Much has changed since our last monthly Lowdown report.
Here in the UK, Labour's landslide victory has left the Conservatives in disarray. Their electoral chances were hard hit by the rising popularity of Nigel Farage’s Reform UK Party, which ate significantly into the overall vote share. Reform may only have five MPs, but it came second in no fewer than 98 constituencies, 89 of which were claimed by Labour. Its remarkable share of the national vote signifies the beginning of much debate over what comes next for the Tories.
Sunak himself will stay on in a caretaker capacity while the procedure for electing a new party leader is decided.
The turmoil has not been limited to this side of the Atlantic. Trump was the target of an assassination attempt at a Pennsylvania rally, just days before he was to accept the Republican nomination for a third time. Shots were heard, the panic started and a bloodied Trump was seen surrounded by Secret Service agents before being hurried away in a limousine. The assailant and one attendee were killed, while two spectators were critically injured.
As for the global stock markets, the rally has continued. But since mid-July, the focus has shifted away from the US market-favoured technology sector and the Magnificent Seven. The S&P 500’s technology sector has dropped nearly 6% in just over a week, shedding about US $900 billion in market value. This is against a backdrop of growing expectations of interest rate cuts and a second Trump presidency, with money being drawn away from this year’s winners and towards some of those sectors that have languished in recent times.
Big tech stocks have been leading the charge, and for understandable reasons: they are making money and growing their corporate earnings. And many of those tech stocks are spearheading progress in AI, which will continue to change the direction of corporate activity and people's lives more generally.
Although focus has recently shifted away from the tech sector, and cyclical sectors have been enjoying some time in the sun (there has been a sharp rally in US small cap stocks, for example), strong corporate earnings results over the next few weeks from the tech market leaders could allay some of the fears that have recently dogged these mega caps, and they could regain some of that momentum.
Any signs of flagging profits from AI-related spending could, needless to say, result in a further period of short-term weakness for the Magnificent Seven. And semiconductor shares were hard hit following an earlier report suggesting that the Biden administration was considering tighter curbs on exports of advanced semiconductor technology to China.
To exacerbate things, Trump has recently suggested that Taiwan – the world's leading producer of semiconductor chips – should pay the US for protection against China. All of this led to the benchmark Philadelphia SE semiconductor Index tumbling by around 8% over the week.
Trump went on to say that he would crack down on immigration, slash taxes and give renewed impetus to trade wars were to return to the White House.
As for Joe Biden, mounting pressure on him to step aside as the Democratic Party’s candidate finally came to a head on Sunday. Following numerous errors in recent speeches and a Covid-enforced withdrawal from public duties, it was only a matter of time before he had to end his campaign. He has since endorsed vice president Kamala Harris as the party's new nominee.
But Biden's backing is no guarantee that Harris will receive the wider support of the Party. And the process for selecting an alternative remains unclear.
It is indeed the case that Harris and other Democratic candidates might have a better chance of winning the election. But the consensus view remains that Trump will win.
AI is opening up numerous possibilities and quantum mechanics is ushering in a new age of computing – companies such as Nvidia, Microsoft, Google, Amazon and IBM are all pioneers in this space. So any significant weakness in the tech sector should be viewed as a buying opportunity.
The US Federal Reserve Bank appears to be entering a “Goldilocks” sweet spot. Inflation is coming down, and growth is moderating but not stalling. In fact, according to a recent survey conducted by the Bank of America Institute targeting fund managers, higher inflation is no longer investors’ primary concern. The survey also suggests that 40% of investors think that monetary policy is too restrictive – that's the highest since 2008.
Federal Reserve Chair Jerome Powell said second-quarter economic data has provided policymakers with greater confidence that inflation is being brought under control, possibly paving the way for near-term interest-rate cuts. “Inflation has come down”, he said, “and the labour market has indeed cooled off”, meaning that the central bank’s two mandates – promoting maximum employment and maintaining price stability – are in much better balance. This will incentivise the market to rotate into sectors outside of technology.
All of this is a compelling backdrop for risk assets (equities) and shorter maturity bonds as the yield curve steepens.
Furthermore, while a significant number of US small cap businesses have been unprofitable (they are more dependent on capital markets for financing), any suggestion of lower interest rates will have a considerable impact on the markets’ perception for future profitability.
In actual fact, at the start of July some US hedge funds had a sizeable, short position in small caps. So any position shifting from these behemoth funds will ignite a powerful rotation.
Equally important from a rotation perspective has been the second highest inflows for 2024 into Exchange Traded Funds. Most of the capital invested has gone into large-cap ETFs. But relative to their size, small caps were the big winner: inflows of around US $3.7 billion were invested into the iShares Russell 2000 ETF.
In Europe, the European Central Bank kept its key interest rates unchanged. ECB President Christine Lagarde emphasised that it would not precommit to any rate path, stressing that “economic data would guide its decisions”. She went on to say that a move in September was “wide open”, and added that risks to economic growth were “tilted to the downside”. The ECB and other leading central banks remain cautious over fluctuating inflation.
In the UK, headline annual inflation held steady at 2% in June, partly due to a profound decline in energy costs compared with last year. Core inflation, excluding energy and food, remained at 3.5%. Services inflation, which is closely watched by policymakers, stayed at 5.7%.
Average earnings data, meanwhile, also grew at an annual rate of 5.7% in the three months to May. This has meant that City investors are only pricing in a 50/50 chance of a rate cut in August. We believe that it is now time for the Bank of England to stop squeezing living standards and give serious consideration to a 25 basis points rate cut sooner rather than later.
It is still too early to declare with unwavering confidence that the tide has turned as far as the US stock market is concerned. That said, things have widened out somewhat, and we believe that more sectors and stocks across the whole market will benefit by the time the Federal Reserve Bank introduces rate cuts.
In recent months, we have therefore slightly tilted our core portfolio strategies (risk-adjusted) towards those US small caps and some of those cyclical sectors that will benefit from lower inflation and interest rates. A similar story is likely to play out in the UK where we already have exposure to mid and small cap businesses. We also think that further performance in our core strategies can be achieved by certain style factors, as several of the tailwinds we mentioned above have long runways.
For those portfolios where these allocations seem to make sense, we have accessed them through a combination of active fund management – where skilled managers can find quality companies producing cash flows that trade at discounts – and passive vehicles that track indices and more importantly sectors that will benefit from changes in the macro landscape and rotation.
