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Markets Weekly podcast – 10 June 2024
ECB rate cuts and equity market rally
10 June 2024
With equity markets reaching all-time highs in 2024, Dorothée Deck, our Cross Asset Strategist, explores the forces driving this rally and the possible implications for investors. Other topics include the sectors experiencing most growth and the latest corporate earnings data. As host, Henk Potts also examines the European Central Bank’s decision to cut interest rates, the US labour market and the key takeaways from our just-released ‘Mid-Year Outlook 2024’ report.
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Henk Potts (HP): Hello, it’s Monday, 10th June, and welcome to the Barclays Private Bank Markets Weekly podcast, the recording that will guide you through the turmoil of the global economy and financial markets. My name is Henk Potts, Market Strategist with Barclays Private Bank. Each week, I’ll be joined by guests to discuss both risks and opportunities for investors.
Firstly, I’ll analyse the events that moved the markets and grabbed the headlines over the course of the past week, and then consider the outlook for equity markets. And finally, I’ll conclude by previewing the major events and data releases that are likely to shape the week ahead.
It was a positive week last week for risk assets as US economic activity continues to surprise to the upside. The European Central Bank delivered on its highly trailed rate cut, and the AI boom showed few signs of fading as Nvidia’s valuation surpassed the $3-trillion mark.
Benchmark equity indexes in the US and Europe rallied to record highs. The S&P 500 rose 1.3% over the course of the week and is up 25% over the course of the past 52 weeks. In Europe, the STOXX 600 rose around 1% and is up 14% over the course of the past year.
It’s been a volatile week for emerging markets, as investors reacted to various election results. Indian shares rebounded. That was on confirmation that Prime Minister Narendra Modi will serve a third term after gaining support from other parties.
In South Africa, assets swung between losses and gains as markets tried to understand the make-up of the new government and potential policies, after the ANC got just over 40% of the vote in the recent general election. Political parties, we should remember, have two weeks from the election to work out a coalition deal. ANC leader Cyril Ramaphosa still looks set to remain as president.
Talking of elections, this morning we have seen the euro weaken. That’s on the back of the European elections that were taking place over the course of the weekend, particularly, markets were reacting to what we saw in France, where President Macron called a snap election following gains by the far-right party National Rally.
Speaking of Europe, well, as we mentioned, the European Central Bank delivered on that much-telegraphed rate cut, that’s the first that we’ve seen in five years, but officials failed to provide clarity on the future rate path and shied away from providing the previous dovish communication. As expected, the ECB did cut its main policy rate by 25-basis points, taking the deposit rate down to 3.75%.
However, as President Lagarde stated, the Governing Council has not committed to a pre-determined rate path, stating that the Governing Council will be data-dependent. Well, in terms of the data, the European Central Bank raised its inflation forecast for both this year and next. That’s due to the recovery that we’ve been seeing and that we awaited. If you look at headline inflation, it’s now expected to converge to that 2% target only in the fourth quarter of 2025. That’s one quarter later than we saw in the March projection. Meanwhile, the growth forecast was also, of course, increased.
So, where do rates go from here? Well, the communication would appear to rule out a July cut, but it potentially leaves the door open for September, depending on the incoming inflation print. We still expect quarterly cuts this year centred around those forecasting meetings, so we are still forecasting a 25-basis point reduction both at September and December meetings. Then we expect an acceleration in easing through the early part of 2025, so, with quarter-point reductions in January and March and at the June meeting, and the deposit rate to set at a terminal rate of 2.5%.
Moving on to the US, where the latest jobs report added to the evidence of a resilient US economy and further increases the debate over the inflation target and when that will sustainably be returned back to that 2% level.
Now, the US economy created 272,000 jobs in May. That was ahead of the consensus. The consensus was around 180,000 compared to the 165,000 that we saw in April, alongside which, after declining the previous three months, average hourly earnings rose four-tenths of 1% month on month, 4.1% year on year, although we should note the hot nonfarm payroll report was tempered by the household numbers, which showed that the unemployment rate ticked up to 4%. That’s the first time it’s been above that level since January 2022.
