as JNMTO are strictly correlated with global industrial production. Therefore, we should expect an improvement in manufacturing activities starting in the second half of this year. That we have passed the hardest point of the cycle is also confirmed by other leading economic indicators, including manufacturing PMIs, new orders, and the US Federal Reserve’s business outlook and forecasts for capital expenditures.
In addition to these considerations, we continue to believe that the structural demand remains healthy, driven by higher capital investments from electric and semiconductor manufacturers, from the shift to electric vehicles in the automobile industry, from reshoring initiatives in developed markets, and by a broadening application of robots in other segments of the economy.
That said, the improved outlook is not without uncertainties, and we see risks in relation to China, where demand remains weak, competition is high, and certain manufacturing segments look over-supplied.
Cyclicals: Timing the rotation
As the new economic cycle is likely to start unfolding and gaining steam in the second half of 2024, there will likely be an opportunity to switch into cyclical sectors, which are sectors known for following the cycles of an economy through expansion, peak, recession, and recovery. Examples include tourism, construction, textile and luxury goods. These tend to perform well early in a new cycle, and the new manufacturing cycle will also play a part in this.
Given the strong performance of cyclicals in 2023 against the backdrop of ebbing recession fears, markets are already discounting a strong economic recovery, both in the US and Europe. Equity markets, especially in big tech, continued to power ahead this year, driven by improving economic growth prospects coupled with falling inflationary pressures. A reassuring earnings season, particularly in the US, also supported the recent rally.
What does this mean for investors?
On the topic of timing, we are not quite ready to go all-in on cyclical stocks. As the economic cycle turns, there will be plenty of opportunities in this space down the road. For now, a selective exposure is warranted, e.g. to automotives, semiconductors, machinery and equipment, and transportation.
During the last earning season, many companies also announced that they are seeing the end of the destocking of inventories and the start of a new cycle. While they still expect some weakness in the first half of this year due to the persistence of economic uncertainties and the debate around interest rate changes. Hence, the recovery and manufacturing cycle is bound to be backloaded and might start in the second half of 2024. As the market tends to price in advance changes to the economic environment, we believe that the time to invest is now rather than later.
Going forward, we recommend investors obtain exposure by investing in thematic indices (such as the newly upgraded Automation & Robotics theme) or in single names. We also continue to remain constructive on large-cap growth stocks, with a bias towards the US over the longer term.