Favorable market for the second half of the year, but beware of risks

MAPFRE Gestión Patrimonial Monthly Report

The end of June marks the start of the summer season, when airport traffic increases considerably. Since central banks embarked on a radical shift in monetary policy (from very lax to very tight) in mid-2022, many investors have used the simile of an airplane landing to express their view of how economies’ growth will be slowed by the effect of interest rate hikes. While the consensus in 2023 was for a hard landing, (a sharp drop in inflation and GDP with rising unemployment) as the North American economy continued to defy the laws of gravity, the market consensus began to consider other options such as a soft landing (inflation converging towards 2% with no significant damage to growth and unemployment) or even no landing (growth and inflation rising and unemployment falling).

In the first half of 2024, the absence of turbulence has raised investor optimism (with the invaluable help of the rise of artificial intelligence), discounting the perfect scenario with increasing probability (and ruling out a re-acceleration of the global economy): disinflation has been confirmed with lower month-on-month rates of price change and a normalization of many of the macro variables that had been disrupted after the post-pandemic recovery.

More recently, however, the weakness observed in consumer and business sentiment has been reflected in macroeconomic data (ISM, retail sales, unemployment, etc.) and has pushed the US macro surprise index to its lowest level in several years. Rather than worrying about this recent weakness, the market seems to be returning to the mantra “bad data = equity rallies” in anticipation of laxer monetary policy to avoid a financial crash and counteract the increasingly exhausted fiscal pathway.

The Fed: higher rates for longer

The market greatly anticipated the U.S. Federal Reserve (Fed) meeting in June following the decision a week earlier by the European Central Bank (ECB) to cut rates. The monetary policy decision also coincided with the release of the May inflation figure for the United States.

Starting with prices, the figure came in below expectations for the first time in three months (3.3% vs. 3.4% year-on-year), mainly due to lower energy prices. In the breakdown between services and goods inflation, the disinflationary path is continuing in goods, which fell for the second consecutive month and stand at a year-on-year rate of -1.7%. In the case of services, we are observing a slightly slower increase mainly due to a mild drop in imputed rents (a component that weighs more than 25% in the U.S. CPI basket). Once this data was published, U.S. Bond yield demands moved downward, only to be neutralized a few hours later by Fed Chairman Jerome Powell's speech at the press conference following the Fed meeting.

Although the Open Market Committee decided to keep interest rates unchanged, there were several significant changes with respect to the previous quarter's dot plot and expectations. Specifically, the voting members of the Fed went on to predict only one rate cut throughout 2024 (versus the three expected at the March meeting) and raised the neutral interest rate (which neither accelerates nor slows growth/inflation) by 0.25% to 2.75%. The last and most significant point, in our view, is the Fed’s recognition that the US economy needs structurally higher interest rates to control prices (something we have regularly discussed in our monthly reports). Despite all this, the market continues to expect two interest rate cuts from the Fed in the remainder of the year, especially after the weakening macro data discussed above.

Diversification still does not pay

With the first half the year over, the trend of concentration in the indexes remains intractable. It’s no wonder then that many investors have set their sights on second quarter corporate results as a catalyst that will increase the number of companies surpassing the index average and that the bull market that began in October 2022 looks healthier, with a higher degree of participation.

In this regard, the market expects double-digit earnings growth (10.57% in 2024) in the United States, led by the technology and communications sector, but with the contribution of other less frequent sectors such as the financial sector or utilities. It is also important to note that profit growth would also remain in double-digit territory in 2025.

Turning our attention to Europe, the expected growth for 2024 will be slightly negative (after a 2023 in which European companies outperformed US companies in growth) due to the lack of large technology companies to push earnings growth upwards, along with a weak recovery of Chinese domestic demand due to its high dependence and the loss of momentum (mainly fiscal) by the major economies (France and Germany).

2024: an election year

Everyone already knew that 2024 would be an unparalleled year when it comes to electoral processes. At the beginning of the year, many analysts mentioned the more than 100 elections to be held in their market guides, as well as the repercussions many of them could have on a geopolitical landscape altered by wars in Ukraine and Palestine and a fragmentation between the allies of the two major economic powers: the United States and China.

As recently as June we had elections in Mexico, in Europe for the European Parliament and in France (following the failure of President Emmanuel Macron's party in the previous elections). All of these elections led to increased volatility in the price of the assets most exposed to these countries: the Mexican peso fell sharply after the absolute majority victory of the leftist candidate Claudia Sheinbaum and the French risk premium rose to 80 basis points after the victory of M. Le Pen's party in the first round of the legislative elections.

Apart from the election results (for which the market has shown very little predictive power and zero long-term impact) geopolitical risk has been rising as uncertainty has also increased. This uncertainty has also begun to be felt in the United States in the run-up to November's presidential elections. Indeed, the controversial performance of incumbent Democratic President Joe Biden in a first debate with his opponent Donald Trump boosted the Republican candidate's chances of being re-elected president. We have also since seen a rise in the IRR of inflation-linked bonds and a brief rally in the more cyclical segments of the market.

In the coming months, political noise will increase and share the limelight with the decisions of central banks which, in our view, continue to be the main players in the medium and long-term performance of the markets.

Conclusions: prospects remain good

The first half of the year ended with a fairly solid performance for the global economy: growth forecasts have been adjusting upwards and risk assets have outperformed those with a more defensive profile. The overall picture for the remainder of the year still suggests to a quite favorable environment for markets, especially if we look at corporate earnings. Nevertheless, the recent weakness of certain macro figures, coupled with the absence of any new fiscal stimulus, the lack of progress in tempering inflation and a still restrictive monetary policy present risks that should still be taken into account when assembling a portfolio.