The big headlines Q2

In this regular piece, we summarise the key headlines from the quarter that have impacted investment performance. Feel free to download and share it directly with your clients or read our interpretation below for further commentary.

Our interpretation

David Aujla (DA), who is lead manager of our Summit Growth and Responsible ranges and who co-manages our Model Portfolio Service, alongside MPS Portfolio Manager Ben Gutteridge (BG) and analyst Sarah Fox (SF), share their thoughts on the key developments of the last quarter and how they’re affecting the portfolio management of their respective products.

Election Fever

Deep into the second quarter of 2024 it was announced that in very early Q3 we would observe two major international elections, one domestic and one in France. Our usual discipline of discussing events only in the most recent ‘completed’ quarter has been abandoned to keep the content as relevant as possible to our audience; rather than feigning excitement about the unknown (but known) result!.

Looking inwards first and, as expected, the absence of any surprises delivered a ‘meh’ response from UK assets. Of course, this could change, for better or worse, as we learn more about the policy priorities of this administration, and so anticipate the Autumn Budget with some excitement/trepidation. Amidst that announcement we should learn how taxes and borrowing may adjust to fund some ambitious spending plans. For now, however, it appears the Labour Party’s espousal of a cautious approach to handling Public Finances, along with a keen eye on rejuvenating growth (highlighting a European ‘reset’ and loosening planning laws) are not generating any obvious market anxieties. We look forward to exploring this topic in more detail in future quarters.

Unlike at home, French assets moved in a more troubling direction following the snap election announcement. Markets breathed a sigh of relief however, as it became clear neither the Far Right nor Far Left parties would secure majority rule; and implement their deficit busting agenda. Indeed, whilst the situation remains fluid, it appears a centrist coalition, including President Macron’s En Marche party, may eventually form a government. To stress, however, this outcome is not for certain, and would only likely follow some difficult negotiations.

Regardless of how long it takes, investor sentiment has been buoyed by the avoidance of more ‘populist’ policies. The weak hand of government, whatever form it takes, can exact little change on policy, leaving Macron’s ‘deficit improving’ reform efforts beyond the reach of change – at least for the time being.

Looking ahead and it’s interesting how the UK has seemingly, overnight, become a political ‘safe haven’ given the increasingly fractious trends observed on the continent.

Europe’s Historic Pivot

Amidst the euphoria and (inevitable) disappointment of the Euros, we can reflect that it’s now been 50 years since once of the most iconic moments in European football. Also on the fields of Germany, during the 1974 World Cup, the Dutch Captain, Johan Cruyff, executed a pivot of such guile that not only was the move labelled the ‘Cruyff turn’ but, legend has it, the unwitting Swedish defender is still roaming the pitch looking for Cruyff to this day.

In June of this year we saw the ECB deliver a policy ‘turn’ of similarly historic significance, deciding to cut interest rates for the first time in some 9 years, and doing so in advance of the US Federal Reserve; an almost unprecedented move. The decision was well flagged so did little to surprise markets, indeed a message of patience was keenly delivered as it relates to managing the persistent menace of (rebounding) inflation; restating their data dependency and refusing to commit to a path for future policy easing.

Despite the ‘hawkish cut’, the ECB joins the ‘easing club’, following the Swiss, Swedish and Canadians in executing a reduction in interest rates, with our expectation that each will continue to ease as the (slow burn/volatile) disinflation narrative continues.

The policy adjustments of the ECB seem less likely to take hold in the annals of history as much as the romantic scenes on the sports field, however, we note the former ECB President, Mario Draghi’s, ‘Whatever it takes’ speech is (so far) proving enduring. Perhaps the ‘Lagarde Cut’ may add to the budding list of historic European pivots.

Artificial Inefficiency

The second quarter was another outstanding period for US Large Cap Growth stocks, reaffirming both their dominance and leadership among global equities. Within this cohort reside the loosely defined Technology stocks, with those names most closely associated with the A.I. theme posting some of the best returns. No doubt valuation has played a role in this outsized performance, as investors are swept up in the potential this productivity enhancing Tech can deliver, but share price moves have been backed up by some sensational earnings performance too. Such startling moves, to my mind, highlight how surprised investors have been by the operational achievements of these businesses and, in so doing, throws into question the suggestion US markets are the ‘most efficient’.  It’s a near certainty US Large Cap stocks are the most heavily researched businesses on the planet, with the greatest level of analyst coverage, however, that NVIDIA’s results can ADD $272bn to its market cap in a single day, more that the total market cap of the FTSE 100’s largest constituent, suggests a grand underappreciation of how stunningly these businesses are doing. To hedge portfolios against this ‘inefficiency’ the case builds for an active approach within this sphere, or at least a pivot to a Growth biased passive option. Indeed, on that basis, let me steer you toward the Invesco Time in the Market Podcast, available on the major Podcast Platforms, and Episode 16 in particular – A Nasdaq review with Ryan McCormack. In this Ep we debate valuation extremity, NVIDIA, Apple and Tesla, the pertinent areas of A.I. success, the impact (or not) of bond yields and potential consequences of this year’s US Presidential Election. A fascinating and stirring 20 minutes!

Interest Rates

The second quarter saw continued volatility for bond yields, which swung up and down in a wide range driven largely by changing market expectations around the outlook for monetary policy. Even though the ECB was the latest bank to cut rates in June following similar moves from the Swiss, Swedish and Canadian central banks, all eyes remained very much focused on the U.S. Federal Reserve.

Fed Chair Jay Powell noted that inflation is taking longer than expected to reach the Fed’s target. Consequently, investors revised their expectations, recognising that the Fed is unlikely to start the rate cut cycle before September. If inflation and job data remains strong through the summer, the first-rate cut might be delayed until year end. As a result, fixed income experienced mixed performance in the second quarter. Some major government bond indexes were flat over the period, while some major high-yield indexes posted modest gains.

Despite slower progresses being made on inflation, especially core inflation, than policymakers would have liked, we remain of the view that as supply and demand factors in Western developed economies come into better alignment, inflation will continue to fall toward central bank targets. Though gradual, this should favour a bias towards further policy easing. Coupled with attractive level of yields on offer, a more supportive macro backdrop should become increasingly favourable for fixed income investors going forward.

Inflation

Disinflation continued in most developed economies, with some experiencing more progress than others. While disinflationary progress stalled in the U.S. during the first quarter, it improved in the second quarter. Even though the Fed didn’t cut rates in Q2, the CPI release for May that was released in June showed the slowest monthly core CPI since August 2021. Here in the UK, supportive base effects meant UK headline inflation returned temporarily to target in June, but this drop in inflation was widely expected and a series of strong wage prints plus a forecast reacceleration in inflation meant the BoE felt unable to cut rates.

Inflationary pressures today remain mostly driven by services. A tight labour market in many parts of the world, including the UK, means this element of inflation is harder to bring down. With this said, signs of easing wage pressure conditions coupled with weaker consumer data suggest that the worst may be behind us and the service spending should soften from here.

Our base case is for inflation to continue to moderate over our forecast horizon across most regions, with disinflation being realised more quickly in non-US developed market economies. Having said this, disinflation is an imperfect process, and so we expect there to be disappointing data points along the way.