Now, given the fact that we’ve published our Mid-Year Outlook this morning, I did want to spend a couple of minutes taking you through some of our macro headlines. As highlighted in the publication, we continue to forecast an easing of global growth over the course of the next couple of years, a softening in price pressures and lower interest rates.
Lots of clients have been asking us about inflation. We think a mixture of base effects, lower energy prices, the restrictive monetary policy that’s been in place and less supply-side restriction has helped to curb price pressures. However, of late, CPI has proved to be a little bit more sticky than many economists had been anticipating.
Now, we forecast that global consumer prices will rise by 2.6% during the course of this year. We’ve got 2.4% pencilled in for 2025. Now, that actually should prove to be more palatable than that 3.9% that was registered during the course of last year. But we think that the slower decline more recently in CPI is likely to influence the pace of policy shift, with rates likely to stay higher for longer in several regions, particularly, as we’ve been talking about, the United States.
Now, we do know that geopolitical risks will continue to be prevalent in the second half of this year, but how much of these will influence growth and sentiment I think still remains to be seen. The Ukrainian and the Middle East conflicts continue, however, to impact commodity markets and global supply chains, and growth-sapping trade tariffs are also starting to re-emerge.
As we’ve been discussing, this year is a seminal political period which could have profound implications for global stability, international diplomacy and economic policy, so we’ll be watching developments there very carefully indeed. But also we should remember a backdrop of uncertainty will make it a pretty difficult time, I think, for policymakers, including the conflicting forces of dovish monetary policy playing out versus this more constrained fiscal backdrop.
But, overall, we see a resilient year ahead. To give you some numbers around that, we expect the global economy to grow at 3.1% during the course of this year. We’ve got 3% pencilled in for 2025, which actually would be quite encouraging, given the variety of pressures that still continue to challenge the global economy.
Our focus in the second half of the year, of course, will remain on the resilience of the recovery, the progress on reducing the inflation profile and the cadence of rate cuts. If the inflation measures do return back to those levels, central banks reduce borrowing costs that, of course, will be seen as a positive.
However, the ongoing geopolitical tensions, reduced consumer spending power and fiscal restraints are likely, we think, to constrain the speed of recovery over the course of the next couple of years.
So, that was the financial markets last week and the outlook for the global economy. In order to discuss the prospects for stock markets in the second half of this year, I’m delighted to be joined by Dorothée Deck, Cross Asset Class Strategist with Barclays Private Bank.
Dorothée, great to have you back with us again today. As we know, equity markets have continued to defy gravity lately. Have you been surprised by the strength of the rally, and can you elaborate on the drivers behind the moves that we have been seeing?
Dorothée Deck (DD): Hi, Henk, good to be with you. So, absolutely, the strength of this rally has been remarkable, considering all the headwinds we have had to contend with, from rising bond yields to higher geopolitical tensions. Apart from the 5% fallback in early April, which was quickly reversed, global equities have gone up almost in a straight line, and we’re now back to all-time highs globally, 26% above the October lows.
With regards to the drivers, clearly the rally has been led by the tech sector, followed by communication services, industrials, and financials. At the stock level, it has also been highly concentrated in a small group of mega-cap names in the broad technology sphere in the US.
So, if we look at the S&P 500 index, for example, 45% of the performance since October can be attributed to only seven companies: Nvidia, Microsoft, Apple, Amazon, Meta, Alphabet and Broadcom. Without those stocks, the S&P would be up 17% from the lows, not 30%. So, while the magnitude of the move has been impressive, the rally itself hasn’t been totally surprising. Economic activity has been generally more resilient than expected in major economies and inflation has come down faster than expected, and we know that equity markets tend to rerate when growth expectations improve relative to inflation expectations.
