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Please see this weeks Markets in a Minute update below from Brewin Dolphin, this analyses the difference in recent performance between U.S. and European equities:

Last week markets were reasonably positive, with stocks and bonds generally higher. But this sentiment has shifted slightly over the past few days as investors reflect on high valuations in some areas of the market.

The improvement in bond markets followed benign inflationary data released by the U.S. Bureau of Labor Statistics the week before last. This firmed investors’ expectations that the next move in interest rates will be down rather than up.

But around that theme, there were differences in bond market performance. At a time when national finances are stretched and there’s an unprecedented number of elections taking place, political factors are likely to be important.

Populism and bond turmoil: The French connection

We still have months to go until the U.S. election, but in Europe, voting will be taking place much sooner. The French bond market in particular has been adjusting awkwardly to new political uncertainty.

The poll-leading National Rally party spent the 2022 presidential election pledging to slash VAT on energy, exempt the under-30s from income tax, and allow retirement at the age of 60 for many workers, with only reduced immigration and a clamp-down on fraud as potential means of funding these enormous tax cuts/spending increases.

Also riding high in the polls is the New Popular Front, an alliance of left-wing parties that also advocates a big fiscal expansion. This has seen a rise in French borrowing costs as investors try to discern the likelihood of these policies coming to pass.

Since calling the election, the polls continue to suggest populist parties that have made unrealistic spending pledges will win the largest share of the vote. The historical evidence would suggest they’ll moderate their plans once in office. To be fair, it’s true of almost all parties, whether populist or establishment, that their commitments reflect more wishful thinking than firm policy promises; it’s just that the difference between aspiration and outcome is likely to be far starker with the populists.

Reality check: A French revolution

It’s possible the new French government attempts to enact its fiscal largesse – in which case, we could see a bond market revolt. It might be tempting to call this a repeat of the Liz Truss mini-budget, but even in that instance, the most likely ultimate outcome is a chastened government conducting a policy u-turn.

Ultimately, the Truss government in 2022, the populist Italian coalition government in 2018, and French President Mitterand in 1983 all succumbed to more conventional fiscal policy under pressure from the market.

Is the UK banking on a change?

In the UK, we’re just over a week away from the election and the polls continue to favour the Labour party by a historic margin. The government heralded some good economic news last week, as the inflation rate declined and public finances improved.

If you recall, one of the arguments in favour of holding the election early was that there was a very strong chance of an improvement in inflation numbers in this last release before polling day. The prime minister can now demonstrate inflation has returned to target, but he can be less confident about the path of prices thereafter.

Another reason to bring the election forwards was that there was no longer a rationale to wait and deliver more tax cuts in an autumn budget. Does the good news on public finances released on Friday change that? Not really. Although it means the UK is no longer borrowing more than the Office for Budget Responsibility had forecast on a cumulative basis this year – the meaningful fiscal pressure remains. Neither main party seems likely to be able to meet its manifesto commitments without finding new tax revenue after the election due to the unrealistically low departmental spending budgets that have been forecast.

Coming back to the inflation numbers, and they showed the inflation rate returning to target. However, much of that’s a reflection of volatile price movements in food and energy, which are considered outside of the Bank of England’s gift to influence.

Core inflation runs at 3.5%, well above target. And the services category, which could be considered to reflect wage inflation, was particularly sharp. Services prices rose by 5.7% over the last year and 0.6% over the last month alone. There was little within this print to justify a cut in interest rates.

Nevertheless, when the Bank of England’s Monetary Policy Committee (MPC) met last week to consider interest rate policy, it clearly felt the case for a cut was building. Two members voted for a cut outright, and the minutes of the meeting reveal a discussion about this troublesome services inflation.

Of the seven remaining members, “some” felt that services inflation indicated that inflationary pressure remains. “Some” is MPC speak for two to three members. It’s distinct, for example, from “several”, which would mean three to four members.

The others were less troubled by services inflation, believing it to be driven by temporary factors like the seasonal increase in the national living wage. These “others” would seem sufficient, if added to the two currently proposing a cut, to reach a majority, and the wisdom of the markets now implies there’s a 60% chance of rates being cut in August.

