Beneath the surface
Laurent Denize, Global Co-CIO, ODDO BHF AM.
“Overall, when we consider the global outlook, the environment is a rather supportive one for risky assets. However, there are plenty of concerning developments below the surface leading to downside risks in the “higher for longer” scenario”
After a straight-line upward movement for most asset classes in Q1, Q2 has been more mixed. Entering H2, the big picture remains broadly supportive. However, beneath the surface, financial markets appear vulnerable to multiple threats, from stalling activity momentum and toppish technicals to faltering Tech leadership and election uncertainty. The impending earnings season is unlikely to provide much relief. Is this the calm before the storm? While this is clearly not our base case, we see conditions in place for financial markets to take a summer break.
Economies show signs of softness
In the United States, recent trends indicate fading momentum in growth expectations, with the US economic surprise indicator moving into negative territory. Meanwhile, the US unemployment rate has risen to 4.1%, breaking through its 36-month moving average for the first time since the COVID crisis. Historically, when this has occurred, a quick spike in the unemployment rate has followed.
In Europe, the significant fall in June PMIs (45.8 for PMI Manufacturing), the decline in Germany’s IFO business climate index, and the downturn in the European Commission Business and Consumer Survey suggest that the nascent recovery remains fragile. Political uncertainty in France is not helping matters.
Moreover, the effects of restrictions on shipping in the Red Sea and Panama Canal are being felt globally. World trade is under immense strain amid rising freight costs and potential increases in supply chain disruptions. The impact on global GDP growth will not be negligible.
Bad news is good news… for now
Despite the softening economic backdrop (“bad news”), prices in financial markets have been rising overall. This seemingly counterintuitive behaviour stems from the fact that a weakening economy heightens the prospects for rate cuts by central banks (“good news”). As long as the Fed keeps the door open to a first cut in September, markets may give it the benefit of the doubt and view bad data positively. However, disappointment may follow if at least two rate cuts do not occur before the end of 2024. This scenario is our central forecast with normalising corporate pricing, decelerating wages, and range-bound energy prices.
The story is quite different for the ECB, as economic growth remains lacklustre in the Eurozone and inflation continues edging towards 2%. To that extent, bad news is indeed good news.
Political risk acts as a headwind
In the super-election year of 2024, when almost half the world’s population will go to the polls, election uncertainty is weighing on the economic outlook and amplifying the likelihood of a more rangy rather than trendy market in H2. The upcoming US election will surely bring market-moving headlines. Our conviction is that a Trump victory poses a risk for Europe but would likely benefit US equities (Small Caps, domestic Cyclicals, Banks, Tech, Healthcare, Energy). Conversely, European and Chinese equities may be seen as the losers in such a scenario, particularly export-oriented sectors like Automotive and Semiconductors. Another macro question related to US politics is how labour supply might be constrained if there’s a slowdown in the flow of migrant workers.
