MARKET INSIGHT – May 2024

MARKET INSIGHT

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

Till April’s dead, change not a thread!

Just as near-winter-like temperatures returned to the shores of Lake Geneva in April, so too did the financial markets during the past month. We don’t intend to discuss climate change and its consequences here, but the fact remains that the scenario of a “no landing” in the US economy – in other words, economic growth in defiance of high interest rates – continued to gain momentum. From solid retail sales to the unexpected upturn in industrial PMI indices and, of course, that accursed inflation, everything told investors that, at this stage, the US economic machine was still running at full speed. Upset or not, this is not a common occurrence.

In recent weeks, we have also been following the escalation of the situation in the Middle East and the Iranian attack on Israel. Fears of a conflagration now seem to have subsided somewhat, but the geopolitical context is nonetheless increasingly unstable, and must be clearly considered in stock market performance over the coming months.

The sometimes-fanciful forecasts of six to seven rate cuts by 2024, which we read here and there in January, seem a long way off. Four months on, Jerome Powell and his colleagues at the FED are faced with a different reality. That of the continuing resilience of the economy, and probably consequently that of a choice to be made by the institution between continuing to prioritize the fight against inflation and economic growth.

The consensus had by no means been entirely wrong, for even if the number of rate cuts the FED was to make this year had begun by being greatly overestimated, on the inflation front, the scenario describing a first part of the cut as “easy” to achieve, followed by a phase in which price growth would be more “sticky”, between 3% and 4%, seems accurate.

The question now is what attitude the US central bankers will adopt. Will they reaffirm a rigorous inflation target of 2%, potentially at the cost of greater pressure on economic momentum, or will they pursue a less aggressive message, highlighting a longer period of high interest rates than initially expected, with a view to one or two rate cuts this year?

It seems likely to us that US growth should remain at a high level over the coming months, but without accelerating

We clearly prefer this second scenario. Over and above the US economic figures, which can only leave investors in admiration, it seems likely to us that US growth should remain at a high level over the coming months, but without accelerating. As a result, inflation looks set to stagnate at current levels, although we do not envisage a scenario similar to the 1970s and a second peak.

The European picture is very different. April brought little more than the confirmation of very different economic dynamics on either side of the Atlantic. However, we like to see the glass as half-full, because even if Europe’s industrial sluggishness, particularly in Germany, is by no means a positive factor for the old continent, the situation at least has the merit of making the forthcoming action of the European Central Bank clearer, with the first rate cut expected as early as June.

We therefore expect a time lag between European and American monetary policies, with the former appearing far more urgent to ease than the latter.

It’s also impossible not to consider the European political panorama which, while not alarming us at this stage, is nonetheless pointing to a number of protest movements and, as is traditionally the case, the rise of radical movements. These signals should not be ignored, and make it all the more appropriate to give Member States’ economies a little breathing space by starting to loosen the grip on interest rates.

Finally, a few words about China, whose economic situation seems to be stagnating. Here again, some will prefer to take an optimistic view and speak of stabilization after months of a far deeper slump than we might have feared at the time of the country’s post-Covid reopening, where the spectrum of a serious property crisis was a cause for concern. We note, however, that tensions with the United States are far from easing, and recent measures concerning Apple in China or Tik Tok in the land of Uncle Sam do not augur well on this front. It will probably take a long time for foreign investors in particular to regain confidence, and the country will first have to demonstrate its ability to revive its economy.

In recent weeks, stock market indices have logically integrated the various developments described above. April, while not a very bad month, saw the end of five consecutive months of gains for equities. The strength of the US economy and the disappointment of seeing the decline in US inflation come to a halt led, unsurprisingly, to a rally in US 10-year yields and continued dollar strength.

In such an environment corporate bonds have logically suffered, and their performance over 2024 has brought some very enthusiastic investors about the revival of this asset class back to reality. As long as interest rates (particularly in the US) remain at these levels, it seems difficult for the major bond indices to perform well. In addition, we recommend paying particular attention to the quality of balance sheets of particularly those whose ratings are close to the limit of the investment grade universe. The continuous pressure exerted by central bankers over many quarters is bound to end up weighing on the most fragile balance sheets, as evidenced by the number of bankruptcies since the start of the year. Patience, strategy diversification and caution are therefore the watchwords for bonds in the current context.

An additional element of interest is, of course, the earnings season, which is already well underway at the time of writing. Although it’s still too early to judge the overall quality of these quarterly results, some of the biggest companies, particularly in the technology sector, have already released their figures. The general trend is once again positive, confirming the strength of the US economy.

Beware, however, of the reaction of investors who, as we know, are not always content with just good results, but are just as keen on encouraging prospects and good visibility. After long weeks of rising equity markets, we know that expectations are very high, and that it’s not enough to publish above-consensus figures to shine. Recent releases from Meta and IBM clearly demonstrate this. Beyond the figures, the market is regularly ruthless when it comes to future prospects and the strategies outlined by companies’ top executives.

It’s an illusion to believe that despite the impressive resilience of the US economy, we are once again in a “goldilocks” scenario in which corporate economic performance is a given

It goes without saying that any disappointment will be punished even more immediately. It’s an illusion to believe that despite the impressive resilience of the US economy, we are once again in a “goldilocks” scenario in which corporate economic performance is a given. While consumers (especially in the US) continue to spend and feel reassured about their ability to find a new job quickly if they need one, they have also become more selective in their spending.

Although it has not slowed the economy down significantly, the high inflation of recent quarters has clearly led consumers to pay more attention to their spending, without however curbing it to any great extent. In market terms, this is reflected in a strong dispersion of stock market performances between companies in the same sector, and favors active managers with proven stock-picking skills.

We feel comfortable with our current allocations, which we are keeping unchanged. The good results obtained after these first four months and the low volatility shown by our portfolios meet our performance and stability objectives. We remain ready to be nimble and are keeping a portion of cash to provide an attractive risk-free return, while also serving as potential ammunition in the event of a buying opportunity, should a consolidation materialize.

Cautious optimism therefore remains the order of the day and our solid diversification will have enabled us to sail serenely through the choppier waters of April.