But if these members feel that way, why are they not cutting now? Clearly, they need to see some further evidence of inflation slowing or the economy weakening between now and then.

A fly in the ointment of the improving inflation story is the persistence of some alternative measures of inflation. We calculate the median monthly inflation move to give a more stable indication of underlying inflationary pressure.

Since 2021, this measure has exceeded the 0.2% that would be consistent with the Bank of England’s inflation target. An improvement in this metric would seem a necessary precondition to inflation staying close to target.

Things can only get better?

In the absence of moderating services inflation, why do people feel comfortable expecting interest rate cuts? Because the economy is slowing. The key evidence for this comes from the labour market, but the data is inconclusive, and key measures like redundancies certainly suggest that employment is not collapsing.

Meanwhile, consumers have been recovering from postpandemic inflation and are now beginning to increase spending. National Insurance has been cut, which increases their post-tax incomes, and survey evidence suggests consumers have replenished their savings with wages outstripping price growth for a few quarters.

This was reflected in Friday morning’s retail sales numbers for May, which were quite strong. A combination of better weather than in April, income growth, rebuilt savings and lower goods prices have enticed consumers back to the shops.

Hopefully, nothing happens to upset the improving national mood, but with an election and the European Football Championship taking place over the next fortnight, it could be an emotional time.

Please continue to check our blog content for advice, planning issues and the latest investment market and economic updates from leading investment houses.

Andrew Lloyd DipPFS

26/06/2024

Please see today’s daily update from EPIC Investment Partners received this morning:

Europe finds itself at a critical juncture, grappling with a severe competitive crisis that threatens its long-standing position in the global market. For the past two decades, the continent has struggled to keep pace with productivity growth in the United States, facing what experts term a “competitiveness crisis.” This predicament stems from a complex interplay of economic, technological, and geopolitical challenges. 

At the heart of Europe’s economic woes lies a combination of structural issues, including labour market rigidities, high taxation, and regulatory burdens. High public debt, particularly in Southern Europe, constrains fiscal flexibility and limits public investment. Additionally, an ageing population places increasing pressure on social welfare systems, further complicating economic stability. These are some of the issues we highlighted ahead of the European Debt Crisis, and some of the main reasons we launched the Next Generation Bond Strategy. We believe that a nation’s economic growth is under pressure once the ageing population grows whilst at the same time the working age population shrinks. These pressures can arise despite improvements in technology and productivity.  

In the technological arena, Europe lags the US and China, especially in crucial sectors such as digital technologies, artificial intelligence, and biotechnology. Lower investment in research and development hampers innovation, reducing Europe’s ability to lead in new technological advancements. This technological gap is exacerbated by the slower pace of digital transformation in European businesses and public services. 

Geopolitical tensions add another layer of complexity to Europe’s challenges. Trade disputes, political turmoil, and rising protectionism create uncertainties for European businesses. Energy dependence, particularly on Russian imports, exposes the continent to security risks and price volatility. Moreover, Europe’s influence in global economic governance is waning compared to the growing clout of China and the sustained dominance of the US. 

A critical issue often overlooked is the sharp decline in foreign direct investment (FDI) flowing into Europe. FDI inflows have plummeted below their 2017 peak, with economic powerhouses like Germany and Britain suffering sharp contractions in recent years. This decline in FDI could prove disastrous as Europe seeks to secure more resilient supply chains and avoid its own “China shock.” 

To address these multifaceted challenges, Europe must adopt a more strategically assertive mindset. This may include implementing policies similar to China’s mercantilist strategies, such as mandating technology transfer through joint ventures for foreign companies seeking market access. Additionally, initiatives like the European Green Deal and the Digital Single Market aim to foster sustainable growth and enhance digital infrastructure. 

Ultimately, addressing Europe’s competitive crisis requires coordinated efforts at both national and EU levels, along with proactive policies to adapt to the rapidly changing global landscape. By tackling these challenges head-on, Europe can strive to regain its competitive edge and ensure long-term prosperity. 

Please continue to check our blog content for the latest advice and planning issues from leading investment firms.

Charlotte Clarke

25/06/2024

Please see the below article from Tatton Investment Management providing their insights into global markets over the past week. Received this morning.