Unsurprisingly, valuations are now elevated by historical standards. Of course, some regions look cheaper than others but, globally, equities are now trading at 17.5-times projected earnings, 20% above the long-run averages. So, this doesn’t leave much room for disappointment on the growth side or the inflation side, and it means that a significant increase in corporate earnings is now required to justify the recent moves in equity prices and for the rally to be sustained.
HP: Well, thank you for taking us through the details of the rally that we have been seeing, and talking about how narrow certain parts of the markets that we have been seeing in some of the benchmark indexes have been. You mentioned the economic backdrop there, Dorothée. What type of economic scenario do you think the markets are currently pricing in, and how does that compare with your own expectations?
DD: So, there has been a lot of debate in recent months about the type of economic landing central banks would be able to engineer. We’ve talked about it on this podcast. And the narrative has shifted drastically in the past few months from fears of a ‘hard’ landing at the start of last year to hopes of a ‘soft’ landing or even a ‘no-landing’ this year.
Out of those three scenarios, the market seems to be discounting the most optimistic outcome of a no-landing of the economy. So, according to our numbers, global equities are pricing in a significant re-acceleration in business activity and a strong rebound in corporate profit above what analysts currently expect. This looks complacent to us. The US manufacturing sector has been in contraction territory for most of the past 18 months and global earnings have been flat year on year.
Analysts currently expect global earnings to grow by 10% this year, which is already above trend growth of 8% over the past 50 years. We’re more conservative. As you mentioned previously, we expect global growth to decelerate and remain below trend for the next couple of years.
Those forecasts are consistent with flattish earnings growth this year, which is also backed up by historical relationships with business surveys and bank-lending standards. And this is why we believe it will be so important for investors to be selective in this environment, because, clearly, some companies will be able to deliver on those high earnings expectations but many won’t.
HP: OK Dorothée, let’s put some of those factors into context and think about what it means from an investment strategy perspective. How do you think investors should be positioned?
DD: So, we see limited upside potential at the index level, at least in the near term, but we continue to see opportunities under the surface, that’s within stocks, sectors and regions. As the economy slows, we expect investors to become more discriminating, with a renewed focus on company fundamentals, and this type of environment favours stock picking and active management.
Now, based on our macro outlook, we would emphasise quality and defensive stocks as core holdings in the portfolio, and by quality I mean companies with a strong profitability, solid balance sheets, low financial leverage and stable earnings. But, given the uncertainty, we would also reiterate the importance of diversification across sectors and geographies as investors should be prepared for a range of economic outcomes. And this is why it makes sense to complement those core holdings with selective exposure to more cyclical parts of the market that should benefit if global growth turns out to be more resilient than we expect.
Another option is to maintain exposure to structural growth trends, which tend to be less correlated with market moves. Certain themes continue to attract a lot of attention, including the adoption of AI within the wider economy, as well as security in its various forms, whether related to cyber, food or defence.
HP: Well, you’ve mentioned a few sectors today. I want to get into a little bit more detail. What are your thoughts around sector allocation at the moment? Do you see any attractive opportunities in the market at present?
DD: So, as mentioned previously, we favour quality and defensive sectors as core holdings in a portfolio. A lot of those quality companies can be found in the broad technology sphere, but we would rather invest at the stock level in that space, because the sector is so heterogenous.
Going back to sectors, we think defensive sectors are well positioned in the current environment, as they tend to outperform the broader market in periods of slowing growth and declining yields, and they have also lagged the market in the recent rally.
Within those, utilities and consumer staples look particularly attractive. They remain reasonably priced, despite a strong rerating in the case of utilities in the past three months. They trade at a significant discount, or at a modest discount to history, especially in Europe, offer a superior dividend yield and analyst earnings expectations look conservative.
Now, given the uncertainty, we would complement those core holdings with selective exposure to deep-value cyclicals, which should behave as a hedge if our central scenario doesn’t pan out, ie if economic activity proves to be stronger than expected or if inflation is more sticky.
