Commentary for June 2024
Market Overview
Global equity markets advanced a further 3% in June. However, beneath the surface there was an unusual level of divergence between regions. European markets sold off sharply in response to rising political uncertainty following the French elections. Markets in the UK and Japan consolidated following recent gains, closing broadly flat. In contrast, emerging markets rose 5%, led by a gain of 8% in India. The US also made new record highs, advancing a further 4%, encouraged by better-than-expected inflation data. In sector terms, the rise was driven by a 6% recovery in tech stocks following a previous period of underperformance. Nvidia, the poster child for artificial intelligence, rose to top US$3 trillion in value, briefly overtaking Microsoft and Apple to become the world’s most valuable company before succumbing to profit-taking at month end. Bonds closed 1% higher.
The month was dominated by a series of political events across the globe. In France, Macron’s early snap election gamble failed to clarify anything and doesn’t augur well for decision-making in government going forward. While Marine Le Pen’s right-wing National Rally came in first during the initial round, the second-round result was essentially a three-way tie. The most likely path forward is an uneasy coalition between the left-wing New Popular Front and President Emmanuel Macron’s centrist Renaissance Party. The success of both right- and left-wing parties at the expense of Macron have given rise to concerns about France’s commitment to the EU project and further integration. Both are in favour of more expansive fiscal policies at a time when France is already running a fiscal deficit of 5.5% of GDP and a debt ratio of 110% of GDP, far ahead of European Commission rules. Government bond spreads between France and Germany widened sharply as French bonds sold off to reflect the increase in political uncertainty. The Euro and equities also fell sharply, with the French index down 6% compared to a 2% fall for the broader eurozone index.
Of greater importance was the disastrous performance of President Joe Biden in the pre-election debate with former President Donald Trump. It revealed that ongoing chatter about Biden’s cognitive health is not just propaganda and selective editing, as his campaign team have recently claimed. This led to an overnight collapse in ratings for the Democrats, putting Republicans firmly in the lead with four months to go.
The General Election in the UK meanwhile had little impact on markets, although the landslide victory for the Labour Party was largely as predicted. However, the headline figure concealed a country that is far more divided than our first-past-the post system may reveal, with Labour’s share of the vote largely unchanged since their defeat in 2019.
The ECB cut interest rates for the first time in five years, citing progress in tackling inflation. This decision follows Canada, Sweden and Switzerland, where central banks have all cut rates recently. The Bank of England chose to keep rates unchanged at its June meeting. However, hopes are high that it will follow suit in either August or September.
Economic news flow in the UK was generally ahead of expectations. GDP growth came in at 0.4% in May, twice the expected 0.2%. The annual rate of inflation fell to 2%, down from 2.3% in April, suggesting that restrictive monetary policy is doing its job. The good news for consumers is that wages continue to rise at a faster rate, up 5.4% per year between March and May, meaning that income for workers is rising in real terms. Overall consumer confidence improved for a third month in a row to the strongest level in more than two years.
In the US, inflation figures for May came in cooler than expected for the second month in a row, sending stock and bond prices higher. Weaker data is also starting to show up in the labour market, where job openings have turned down while job cuts have risen, as evidenced by an uptick in weekly jobless claims. The rate of unemployment crept above 4% for the first time since 2021. Similarly, retail sales, consumer spending and sentiment surveys pointed to a slowdown in the consumer sector. Softer economic data revived hopes for a cut in rates as soon as September. Unsurprisingly, therefore, US bond yields moved lower, a trend that was echoed across the West.
Looking Forward
As we reach the mid-point of 2024, confidence in the economy and financial markets is much higher than it was at this time a year ago. Stocks have had a phenomenal run in recent months and while the medium-term outlook remains positive, a period of consolidation is likely over the summer months as markets digest these gains.
Global monetary easing may not be swift or synchronised, but it is finally happening. Almost all major central banks are now on a path to interest-rate cuts (the exception being Japan). Policy easing expectations in the US have escalated once again, encouraged by the slew of weaker data. Markets are now pricing two cuts by year end, with a strong likelihood of the first in September. The Bank of England is expected to move earlier.
The recovery in tech stocks may have limited room to run. The group’s price-to earnings multiple has bounced back above 28X, a level that has served as a ceiling over the past five years. A number of strategists have noted that a significant amount of hype is baked into current valuation levels, particularly among the big artificial intelligence plays such as Nvidia, whose price commands a lofty multiple of 77X earnings. A key question when valuing these stocks is that no one can be sure what the revenues are going to be. The answer lies in the extent to which AI can become a genuinely transformational technology that adds to total productivity and profits, rather than just making money for a handful of mega cap stocks.
Valuations, interest rates and earnings momentum all support a rotation in leadership going forwards. As rate cuts proceed and markets anticipate a boost in growth, the earnings gap between tech and the rest of the market should close, allowing value shares to catch up to their growth peers in performance terms. Now is a good time to ensure equity allocations are suitably diversified to ensure they are set up to thrive in the conditions of the future, not the past.
Our Strategy
Equities, outside of US mega caps, remain attractive given an environment of stronger growth, gradual policy easing and improving corporate fundamentals. On a global basis our standard portfolios are overweight the UK, Japan, Asia and emerging equity markets.
The outlook for UK equities is the most compelling among major markets. The Labour Party’s centrist and fiscally cautious approach is unlikely to significantly alter the short-term path of either the economy or the bond market, which should allow further scope for UK equities to continue to close the valuation gap with their global peers. The market is currently valued at 10X price to earnings. Historical data from Liberum dating back to 1927 shows that when valuations are below 10X, returns in the following 3 to 10 years have averaged around 14% per annum. From starting valuations of 10-15X, returns have averaged around 9-10% over the following 3 to 10 years.
Japan remains attractive both in valuation terms and on improving fundamentals. A decade of shareholder friendly reforms is enhancing corporate returns and profitability. At the same time, inflation has finally reignited in the economy, allowing businesses to raise prices and wages for the first time in decades.
The US monetary policy outlook is likely to be most supportive for emerging markets, where equities are benefiting from stronger domestic demand and growth. India is taking steps to become an alternative manufacturing hub for global trade, with a low cost of labour, investment in infrastructure and pro-business environment. Economic growth is accelerating towards 8%.
While equities remain our preferred asset class, the prospect of lower rates means that bonds should outperform cash. Bonds also provide diversification in the case of slower growth but will not protect portfolios from the possibility that inflation remains higher for longer (except for index-linked bonds). Alternative assets such as gold and commodity stocks offer an additional source of diversification and allow us to hedge against inflation and other potential risks and capitalise on wider opportunities outside of traditional bonds and equities.