Stock market highs don’t feel so high.

Even though global stocks reached another all-time, the mood feels subdued. This is partly seasonal – a US national holiday and June’s option expiry date distorted trading – but partly because growth is so uneven. US business sentiment surveys showed surprising strength yet again, while European firms’ sentiment languishes under political risk.

Even US markets are uneven. Nvidia briefly became the world’s biggest company by market cap and has accounted for more than a third of the S&P 500’s year-to-date returns. This isn’t a classic valuation bubble, though: investors seem to have just reluctantly accepted it’s the only one that can make big money no matter what. The AI rally has been phenomenal, but it isn’t yet growing productivity or living standards outside of tech giants like Nvidia. This might explain why Americans feel so negative about their economy despite decent aggregate data. Soft patches mean the Fed can cut rates in the Autumn, but it would be a shame if all this does is add another few more billion to Nvidia’s market cap.

The Bank of England left interest rates unchanged, but strongly hinted it would cut in August. Markets aren’t fully convinced but, after headline inflation dropped to 2%, it would upset things if the BoE didn’t. The UK’s election outcome also looks like a done deal, and this policy certainty is coinciding with improved growth prospects. This stands in contrast to deep uncertainty in France, which is why sterling has gained against the euro.

Going east, Japan’s yen is still the weakest currency, though, thanks to its incredibly easy financial conditions. The Bank of Japan wants corporates to invest, but the country’s private sector seems to have forgotten how. This is a problem for China too, as the renminbi’s loose dollar peg means it has appreciated around 10% versus the yen this year. Chinese financial conditions are remarkably tight, despite the economy needing support.

A renminbi devaluation would therefore be reasonable, but is politically difficult, both domestically and among US politicians. China’s weak economy means it needs to play nice. That should be good for the global economy but, like everything else, is a mixed bag.

Markets unfazed by Labour’s lead.

Polls and betting markets suggest a Labour victory in July 4th’s election is a done deal. Since the stereotype is that markets prefer Conservative rule, some have blamed politics for the FTSE 100’s underperformance over the last month.

That is a stretch. The FTSE 100 is dominated by large commodity multinationals and banks, so is much more influenced by global growth than domestic politics. Global growth expectations were strong earlier in the year – and the FTSE outperformed – but they are weaker now, and the FTSE is underperforming.

Investor anxieties about Labour are mainly around tax rises – but the party has ruled these out for income tax, national insurance, VAT and corporation tax, and Paul Johnson of the IFS calls the party’s planned rises “trivial”. Nothing in Labour’s communications or the market reaction leads us to doubt that.

Kier Starmer and his party have been much cagier about capital gains tax (CGT), though. A majority of voters think he will hike it, according to a Telegraph poll, and CGT does feel like the most politically viable source of extra funds. An increase could hit some private equity funds, though they would probably just move tax bases. It will probably boost demand for more tax-efficient investment structures too. After Rishi Sunak lowered the threshold for taxable gains in April, for example, our fund of funds wrapped portfolio structure saw increased demand.

All this has a pretty minimal effect on the value of investments, though. That tends to be decided by the real economy rather than the tax outlook. UK large cap will continue to be driven by global affairs, while small caps will be driven by domestic growth. On that front, Goldman Sachs see a small boost to demand from Labour’s slightly more expansive fiscal policy. But realistically there will not be much of a difference – given Labour’s plans to strengthen the Office for Budget Responsibility. Markets think there is little scope for surprises.

Commercial Real Estate: risks and potential recovery

Commercial real estate (CRE) is struggling. These troubles have thankfully not spread to the financial sector – as many thought they would after the collapse of Silicon Valley Bank last year – but risks are simmering rather than cooled entirely. $2tn worth of US CRE debt is set to mature in the next three years. $670bn of this is “potentially troubled”, according to Barry Gosin of brokerage firm Newmark. As such, banks will have “to liquidate their loans or find other ways to reduce their weight in real estate”.

Higher interest rates hit CRE with the double whammy of squeezing their leverage and dampening property values. Firms will probably have to refinance at harsher rates, as US rate cuts have been repeatedly delayed this year. $929bn will mature in 2024 alone. Banks might be forced to offload the debt at a discount, due to post-financial-crisis regulations.

