This note contains an overview of our market views, what we are watching, and our portfolio strategy. Any reference to portfolio positioning relates to our flagship discretionary portfolios. Clients with bespoke or advisory portfolios should consult their Client Advisor for the latest update on your portfolio.
At a glance
After another week with some volatile trading sessions, the S&P 500 equity index closed about 2% lower. US Treasuries rallied, with the 10-year yield falling to well below 4% (and, therefore, bond prices rising, as they move inversely to yields) as markets priced in more interest rate cuts by the US Federal Reserve (Fed). That made the US dollar decline against major, currencies, and the gold price move higher.
Heading into last Wednesday’s Fed meeting, investors were almost certain, and in hindsight rightfully so, that an interest rate cut in July would not happen. Fed Chair Powell’s message that a rate cut “could be on the table” assuming inflation continues to moderate, broadly met expectations. The prospect of the Fed starting its long-awaited easing cycle, set the stage for a market rally. But the release of weak economic data on Thursday marked a sharp market reversal. The Institute of Supply Management (ISM) Manufacturing Purchasing Managers’ Index (PMI), a measure of US manufacturing activity, fell to its lowest level in eight months. The equity sell-off continued on Friday with the release of disappointing US labour market data. The US economy added far fewer jobs in July than expected and the unemployment rate rose to 4.3%. By and large, all the research and advice we filtered through suggests that these data don’t point to imminent recession. Rather, they suggest a slowdown towards a more normal pace of growth.
Our positioning in the context of market volatility
After a lengthy period of calm, markets have recently become more volatile. This is not unusual at a late stage of the economic cycle as investors start to question the longevity of the cycle itself, plus elevated valuations and high profit margins. While we should be careful not to read too much into a few (weaker) data points, we are monitoring all the incoming information closely to ensure our soft-landing scenario (slower but positive growth, and rate cuts) remains on track. A fragmented world with heightened (geo) political risks, including the US election in early November, as we described in our 2024 Counterpoint Investment Outlook, is also a source of volatility. To navigate this environment, we gradually increased portfolio diversification through strategical and tactical positions.
Our strategic investments in high-quality bonds, US Treasuries in particular, are fulfilling their traditional role again as a hedge against downside growth risk, performing well during this period of market volatility. Such a scenario would also be favorable for our position in gold. And, if geopolitical risks were to rise further, our commodities position would likely benefit, too. The tactical position we initiated in short-dated European government bonds (in euro-denominated portfolios, while in sterling-denominated portfolios we added short-dated UK gilts), stands to benefit if central banks deliver more rate cuts to support growth. Also, we recently closed our small-cap equity position. After an initial rally, this market has been under pressure lately, as it’s quite sensitive to US economic growth, which is slowing more than expected. Furthermore, the ‘insurance’ instrument we hold in portfolios (where permitted by client knowledge and experience, investment guidelines and regulations), protects, against significant equity drawdowns, to a certain degree. Building robust portfolios that can withstand a range of economic outcomes, allows us to stay invested in high-quality assets with attractive long-term potential.
BoE delivers rate cut, eurozone economy on recovery path, Japanese yen rallies
The Bank of England (BoE) delivered its first rate cut, as we expected – the first reduction since March 2020. This had been quite likely but not obvious, with markets only assigning a 60% probability to a rate cut. The policy rate was lowered by a quarter-percent to 5%. Governor Bailey indicated that policymakers have to be careful not to cut rates too quickly or too much. We definitely expect one more cut from the BoE this year, and see odds of two cuts. In Japan, the central bank (Bank of Japan, BoJ) raised its key policy rate from 0.1% to 0.25% and indicated its intention to shrink its balance sheet. Following BoJ Governor Ueda’s press conference, the Japanese yen rallied and Japanese stocks fell sharply as a result, given that a stronger currency could negatively impact corporate earnings.
The preliminary second-quarter GDP report for the eurozone came in better than expected, in line with our long-standing forecast. The economy is on a modest recovery path, albeit unevenly across sectors (services doing better than manufacturing) and countries (peripheral countries such as Italy and Spain outperforming core ones such as Germany, which contracted outright, and France). Eurozone inflation for July surprised slightly to the upside, but we don’t expect this will prevent the European Central Bank (ECB) from cutting its key policy rates once or twice more this year, with the next cut likely in September. We continue to hold a somewhat higher allocation of eurozone equities to benefit from the economic recovery, more ECB rate cuts and relatively attractive valuations.
This week: more earnings reports & US jobs data
We are now more than halfway through the Q2 earnings season. Overall, Q2 earnings-per-share growth is coming in better than expected in both the US and Europe. However, it’s notable that the majority of earnings growth can be attributed to more defensive sectors. Most companies that have issued profit warnings are from cyclical sectors.
The earning season for Big Tech has been mixed, with Google, Amazon and Microsoft delivering their smallest earnings-per-share beats in several quarters. Share price reactions to the Big Tech companies’ earnings reports have been mostly negative. Apple has been a bright spot, as the company expects consumers to upgrade to a new iPhone with the launch of AI features later this year. After last week’s disappointing US labour market data, we will be closely watching the weekly US jobless claims report on Thursday.
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Information correct as of 5 August 2024.
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