As suspected by the market for some time, Joe Biden has decided to pull out of the US presidential race, endorsing his Vice President, Kamala Harris. While Harris polls better than Biden, she still lags Donald Trump. Even though there don’t seem to be any obvious challengers within the party, the Democrats can still choose other candidates. Meanwhile, Trump has officially accepted the Republican nomination. At this stage, our US equity exposure is in line with our long-term allocation, nothing more but also nothing less. During the first Trump presidency, US equities outperformed other regions. But valuations were lower back then, and the market wasn’t driven by a concentrated number of stocks as it is currently. Speculations that Trump’s policies could be mildly inflationary, given a possibly large fiscal stimulus, may also impact US Treasury bonds. We’ve recently reduced our exposure to those and we’re also underweight US investment grade bonds, preferring their European counterparts across government and quality corporates as valuations are more attractive. In addition, we’ve built our portfolios in a way that aims to withstand bouts of volatility in case it picks up further over the summer. We are well diversified across asset classes and regions and own an ‘insurance’ instrument designed to mitigate the impact of an equity market drawdown in the US and Europe (where client knowledge and experience, and regulations, permit).
Diversification remains key to navigate possible short-term turbulence
In the absence of major economic releases last week, company earnings and geopolitical developments took centre stage. This somewhat deepened US-China tensions, with the uncertain situation in the South China Sea grabbing the headlines once again, but particularly hitting the tech sector. The tech war between the US and China has been going on for a while, but protectionist comments from Trump hit tech stocks, which underperformed other large stocks. This was compounded by the Microsoft IT outage on Friday. However, earnings reports from Taiwanese TSMC and Dutch ASML revealed surging demand for AI chips and related semiconductor tools. We don’t think this structural trend towards AI would be in jeopardy if Trump were to win the election, so we’ve positioned our portfolios to capture it over the long run, via our single-line equities, thematic funds, and our strategic US equity exposure.
Lower rates likely in Europe, a tailwind for short-dated government bonds
As we’ve recently increased our exposure to short-dated European government bonds in our euro-denominated portfolios, we closely followed the monetary policy meeting of the European Central Bank (ECB) last week. The ECB decided not to cut interest rates (the main refinancing rate remains at 4.25%) and President Christine Lagarde offered very few clues about the next policy move. However, we still believe the central bank will deliver another interest cut in September as inflation slowly drifts back towards the 2% target. On the other side of the Channel (where we increased our exposure to short-dated gilts), headline inflation stayed at the 2% target in June. Despite some stickiness in services inflation, several leading indicators point to lower inflation in the UK. We think the Bank of England will start cutting interest rates in August. Last week, short-dated EUR and GBP government bonds yields fell (i.e. prices rose) on expectations of interest rates cuts.
Fundamentals matter
This week began with a surprise interest rate cut by the People’s Bank of China, a move aimed at supporting the country’s recently disappointing economic growth. At this stage, we’re neutral emerging market equities and running a structurally low exposure to emerging market debt. In the eurozone, markets expect Wednesday’s release of the purchasing managers’ indices for July to show a rebound in economic activity. We think it’s on track to meet our above-consensus growth forecast of 1% for 2024. The improving economic activity driven by services has been one of the reasons why we increased our allocation to European equities recently. In the US, economic growth for the second quarter (Thursday) has likely rebounded from the first quarter. This underpins the resilience of the economy and the fact that a recession is still quite unlikely over the next 6-12 months. That said, relative to the strong growth of last year, the US is clearly slowing. Inflation will be in focus again this week, with the release of the US personal consumption expenditures index (Friday), the US Federal Reserve’s preferred inflation measure, which we believe is likely to moderate further towards the central bank’s target. Unless inflation comes in higher than expected, markets will likely still expect a September interest rate cut in the US, at least until the release of the jobs report next week. The corporate earnings season is still in full swing and could reflect a rather good growth story. Notably, US tech giants Alphabet and fellow magnificent-7-member, Tesla, are due on Tuesday. European mega-caps, Roche and Nestle, report on Thursday.
Data as of 13/07/2024.