That could mean opportunity for those buying the debt. In January, the billionaire founder of Zara expanded his personal stake in CRE via a “buy the dip” strategy. CRE prices are hardly recovering strongly this year, but the sector seems to be over the worst of its troubles.

The CRE market is seemingly in limbo – beyond the worst of its problems but lacking the positive momentum to truly rebound. Goldman Sachs summed this up last month as CRE debt being “volatile, dispersed, but not systemic”. Interestingly, Goldmans points out that current growth in lending to CRE is being driven by smaller banks. Falling US rates, which markets currently expect in September, would support this.

That should bring back some investment demand, helping the more resilient companies. CRE conditions are still tough but, compared to a year ago, the threat CRE stress poses to the wider financial system looks minimal.

Please continue to check our blogs for advice, planning issues and the latest investment, market and economic updates from leading investment houses.

Alex Clare

24/06/2024

Please see today’s daily update from EPIC Investment Partners received this morning:

The banking collapse of 2008 serves as a cautionary tale, a prime example of the dire consequences of risky financial engineering. ‘Engineers’ or bankers bundled sub-prime mortgage debt, presenting the resulting pools as squeaky clean, triple AAA rated, low-risk mortgage-backed securities (‘MBS’) and collateralised debt obligations (‘CDO’). This was just the beginning, as firms went on to create (CDO)2, pools composed of the lower-quality portions of unsold CDOs. Insurance ‘engineers’ also played a role, with AIG writing insurance on CDOs and selling it to firms that didn’t even own the underlying CDO. The layers of leverage on leverage on leverage led to the collapse, a stark reminder of the potential dangers of financial engineering.  

One may naively believe that a seismic event such as this would curtail financial engineering, and for the most part, it has, due to significantly improved regulatory standards for banks. However, in March 2023, we saw Silicon Valley Bank (SVB) fail, making it the largest bank failure since the Great Financial Crisis. There were several factors that caused the failure: concentration risk around clients and, therefore, a coincident need for liquidity; as well as losses incurred due to the magnitude and speed of interest rate rises that happened in the year leading up to the failure, which ultimately led to a run on the bank.   

However, a number of other regional banks escaped failure due to another engineering ‘trick’ sometimes employed in the way entities account for securities held on balance sheets. Classifying their securities as ‘held-to-maturity’, they no longer needed to report mark-to-market valuations and, hence, did not need to show any (large) unrealised losses on holdings. These assets could then be reclassified as ‘available-for-sale’ once they had recovered in value, despite, on paper, not being any different than SVB’s assets.   

More recently, we saw another use of financial engineering that may be more beneficial to society than the previous examples. President Zelensky attended the G7 Summit this year, to reinforce the message that aid is required urgently from allies and peers.  The G7 nations of Canada, France, Germany, Italy, Japan, the UK and the US have been important financial and military supporters of Ukraine since Russia’s full-scale invasion in 2022. The Russian assets that were frozen by the group, alongside the EU, when Moscow invaded Ukraine amounted to $325bn. Most of the assets of the Central Bank of Russia are being held in Belgium. Under international law, countries cannot confiscate those assets from Russia and give them to Ukraine, but with a bit of creative financial engineering, there may be ways these assets can still benefit Ukraine.   

The plan is to take out a loan on the international markets, giving about $50bn a year to Ukraine, and use the c.$3bn in interest generated from the frozen Russian assets to net off the interest required on the Ukrainian loan. This will be massively beneficial for Ukraine in its efforts. A good outcome seems likely with the majority of the G7 in favour of the plan, potentially a case of financial engineering and innovation going right.   

Please continue to check our blog content for the latest advice and planning issues from leading investment firms.

Charlotte Clarke

20/06/2024

Please see below, an article from Brewin Dolphin discussing the latest US inflation data and what this could mean for both markets and consumers. Received late last night – 18/06/2024

Last week was eventful on many fronts – from macroeconomics and central bank interest rate decisions to corporate news and politics. There were plenty of things to digest for investors, but there has been a clear divergence in U.S. and eurozone market performances.

