November Market Update 2024
This month we discuss the market reaction to Donald Trump’s emphatic victory, and Europe’s struggles amid political paralysis in Paris and Berlin.
October Market Update 2024
October Market Update 30.09.2024
— Harold Wilson
“A week is a long time in politics.”
Summary
- There was much dispersion across equity markets in October, yielding a familiar pattern of winners and losers: the US beat Europe and EM; and Tech beat everything else.
- Further equity index concentration is likely to make life harder for active equity managers who want to build prudently diversified, index-beating portfolios.
- US outperformance reflects its better economic fundamentals than Europe and China (where stimulus announcements still lack sufficient detail on fiscal measures).
- Sovereign bonds sold-off in October, particularly US bonds, as US economic data pointed to continued labour market resilience and markets priced out the risk of a hard landing. Meanwhile, credit rallied and the US yield curve steepened. We benefited in relative terms thanks to our exposure to both credit and lower duration than global bond benchmarks.
- Going forward, however, we will continue to extend duration and reduce credit risk in case economic conditions deteriorate (a scenario that the market discounts too heavily).
- Most polls ahead of the US election are within the margin-of-error, but Trump appears to have the edge in the battleground states. If he wins, he has promised to slash taxes and regulation, increase tariffs significantly, and seek an immediate end to the war in Ukraine. Taken together, these policies are likely to increase the deficit, lift corporate profits and growth, exacerbate inflationary pressures, and cause a crisis in transatlantic relations.
- We expect a Trump victory to immediately lift equity prices and bond yields (particularly at the long-end), while gold and the dollar rise meaningfully over his term.
Familiar patterns reassert themselves…
There was significant dispersion across equity markets in October, yielding a familiar pattern of relative winners and losers. Geographically, US equities pushed even further ahead of their European and emerging market counterparts. Simultaneously, at the sector level, fast-growing sectors already trading on extended multiples, such as Technology (and in particular the ‘Big Tech’ stocks), outperformed more cyclical sectors like Materials, as well as the lower growth but more defensive Staples, Utilities and Healthcare.
This is the same story that has played out for much of the year; and, after a quarter in which many formerly lagging areas like small caps and value had stolen the show, the hasty reversion to mega-cap technology leadership is a bitter pill for many fundamentally-driven investors. In particular, it suggests that the momentum driving (potentially) dangerous levels of equity index concentration may have further to run. This is likely to make life harder for managers who want to build prudently diversified, index-beating portfolios … and may yet end in disaster should valuations mean revert. But there is no certainty as to if and when that might be.
There is no alternative to US equities.
Moreover, broader US equity outperformance is hardly surprising. It is for the most part justified by fundamentals. Where they are not mired in recession, most of the large European economies are growing at a snail’s pace (with the notable exception of Spain). At the same time, despite anxious consumers saving a growing share of their income (itself negatively impacting growth), core inflation, and particularly services inflation, remain worryingly high. The persistence of high inflation may limit the ability of the European Central Bank (‘ECB’) to respond to sluggish demand by easing monetary conditions, as presently hoped. (As of today, c.-100bps of cuts are priced in to rates markets by mid-April next year, leaving plenty of room for disappointment.) Moreover, the most economically important Eurozone member states, Germany and France, are each facing crises of political leadership. This limits their ability to address their respective structural frailties, and threatens the coherence of policymaking at the European level. Coming as it does at a moment of acute geopolitical risk for Europe – due to the war in Ukraine and the possibility of a second Trump presidency – it compounds the negative atmosphere. And investors are understandably wary of investing in European stocks when other options exist.
“Broader US equity outperformance is hardly surprising. Where they are not mired in recession, most of the large European economies are growing at a snail’s pace.”
The story is different in emerging markets because, in many countries, economic fundamentals paint a comparatively rosy picture. Nevertheless – and crucially – this is not true of China, where economic activity levels have failed to bounce back sufficiently strongly from the pandemic to enliven animal spirits and spur substantial equity investment. The collapse of Chinese property prices due to chronic oversupply of housing continues to depress domestic consumption, and the development of a deflationary spiral is seen as a serious risk. Meanwhile, the government has been criticised for its ostensibly inadequate policy response. Officials did unveil a hefty monetary stimulus in late September (which we discussed in last month’s newsletter) and this propelled Chinese stocks skywards into early October. But these officials subsequently failed to detail what fiscal measures would be implemented alongside the monetary stimulus, and the excitement drained away (along with some of the gains). More details are expected soon – and the fiscal leg of the stimulus may yet be significant. But investors may soon be weighing any of its benefits against the costs of greater US trade protectionism in a second Trump term.
