MARKET INSIGHT – June 2024

MARKET INSIGHT

Prime Partners’ monthly analysis of global economic and financial market news.

A touch of slowdown and a zest of exuberance!

We will not be remembering 2024 as a year in which the famous saying “sell in May and go away” came true.   After a complicated month of April for the major equity indices, a few pessimistic comments began to crop up, raising fears that this well-known adage would come true this year. This has not been the case, to say the least, as recent weeks have seen a rebound in equities and the setting of new highs.

However, the equation with two unknowns that has been occupying our thoughts for several quarters remains intact.  FED decisions and U.S. economic growth are still at the heart of the debate when it comes to determining which asset allocation to adopt in our portfolios. To be sure, as the weeks go by, US economic figures and statements by central bankers provide increasingly precise indications. In addition, corporate earnings are now a known factor, and do not worry us too much at this stage, as first-quarter results have been generally good.

Watching the financial markets is a never-ending process. The large number of publications, whether economic, corporate or in the form of media interventions by the various central bankers, are all data that generate sometimes significant stock market movements with no real possibility of anticipation. We therefore seek to identify longer-term trends in order to steer our allocations. With this in mind, a number of US figures recently caught our attention: The ISM services index fell below the 50-point threshold, which is rare enough to deserve a mention. We are indeed dealing here with an economic indicator that has long been a symbol of the resilience of the US economy.

As one number does not a trend make, we will be keeping an eye out for the confirmation, or lack thereof, of this little chill over the coming weeks, but we note that other recent US economic figures (NY Empire manufacturing index, consumer spending) seem to be pointing in the same direction.

After what might be described as a state of grace over the last few quarters, the US economy may be beginning to show the first signs of a slowdown

After what might be described as a state of grace over the last few quarters, the US economy may be beginning to show the first signs of a slowdown, which, it should be remembered, were long overdue.

Recent weeks have also provided us with information on the current state of inflation, which remains the parameter most closely scrutinized by the markets in anticipation of future rate cuts. After an initial period of quasi-stagnation this year (following a sharp decline in 2023), US core inflation resumed its decline in April, and this was greeted with relief by investors.

The good news is that, so far, companies do not seem to be alarmed at the prospect of a sharp slowdown in activity. If inflation resumes its descent towards the levels required by the FED to begin cutting interest rates, we may well be witnessing the first signs of the US economy’s famous “soft landing”, which, admittedly, has been much slower than expected to materialize.

Outside Uncle Sam’s country, visibility may be slightly better, but the situation is often not as good. Europe seems to be beginning to pull out of the doldrums, with some indicators pointing to a modest recovery in the more industrial parts of the economy, even if the days of splendor (particularly in Germany) still seem a long way off. On the monetary front, the ECB is unlikely to cause any surprises and should initiate its first rate cut in June. Let’s not lose sight of the fact that the political climate remains highly uncertain. Elections to the European Parliament in early June are likely to reveal major divergences and a rise in parties at the extremes of the political spectrum.

Last but not least, there is China, whose equity indices have certainly rivalled those of developed markets to date (after three years of abysmal performance), but for which we still see few concrete signs of a marked upturn in economic activity. Moreover, the recent military drills around Taiwan remind us that the geopolitical situation in the region remains highly uncertain, and justifies an appropriately cautious exposure to Chinese equities.

As for financial markets, the earnings season has once again reassured investors. Although they remain merciless whenever there is the slightest disappointment over results or outlook, on the whole, they have considered positively statements by CEOs for the months ahead.

The title of this report mentions “a zest of exuberance” in reference to some of the stock market reactions observed here and there. Nvidia’s earnings release immediately comes to mind, as it was eagerly awaited by traders and serves as a true barometer of the stock market rally sparked by artificial intelligence. Despite extremely high expectations, Nvidia, the undisputed leader in the semiconductor sector, once again kept investors happy with its 3-digit sales and EPS growth (+462% year-on-year!). Simply phenomenal. At the time of writing, Nvidia’s shares are boasting a 130% gain in 2024, after having already risen 238% last year… The amazing part is that, with a record operating margin of nearly 62%, this might almost seem justified…

Exuberance can also be seen on the downside. Even when it is a temporary phenomenon, following results deemed disappointing relative to expectations or botched management communications, certain stocks that are regularly hailed by the market are currently not benefiting from the enthusiasm surrounding equity indices. For instance, the famous “Magnificent 7” have been whittled down to just 5, with Apple and above all Tesla far from keeping pace this year.

All this reinforces our view that it is crucial not only to be exposed to the right sectors, but also to pay special attention to the stocks you pick within them. In other words, high expectations, persistently elevated interest rates and somewhat more mixed signals regarding the strength of US economic activity form an environment in which stock selection and active management should be given priority.

On the fixed-income side, our strategy of combining various “niche” funds, active in specific segments of the bond spectrum (high yield, emerging corporate bonds, etc.), together with a more traditional product in which we control the sector and duration components, enables us to deliver performance. The major diversified bond indices are in negative territory this year, and there is no doubt that the “higher for longer” rhetoric on interest rates, and even talk of a further hike by the Fed, are not very favorable for bonds. It therefore seems essential to us to be tactical in managing the fixed-income portion of our allocations, and not to place all the responsibility for their performance on equities. In addition, and in line with the slightly more cautious message we are giving here, bonds with ratings indicating middling balance sheet quality (BBB-) should be considered with care, as they are by no means all equal!

High expectations, persistently elevated interest rates and somewhat more mixed signals regarding the strength of US economic activity form an environment in which stock selection and active management should be given priority

It is also worth mentioning the contribution of the alternative strategies featured in our allocations (in which we include gold). In addition to contributing positively to performance to date (as they did last year, and even in 2022 for some of them), they will cushion any potential shock should the US economic slowdown we sense turn out to be deeper or faster than expected.

Finally, a few words about an asset class too often overlooked: cash! With current dollar yields higher than for bonds, it would be a shame not to keep some cash in our portfolios. Zero risk, maximum liquidity and one-year yields close to 5% in USD… What else? as George Clooney would say!

On financial markets, everything is a question of proportion, and we will continue to keep a close eye over the coming weeks on the extent of any potential US economic slowdown and its consequences for interest rates and corporate earnings. After a promising start to the year, with the performance of our allocations matched with contained volatility, it is now time to act responsibly, maintain a good level of diversification and exercise a little more caution.