The S&P 500 and the Nasdaq Composite reached new record highs last week, as investors continued piling into U.S. tech stocks and other equities, bolstered by multiple good news reports. To summarise, the positive drivers are disinflation trends, the Federal Reserve signalling it’s willing to cut interest rates, and supportive corporate developments relating to artificial intelligence (AI).

U.S. inflation data lower than expected

Let’s first look at the trigger moment for last week’s U.S. equity rally, which was the lower-than-expected U.S. consumer price index inflation (CPI) data for May. Both U.S. headline and core CPI (which excludes food and energy) slowed more than expected in May – from 3.4% to 3.3% year-on-year and from 3.6% to 3.4% year-on-year, respectively. This is the lowest figure for core CPI since April 2021.

The fall in gasoline prices was a key driver of CPI being flat month-on-month, which helps offset the ongoing strength in shelter inflation. There are a few positive reads in the report, such as a big drop in airfares and modest falls in new vehicle prices and car insurance.

The elephant in the room remains the elevated shelter inflation, which is taking longer to slow, but leading indicators suggest it will eventually.

Overall, the latest U.S. CPI reports have provided more evidence of disinflation and removed some concern from earlier in the year that inflation has re-accelerated. We’ve a way to go with U.S. disinflation, but there is progress despite some bumps along the way.

Adding to the enthusiasm is that U.S. producer prices contracted in May on a month-on-month basis, driven by the fall in gasoline prices. Core producer prices inflation (which excludes food and energy) slowed from 2.3% to 2.2%, which was below estimates.

While producer price releases don’t tend to move markets, the idea is that the lower inflation experienced by manufacturers will trickle down and help ease the price pressures consumers are experiencing – every little helps with the disinflation narrative.

U.S. disinflation has important implications for both Wall Street and the main street. Real wage growth (wage growth adjusted for inflation) accelerated from 0.5% to 0.8% in May, meaning the average household is benefitting from a resilient labour market and lower inflation. This supports the soft-landing thesis.

U.S. inflation reports provide support to our baseline macro view of ongoing disinflation and a soft-landing, with an overweight position in U.S. stocks.

U.S. interest rates, and a revised ‘dot plot’

On the same day U.S. CPI data were released, the Federal Reserve announced its interest rate decision and released its updated summary of economic projections. It was widely expected that the Fed would hold rates unchanged, so all eyes were on its macro projections – particularly the ‘dot plot’, which is a summary of rate expectations gathered from the Federal Open Market Committee’s members.

Since the Fed has revised up its near-term inflation forecasts, it is perhaps no surprise that the dot plot now only indicates one rate cut by the end of 2024, down from the three cuts expected previously. However, the dot plot now shows that four rate cuts are expected in 2025, up from a previous three.

Meanwhile, the Fed expects the U.S. unemployment rate to rise only modestly to a peak of 4.2% in 2025, from 4.0% currently. Inflation is expected to trend to 2% by 2026 as real gross domestic product growth is expected to be sustained at 2%. In short, this is as goldilocks as you can get – a soft landing is the main scenario for the Fed, with inflation coming down without any great damage to the labour market.

During the press conference, Fed chair Jay Powell was grilled by journalists’ questions on the prospective policy path and the thought process of its decision making. The market’s interpretation is that this is a Federal Reserve that is in no big rush to cut, but wants to and stands ready to do so, it just needs to see a few more inflation reports that are in line with the disinflation narrative.

Even though the Fed is flagging only one cut by 2024, markets are pricing in two, with an over 50% chance of the first cut happening in September, shortly before the U.S. election. As you can imagine, markets will remain very sensitive to any upcoming inflation data points.

Tech market rallies…

But the Federal Reserve isn’t the only thing affecting markets at this juncture. As the strong year-to-date performance of large technology companies shows, corporate fundamentals matter more.

Last week, we saw Apple briefly regain its top spot in terms of market capitalisation, after temporarily falling into third place behind Nvidia. Microsoft reclaimed the top spot by the end of the week, but the battle of the big three is getting tight.