What’s next for fixed income?
All else being equal and knowing that the Fed cut its key policy rate (i.e., the ‘Fed Funds’) by an unexpectedly dovish -50bps at the end of September, one might be forgiven for thinking that October would be a good month for sovereign bonds. But it was not to be: bonds sold-off globally, and did so most precipitously in the US. This is because no sooner had the Fed responded to the apparent deterioration of economic indicators with that significant first strike in the easing cycle than a string of more positive economic data released. These data included a big jump in non-farm payrolls and a (modest) reduction in unemployment (from 4.2% to 4.1%). Together they suggest that the labour market remains firm, which is crucial for a consumption-driven economy like the US. The result was a pricing out of recession risk and a significant increase in yields. As October wore on, the odds of a recession appeared to fall further and the US yield curve materially steepened. At the same time, credit spreads narrowed, reaching tights that leave no room for anything other than the softest of soft landings for corporate America. This could be a problem.
“The labour market remains firm, which is crucial for a consumption-driven economy like the US.”
In our portfolio, we have been running with higher credit risk and lower duration than global bond benchmarks, so the combination of spread narrowing and rate rises was accretive to our relative performance in October. But in the medium-term (and subject to incoming data, of course), we plan to dial back on credit risk and add to rate duration. This is because a US recession is by no means impossible – even if it is not our base case – and there is sufficient historical precedent to limit credit risk and favour long duration to hedge such a scenario.
So what if Trump wins?
Now we must turn to the elephant in the room: namely, the US Presidential election. After months of sound and fury, voters will head to the polls on Tuesday next week to select former President Trump or Vice President Harris as their next commander-in-chief. The campaign has certainly been eventful – not least with the defenestration and replacement of one candidate and multiple attempts to assassinate the other. And the choice is stark: a continuation of Biden’s policy mix (with some as yet undefined twists) or a return to America First (…but Bigly). The polls have swung back and forth several times in recent months and remain within the margin of error across most of the battleground states. But Trump is probably odds on to win the Electoral College (if not the popular vote) next week due to unhappiness about immigration and the cost of living.
“The polls have swung back and forth several times in recent months and remain within the margin of error across most of the battleground states.”
Clearly there are many ‘unknowns’ about what a Trump presidency might mean for markets and the world at large. But he has consistently promised to slash taxes and regulation (particularly on oil and gas companies), hugely increase tariffs on China (and perhaps the rest of the world), and seek an end to the war in Ukraine (but not in the Middle East) as soon as possible. Taken together, at least in the short-term, these policies are likely to increase an already unsustainable deficit, lift corporate profits and economic growth, exacerbate inflationary pressures (and perhaps drive a re-acceleration of inflation), and precipitate a crisis in transatlantic relations.
As a result, we would expect the dollar and gold to rise over his term in office as money flows into US risk assets, particularly equities, to benefit from the more favourable domestic environment at the same time that investors and some large EM central banks, notably China’s, hedge against geopolitical and macroeconomic risks related to his foreign and trade policies by buying gold. Within equities, we would expect there to be some dispersion after the election itself, favouring small caps and financials, but a rising tide should lift all boats: if implemented, deregulation and re-industrialisation policies are likely to benefit a wide range of sectors. With US inflationary pressures and Treasury issuance likely to increase under Trump, we would also expect the US yield curve to steepen in the months ahead: short-term rates are still likely to fall but not to pre-COVID levels, while long-term rates are likely to shift only marginally lower (unless recession comes knocking). Finally, in terms of commodity markets the outlook is more mixed. For example, we believe that the war in the Middle East is less likely to expand to Iran under a President Trump. But, if it does expand, the war is more likely to escalate. And with the outlook for China’s economy also unclear, we would not look to add commodities (other than gold) at this point.
“We would expect the dollar and gold to rise over his term in office as money flows into US risk assets, particularly equities.”
Of course, none of this may come to pass: Vice President Harris may simply drop the ‘Vice’ from her title. And a lot can happen in a short space of time. But we will find out soon enough.
If you have any questions about the themes discussed in this article, please do not hesitate to get in contact with us: info@bedrockgroup.ch
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