Nuveen: Japan finally emerging from its decadeslong battle with deflation

June 27, 2024

As the threats of higher inflation and interest rates wane, we think it makes sense to move closer to a neutral duration.

Equities

‘A combination of global economic resilience and strong corporate earnings has propelled equity markets higher over the first half of 2024. This upward move has been accompanied by less favourable valuations, which (combined with uncertainty surrounding central bank policy) leads us to stick with a neutral view toward global stock markets. Overall, we favour a focus on higher-quality segments, leaning toward industries and geographic regions that offer both fundamental and valuation tailwinds,’ Nuveen today looks ahead to the rest of the year. ‘Likewise, we have a less positive view toward areas with a higher degree of economic or interest rate sensitivity.

In the US, we prefer large caps over small (which tend not to do as well when economic growth is slowing). And we see particular opportunities in industries that can benefit from the AI boom. Our sector focus areas include energy (strong supply/demand dynamics) and technology (specifically software and semiconductors, which should be resilient amid slowing growth).

Outside of the US, we think Japanese equities look compelling: Japan is finally emerging from its decadeslong battle with deflation. And while the BOJ is slowly raising rates, Japanese monetary policy remains among the most accommodative in the world. Select emerging markets that feature relative value and improving earnings also look attractive, including China where the rebounding economy creates a tailwind.

Private equity markets continue to struggle, but we still see investor interest that could drive more deal activity.’

Fixed Income

‘Fixed income markets overall appear very attractive. Inflation is slowly easing across most geographies, and global central banks are (for the most part) slowly moving toward more accommodative policy. We don’t expect dramatic rate declines, but believe bond yields should move modestly lower throughout the second half of 2024. Importantly, even if rates remain elevated, current yields still offer compelling income.

As the threats of higher inflation and interest rates wane, we think it makes sense to move closer to a neutral duration. If central banks start cutting rates more aggressively than we expect, investors may want to consider moving to a longer duration position, but we don’t think that is likely nearterm.

Attractive yields and opportunities for additional total return as longer-term rates decline also mean that investors holding excess cash would do well to consider reallocating to fixed income.

One important caveat to our view: we think it makes sense to adopt a longer-duration stance in municipals. The muni bond yield curve is significantly steeper than the US Treasury curve, which provides the potential for current income as well as total returns when and if rates do decline.

We have been advocating a focus on flexibility and diversification across credit sectors, as we see solid opportunities across global fixed income markets. Within that context, we are less positive toward investment grade bonds given recent strong performance and tight spreads. In contrast, we favour the relatively higher quality areas of senior loans and collateralized loan obligations, which feature strong fundamentals and should continue to benefit from the higher-for-longer theme. We also like preferred securities that benefit from a solid issuer base and emerging markets debt investments that feature improving credit quality.

Municipal bonds feature strong fundamentals (solid credit ratings and high levels of cash) and attractive supply/demand dynamics. We see significant opportunities in taxable municipals for non-US investors, and we are focused on the high yield and specialty- and property-tax-backed areas of the muni market.

We also remain constructive toward private credit markets, especially if we only experience a mild slowdown or shallow recession.’

Real estate

‘We continue to see positive signals increase for private real estate. The stiff technical headwinds that have been holding the asset class back for an extended period are fading. Most global rate increases are in the rearview mirror, and rate cuts are on the horizon – a plus for private real estate. Additionally, there is more clarity around pricing, and the spot market has stabilized. At the same time, investor demand is rising: Commercial real estate lending is growing, overall liquidity is improving and, in general, most investors are no longer overweight private real estate.

The US office sector will likely remain challenged given high vacancy rates, but we see broad opportunities across residential, industrial and alternative real estate. Areas like medical office and senior housing look compelling, as they should benefit from long-term demographic trends.

A more stable rate environment (and prospects for cuts), as well as strong pricing power on the part of lenders, continues to support overweighting private real estate debt over equity. We would consider private real estate equity as a hold position.’

Real assets

‘Public infrastructure investments appear especially compelling, as they benefit from still-elevated inflation and have minimal sensitivity to interest rates. Additionally, the essential-service nature of these companies means they should be able to weather slowing growth. Our most favoured areas include data centres (capitalizing on the AI boom), North American utilities (compelling value with highly visible growth) and energy (strong balance sheets and solid earnings prospects). In contrast, we see some risks in European utilities that could be hurt by potentially lower power prices.

We also have a favourable view toward public real estate. Valuations, fundamentals and earnings prospects all look fair to positive, and we expect real estate will benefit when interest rates start to decline. We are seeing particular value in health care (specifically senior housing and medical office), data centres and select convenience retail and grocery-centred shopping complexes that should be able to withstand slower economic growth.

We also see opportunities across private real assets. Within infrastructure, we are focused on capitalizing on two key trends: ongoing digitization, particularly the rapid growth of AI-driven data centres, and clean energy transition, with a focus on electrification. We also see opportunities in agribusiness investments, including investments that focus on food ingredient processing that can reduce in-store labour at quick-serve restaurants (a growing area of the market).

We also remain positive toward farmland as a long-term investment. Farmland tends to be relatively well insulated from both macroeconomic factors and geopolitical risks, which can create diversification benefits. While row crop margins and profits have been declining, they remain above their historic average, and land values continue to increase.’