Analysts generally believe Apple has the tremendous opportunity to capitalise on a wave in the hardware upgrade cycle and get AI applications to mass-consumers at its fingertips. It’s also in a prime position to capitalise on the budding AI-enabled software and apps ecosystem, given its dominance in consumer devices and wearables. Investors have turned hopeful, but the execution of its AI strategy will be key. There is immense competition, and the blistering pace of tech innovation means any near-term progress can’t be taken for granted.

Semiconductor companies continued to rally against the backdrop of AI infrastructure build outs, anticipation of hardware upgrades, and cyclical recovery in the sector. The Philadelphia Stock Exchange Semiconductor index has risen by about 34% year-to-date, outpacing even the near 18% rally in the Nasdaq. We remain constructive on key companies in the semiconductor value chain.

… while European stocks take a turn for the worse

The mood in European markets couldn’t be more different, with European stocks ending the week in the red. The epicentre of the downbeat sentiment is France, where its CAC 40 Index was down almost 6% last week, completely erasing the gains made so far this year.

The trigger is the uncertainty in French politics after President Macron called a legislative election to be held in two rounds on 30 June and 7 July, after the disastrous results from the European Parliamentary votes the week before last. It is widely regarded by markets as a huge political gamble with a high risk of scoring an own goal (no pun intended as the European Championship gets underway).

Currently, Marine Le Pen’s National Rally party leads polls by a wide margin. But it is not just the far right that Macron’s centrist Renaissance Party has to contend with. In a further blow to market sentiment, a coalition of left-wing parties has presented a manifesto ranging from reversing the government’s pension reform and reinstating the right to retire at 60, to raising the minimum wage.

The polls show the far-right party leading with the coalition of left-wing parties being second. Either outcome is feared by financial markets as being more inflationary and detrimental to the state of France’s public finances.

With so much uncertainty ahead, and a possibility of a shift in economic policy and weakened commitment to fiscal discipline, it is no wonder investors in French assets “sell first and ask later”.

It is indeed a difficult period to endure before the market has more clarity. It is worth noting the sell-off in French equities has been indiscriminate this week and even spilled over to the broader European stock market. Market dislocation driven by political events tends to open opportunities for investors to pick up discounted quality stocks with solid fundamentals and international earnings exposure.

Please continue to check our blog content for the latest advice and planning issues from leading investment firms.

Alex Kitteringham

19^th June 2024

Please see the below article from EPIC Investment Partners detailing their thoughts on volatility referring to the Hare and the Tortoise fable.

Last week we discussed the low levels of volatility from a technical perspective. However, there is a related, fundamental question that has puzzled economists and investors alike for decades: “Is market volatility driven by animal spirits or is it rational?” In 1981, Nobel laureate Robert Shiller phrased the question as “Do stock prices move too much to be justified by subsequent movements in dividends?” 

The answer is key to understanding how markets work and whether we, as investors, can trust the prices we see. As Keynes warned: “Markets can stay irrational longer than you can stay solvent.” It is not only about risk, but also opportunity to profit from irrationality if one can time it right. Both behavioural psychology and fundamental analysis depend on markets that regularly deviate from rational pricing, and many investors have argued against the efficient-market hypothesis that prices reflect all available information. 

However, a recent study published by the National Bureau of Economic Research (NBER) suggests that the market may be smarter than we give it credit for. This study argues that stock price volatility can be largely explained by changes in investors’ expectations of future dividends. In other words, when stock prices jump around like a hare on a trampoline, this is not because the market has lost its mind but because investors are updating their beliefs about the company’s future cash flows. The fact that stock prices tend to move in line with changes in dividend expectations suggests that on average, we are pretty darn good at it. 

Such news would be disheartening, setting a high standard for any individual fund manager to outperform a relative index. Should we abandon all our hope and worry about irrational exuberance in the market? 

Well, looking at the crashes of the past as well as recent market movements, it is hard not to think of situations where stocks were either skyrocketing or nosediving based on hype rather than fundamentals. How to account for those? Either these prices are fairly based on genuine expectations, or there is an opportunity hiding at the other end of the spectrum: those sleepy tortoises that we do not think about that are just stuck in the slow lane while the rest of the market jumps around. It might be that, for each exciting jittery hare, there is what seems to be a tortoise in its shell, and no one has bothered to touch it despite a change in prospects.

