In Q1 2024, global equity markets rose by 8% in USD terms, continuing their strong performance from 2023. In contrast, developed-market sovereign bonds declined just over 2% due to persistent inflation concerns, eroding much of the previous year's gains.[1] With continued uncertainty around the speed and timing of central banks’ interest-rate pivots, and because substantial capital has remained on the sidelines in money-market funds, a potential shift of cash into riskier assets, such as longer-duration bonds, corporate credit and equities, could be in scope over the balance of the year.[2]
In last quarter’s edition of Markets in Focus, we explored the changing relationship between government bonds and equities. In this quarter’s post, we focus on the relationship between corporate bonds and equities. Considering the continued bull market in stocks, we examine the prevailing risks in the U.S. markets and the implications for investors choosing to move out of cash positions in 2024. This quarter also marks the start of our integrating fixed-income commentary into this quarterly analysis, to provide a comprehensive view into public markets.
Diminished diversification benefits from credit carried into Q1
Current conditions in global credit markets have been shaped by the tailwinds of high coupons, the possibility of impending rate cuts and growing confidence in a U.S. “soft-landing.” We believe vigilance is warranted, however, given the lingering effects of shocks related to the COVID-19 pandemic.
In the following video, MSCI’s head of portfolio management research, Andy Sparks, discusses the relationships within the bond markets across the credit spectrum, as well as between bond and equity markets, in the four years leading up to 2024 and during the first quarter of the year.
Putting Q1 bond returns into perspective
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Using the MSCI Multi-Asset Class Risk Model, we observed that correlations between corporate spreads and government bonds remain elevated, suggesting a continuation of diminished diversification benefits from debt investments. Around the world, both investment-grade and high-yield credit markets have become more closely coupled to equity markets.
Credit has struggled as a diversifier since the COVID-19 pandemic
Global equities marked by regional differences in style performance
Although global equities were up almost 50% since the start of 2020, they still exhibit patterns that emerged during the COVID-19 pandemic. Over the last four years, the whipsawing sentiment between value and growth stocks has contributed to divergence in regional performance.
Growth stocks in the MSCI ACWI Investable Market Index (IMI)[3] led value throughout 2020, but the trend reversed after the announcement of a vaccine breakthrough and continued alongside rate hikes in 2022. The AI-driven rally that began in late 2022 meant growth stocks surged once again. These broad characterizations mask important regional variations, however.
2020s characterized by whipsawing sentiment in value and growth
In Q1 2024, the so-called Magnificent Seven have driven the U.S. growth rally in equities, despite diverging fundamentals. In addition, European growth stocks, led by firms such as Novo Nordisk A/S and SAP, have outperformed, increasing European firms’ weight in the MSCI Thematic Megatrend Indexes and contributing to the momentum factor’s strong performance.
Outside the U.S. and Europe, value has led in emerging markets (EM) and Japan, pushing Japan to the top of developed-market returns over the past year, with gains also reflecting improved corporate governance.
US and Japan were leaders in developed markets, and India and Taiwan in EM
In the first quarter of 2024, developed markets, led by the U.S. and Japan, outperformed EM by a significant margin, as measured in USD. Emerging markets ended the quarter up slightly, as gains in India and Taiwan were offset by a continued slide in Chinese stocks.
All of the MSCI Thematic Indexes — except for transformative technology, which outperformed the MSCI ACWI Index by a wide margin — had a challenging start to the year.
Top performers in Q1: Japanese equities and the momentum factor
An eye toward valuations in the US
The growth rally in U.S. equities throughout 2023 and into the first quarter of this year could raise the specter of the U.S. market’s being “priced for perfection” relative to other regions. In the following exhibit, we show that the MSCI USA Index is nearing a two-decade high in relative valuation, based on the difference in forward earnings and real bond yields. International stocks were not at the same levels, using the same measure.
In the current climate of reduced equity volatility and the consequent lower put-option premiums relative to historical norms,[4] investors cautious about high U.S. valuations could observe that this condition offers the possibility of gaining reasonably priced downside protection against increasing volatility.
US relative valuation higher than historical average
Coming off the sidelines
Based on valuations, and other signals such as macroeconomic sensitivity and sentiment, our adaptive multi-factor framework favored the value factor, as of March 31, 2024, as it did at the close of last year. Investors contemplating repositioning their cash in the year ahead may wish to consider the impacts of the changing equity-credit relationship and growing regional disparities as they revise their allocations.