Global energy stocks are particularly well positioned in that context. They trade at a deep discount to history and offer one of the best dividend yields amongst those sectors, 4.1% for the dividend yield versus 2% for the MSCI All Country World Index. They can also be an attractive hedge against an escalation of geopolitical tensions, rising oil prices and inflation in general.
HP: Dorothée, you mentioned earlier that equity valuations vary substantially between regions. Do you have any regional preferences either on a one-year view, or perhaps even on a more practical basis?
DD: Absolutely. So, outside the US, a number of markets are still trading at a discount to history. At the regional level, we also have a preference for more defensive markets, such as the UK. We continue to like UK stocks with a defensive tilt, undemanding valuations and attractive dividend yield.
We also see a short-term window for eurozone equities to outperform their US peers over the remainder of the year, although we would be more neutral over a longer-term investment horizon. So, this is mainly driven by relative valuations which are very supportive.
To give you some numbers, eurozone equities are trading at a 36% forward P/E discount to their US peers, compared with 21% discount on average in the past 20 years. That’s over two standard deviations below the long-run average.
Two catalysts should help drive this outperformance. Number one, the divergence in central bank policies with the European Central Bank cutting rates before the Fed. And, number two, a reversal in growth momentum, with economic activity improving from a low base in the eurozone and decelerating from an elevated level in the US.
Now, obviously, the European elections over the weekend and the forthcoming snap election in France add some uncertainty to that and could lead to negative sentiment in the near term, but, generally speaking, we think that macroeconomic developments on growth and monetary policy will remain the main driver of equity performance.
Now, as mentioned, on the one- to two-year view, we would be more neutral on the eurozone. At the index level, eurozone equities are more cyclical and if growth moderates as we expect they’re less likely to outperform the US. Having said that, the relative downside risk appears limited, given the valuation cushion.
HP: OK. We’ve covered quite a lot of ground here today. I want to try and bring that together a little bit. Clearly, the environment, as we’ve been discussing, remains highly uncertain. Volatility we think is likely to pick up in the second half of the year. So, how would you summarise your message to investors?
DD: So, in this environment, we want to stick to quality with a defensive tilt in portfolios. Given the uncertainty, both on the economic and the geopolitical front, it will be important for investors to remain vigilant, flexible and ready to adjust portfolios if necessary. Now, interestingly, and despite all the uncertainty, market volatility remains repressed, which means that some option strategies may be cheaper to implement than in the past, and those strategies can be particularly useful in the current environment to manage risk in portfolios, both on the upside and the downside, if our central scenario doesn’t materialise.
HP: Well, thank you, Dorothée, for your insight today. We know there’ll be a mixture of opportunity and challenges for investors as we go through the rest of 2024. We appreciate you putting those into context for us today.
Let’s move on to the week ahead, where the focus will be on the Fed meeting and the UK employment report. We expect the US central bank will keep rates on hold for a seventh consecutive meeting. Despite more signs of US inflation moderating this year, price pressures remain elevated, specifically in the service sector. Concerns that it will take longer for inflation to sustainably return to the central bank’s 2% target have supported a postponement of the start of the rate-cutting cycle.
We now expect the Fed to cut rates by just a quarter point during the course of this year. We think that’s most likely to come in late summer meaning the fed funds target range will be at 5% to 5.25% at year-end. However, a larger one-point reduction in rates is expected during the course of 2025.
In terms of the UK, within the labour market release we expect weak employment to lead to an increase in the unemployment rate. In fact, we expect it to tick up to 4.4%. Within the private sector, regular wage growth we think will be around 5.9%, as the bump from the national living wage is starting to filter through.
With that, we’d like to thank you once again for joining us. I hope that you’ve found this update interesting. We will, of course, be back next week with our next instalment but, for now, may I wish you every success in the trading week ahead.
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