So, the next time we are faced with the statement that the market is irrational, the appropriate response might just have to be a grating “it depends”. The hare and tortoise may just balance each other out. We should still recognise both for what they are and make investment decisions without prejudice. 

(Although, of course, Aesop’s fable teaches us that it is the tortoise that wins in the end.)

Please continue to check our blog content for advice, planning issues and the latest investment, market and economic updates from leading investment houses.

Alex Clare

18/06/2024

Please see this week’s ‘Monday Digest’ from Tatton Investment Management providing a brief insight into markets over the past week:

Still mostly sticking to the plan

Amid a cacophony of political noise, the Federal Reserve’s updated interest rate forecast that drove markets last week. The signal that rates would be cut just once this year was called “hawkish”, but we think it was more “bullish”.

First though, manifestos. Labour and the Conservatives released their policy plans this week, with markets again largely indifferent. That might sound strange, considering that UK assets have underperformed since Rishi Sunak called the July election – after a period of outperformance. But Britain’s biggest stocks are more focused on global growth, and particularly energy and commodity demand. That’s why they did well before, and not so well now. Rate cuts from the Bank of England – expected by August at the latest – are more important for our domestic markets.

Fed cuts are equally important. Markets had been expecting two this year, but the Fed’s ‘dots plot’ revealed that officials expect to cut rates just once in 2024. This was more about acknowledging US economic strength than a hawkish preference. Recent US inflation data has been soft, but job market data two weeks ago was exceptionally strong. This strength is giving the Fed pause. Officials are sticking to the rate cut plan, just getting more realistic about how, when and to what magnitude it can be implemented.

Markets reacted well, but unevenly. Stocks are up in aggregate, but this is almost entirely down to a handful of tech stocks. This is a sign of generally weakening global growth. Europe has underperformed, not just because of Macron’s surprise election call but weaker Chinese demand too. In the US, smaller caps have slipped back.

After business sentiment surveys next Friday, we will get a better sense of where the economy is heading. Following the very strong run earlier in the year, markets feel a little fragile. It has been powered by a strong run up in earnings expectations which is starting to seem questionable given the run of softer economic data. But if sentiment data is better, we could see pro-cyclical assets do well.

Macron makes an educated bet.

Emmanuel Macron shocked the world this week by calling for a snap parliamentary election at the end of this month. The French President effectively threw down the gauntlet to far-right challenger Marine Le Pen and her National Rally (RN) party, after the latter won the largest share of French votes in last week’s European parliament elections. Macron was clear about his reasoning: “I do not want to give the keys of power to the far right in 2027, so I fully accept having triggered a movement to provide clarification,”

Markets indeed want clarification, having sold off dramatically on the apparent threat of an RN-led parliament. We wrote last week that election-inspired sell-offs tend to be short-lived and can actually make for good buying opportunities. We broadly stand by that assessment in the case of France, but we would add that volatility is likely at least until the final round of voting on July 7th.

Markets’ biggest fear about a RN victory seems to be a fiscal crisis, with Macron’s finance minister warning of a “Liz Truss-style scenario”. We shouldn’t get carried away by hyperbole, though, since sectoral analysis suggests that French companies would be relatively unaffected over the medium term. The long-term is hard to work out, since it depends on what happens at the presidential election in 2027. Marcon seems to be betting that, win or lose, his chances in 2027 will be better than if he lets RN support fester. That is plausible, but a gamble.

The risk for Macron is that an RN-led parliament spends years fighting the executive at every turn and successfully blames the deadlock on him. The risk for markets is that this heightens bond volatility and increases the anti-EU sentiment in the bloc’s second-largest economy. Volatility is likely, in the short-term at least.

Peso struggles despite election continuity

Following the surprisingly large victory for Mexico’s left-wing party Morena in the June 2nd election, the Mexican peso has lost more than 10% of its value against the dollar since the election. This might sound like par for the course as far as Latin American elections go, but markets’ vote of no confidence is more complicated than it seems.

Claudia Sheinbaum, Morena’s candidate and now Mexico’s first female president, represents continuity from president Andrés Manuel López Obrador (nicknamed AMLO). Markets similarly feared AMLO when he came in six years ago, but he achieved the improbable by both pursuing socially progressive policies and staying (mostly) in the good books of international investors. The peso is stronger now than when he assumed office – even after the recent nosedive.

Markets don’t like the scale of Morena’s victory, taking the presidency, a supermajority in the House and nearly a supermajority in the Senate. This makes it likely that 18 contentious constitutional reform bills outlined by AMLO, including the removal of congressional seats and independent regulators as well as directly electing supreme court judges, will be passed. Some fear these undermine the separation of powers. Morena’s economic policies are also seen as unfriendly to international investment.

The fears are not unfounded, but we suspect they might be overblown. Sheinbaum confirmed that she will stick with the current finance minister and fiscal rules. More importantly, Mexico’s politics does little to disturb the structural case for its growth: a beneficial realignment of US trade. After years of US-China trade wars, Mexico became the US’ largest trading partner in 2023. This structural push is not going away, with anti-China sentiment a point of rare bipartisan support in Washington.

Politics on both sides of the border mean clashes with the US are likely, which arguably increases the policy risk attached to Mexican assets. But the underlying case for Mexico remains.

Please continue to check our blog content for advice, planning issues and the latest investment market and economic updates from leading investment houses.

Andrew Lloyd DipPFS

17/06/2024

Please see the below article from EPIC Investment Partners detailing the latest inflation figures and thoughts of the Fed. Received this morning 13/06/2024.

The latest Fed-friendly inflation figures provided considerable relief, as they eased more than anticipated. In May the headline print was flat, while the core reading rose 0.2%. Year-over-year the figures cooled to 3.3%yoy and 3.4%yoy, respectively. The three-month annualised headline CPI fell below 3% for the first time since January. Moreover, the core reading, which decelerated to its lowest level in over three years, was of significant interest given its stickiness. 

Furthermore, the “supercore” measure, i.e. core services less shelter, actually produced a negative print (-0.04%) for the first time since late-2021. So, a considerable cooling from the 0.5% three-month average. On an annualised basis, “supercore” eased to 4.8%, so remains a concern. 

Real average hourly earnings unexpectedly rose to 0.8%yoy with the weekly figure stalling at 0.5%yoy, possibly due to fewer hours worked. 

Although the dis-inflation trend appears to have resumed, policymakers have stressed the need for more evidence of downward momentum before commencing their easing cycle. We believe that while there is a narrative emerging that the inflation report will confirm recent inflation stickiness as merely a temporary blip, it would be premature to make such an assumption, particularly as we have warned that the last “mile” to 2% could be the hardest.

Markets were quick to react, the dollar fell off a cliff, we saw a new all-time high in the S&P Index, and a sharp rally across the US Treasury curve, the 2-year UST yield witnessed the largest single drop so far this year having fallen ~16bps to 4.67%. Futures bets for cuts this year sharply shifted to two cuts, with a ~85% chance as early as September and another by the end of the year. 

Some of the market moves (dollar and USTs) pared back following the FOMC announcement. As expected, the Fed held interest rates steady and signalled it may start cutting rates as late as December 2024, despite continued progress on lowering inflation. The central bank projects only one 25bp cut this year (from three projected in March), followed by four additional cuts (up from three) in 2025, reflecting an outlook for the economy to broadly hold its current trajectory over the next few years. The median core PCE inflation forecasts were revised higher to 2.8% (from 2.6%) and 2.3% (from 2.2%) for this year and 2025, respectively. Futures markets are this morning pricing a 99.9% chance of a cut in November with the possibility of a further cut in December.

Fed Chair Jerome Powell said policymakers see the current policy stance as “about right” and will watch for clear signals from data on inflation, labour market, growth, and risks before adjusting rates further. While leaving the door open to an earlier cut if inflation keeps declining, the Fed appears willing to move cautiously given the uncertain inflation outlook and resilient economic conditions.

Market participants will closely scrutinise PPI data later today, and comments from Federal Reserve officials over the next few days for any indication that the central bank’s rate projections, known as the “dot plots,” failed to fully account for the recent benign inflation data. If policymakers suggest the dot plots are outdated or voice increased concern over persistent inflation, it could reignite speculation of an additional rate cut in 2024.

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Alex Clare

13/06/2024