Quarter 2 ends with a whimper    

Market Review: Until the sell-off in the last few hours of trading in the US, it looked as if the S&P 500 would finish the quarter at an all-time high, above 5,500 and way ahead of most analysts end of year forecasts. In the end, there was less of a bang and more of a whimper as it tailed off into negative territory and slightly down on the week. Bullish fatigue was probably the cause, as investors were content to trim a few gains and rethink positioning for the quarter ahead. European markets were quiet most of the week before elections in France and the UK. China stumbled, and as has been the case for much of the last year, India and Japan registered the most significant gains, although Yen’s weakness undermined the returns for global investors.

Q2 Summary

Overall, it goes down as another good quarter for the global equity markets, with India, under the weight of foreign inflows, emerging as the top-performing country index, a spot that had seemed very likely to go to China after a blistering start to the quarter. The FTSE 100 had led the way in the Western developed markets for much of the last three months before fading in June, as the US once more enjoyed better returns than its European counterparts. Bonds had begun the year as many investors’ asset class of choice but again failed to deliver meaningful returns, trailing the returns on offer from cash for the second consecutive 3-month period.  In terms of sector performance, US exceptionalism has continued over the second quarter, led by Tech and the charge of AI-related companies, with Nvidia at the helm, powering gains of nearly 30% for the L&G Global Technology Trust, a fund I am pleased to say is nestled within the 8AM AQS models.

US – Goldilocks Narrative Keeps Sentiment Positive

Investor sentiment has remained upbeat most of the time, as investors still seem keen to interpret macro data as falling in line with the Goldilocks narrative, which sees inflation gradually receding as economic growth chugs along, not too hot or cold. By now (according to December estimates), we should have seen all the major Central Banks begin cutting rates, but only the ECB has accomplished a quarter-point reduction. However, there are reasons to be more optimistic about others joining the Europeans in cutting. US inflation appears to be steadily falling, and the UK even hit the 2% target last month. And as for economic growth, the not too hot, not too cold analogy is just about spot on. So much so that market pundits have been oscillating between talk of overheating and then impending recession –  a sure sign that the Fed is currently doing an excellent job in steering the economy toward the soft landing we all want.

As if to epitomise that, we had the release of the Fed’s measure of underlying US inflation for May, which decelerated to the lowest advance since 2020, bolstering the case for lower interest rates later this year. And on the other side of the coin, we had the figures for May household spending, which rebounded after a pullback in April and incomes showed solid growth, offering some hope that price pressures can be tamed without lasting damage to consumers.

Have Equity Markets gone too far, too fast? Most specifically the US tech sector ?

This is the primary problem for all investors, including me, at the moment. Has the rally in US equities this year been too extreme, and will we see it come crashing back down to earth sometime soon? The danger of positioning for such an event, as many have, is that the market keeps on running. Every time we see signs of a pullback like Nvidia correcting more than 10 % at the start of the week, investors that might have been “missing out” immediately come piling back in. It almost seems more dangerous to be out of this momentum-driven market than in it.

I share the bullish macro disposition that will see continued economic growth this year, earnings to rise, and inflation to nudge down just enough to see the FED join the ECB and, in turn, the BOE in cutting rates. That’s all good news, but it does appear to be fully priced in, and if any part of that narrative disappoints, then equity markets do look vulnerable.

We have already had appropriate gains for the year that reflect the expectation of good macro news, so a pause would be rational and healthy. Still, this market could yet ‘melt-up’ into dangerous territory.

Further out, from 2025 through 2030, I remain convinced we could see a sustainable bull market. My rationale is simple: rising productivity growth, thanks to the widespread adoption of new technologies in response to the shortage of skilled labour, will support robust growth in GDP and profits while keeping a lid on inflation. As ever, that assumes Politicians don’t go crazy, deficits get addressed, and trade wars between the superpowers don’t escalate into conflict.

Why US Technology Shares, Despite Being Expensive, Are Not Overvalued Like in the Late 1990s

In my humble opinion, while notable for its rapid gains and high valuations, the current bull market in US technology shares differs significantly from the speculative bubble of the late 1990s, and I posit the following reasons…

Robust Earnings Growth:

In the late 1990s, the technology sector’s surge was primarily driven by speculative investments, leading to inflated valuations unsupported by actual earnings. Today, the situation is different. The recent market move is better supported by solid earnings growth. For instance, analysts have consistently revised their earnings estimates throughout 2024, reflecting genuine business performance rather than speculative hype​. The S&P 500 earnings per share (EPS) significantly beat expectations in Q1 2024, growing by 6.8% compared to the anticipated 1.2%. It would be unusual for a market to correct with earnings revisions moving higher.

Valuation Multiples:

During the dot-com bubble, the forward P/E ratio of the S&P 500 Information Technology sector soared to an unsustainable 48.3. In contrast, today’s forward P/E for the sector, while elevated, remains around 30.0. This figure suggests a more rational market environment where valuations, although high, are supported by earnings and growth prospects​. Same for the S&P 500’s forward P/E is currently around 21.0, compared to a peak of 24.5 during the late 1990s bubble.

Technological Advancements and Productivity:

The widespread adoption of new technologies, driven by advancements in AI, cloud computing, and other innovations, is boosting productivity and economic growth. This tangible effect is a crucial difference from the 1990s when many tech investments were in unproven business models. Today, companies like Nvidia are leaders in AI and computing technologies with immediate and widespread applications. Many investors are making the mistake that because they either can’t see the effect directly or don’t understand its application, it must be like the 90’s.

Economic and Monetary Conditions:

The Federal Reserve’s current stance, coupled with low inflation rates close to the Fed’s 2% target, provides a more stable economic environment than in the late 1990s. Moreover, if recession fears rise, the Fed stands ready to intervene with easing measures, which would help support market valuations​.

So, while US technology shares are expensive, their valuations are underpinned by solid earnings growth, technological advancements, and a more balanced contribution to overall market earnings. Unlike the speculative bubble of the late 1990s, today’s market environment is characterized by solid fundamentals and supportive economic conditions, making the current high valuations more sustainable. That being said, we may see a choppy period over the year’s second half, punctuated by corrections that bring in underweight investors seeking better entry points.

France goes to the Polls this weekend for round 1 of the parliamentary elections

The upcoming French elections are shaping up to be highly competitive, with the National Rally (RN) expected to secure around a 1/3rd  of the vote in the first round, closely followed by the New Popular Front (NFP) and President Macron’s Ensemble group trailing at around  20%. Due to France’s two-round electoral system, the final distribution of seats remains uncertain. Analysts suggest multiple potential outcomes, including an RN majority or minority government, a centrist government possibly led by a technocrat or an NFP-led minority government. If no majority is formed, President Macron must appoint a Prime Minister reflecting the National Assembly’s power balance, with the RN’s Jordan Bardella stating he won’t accept the role without an absolute majority.

The most likely outcome is a government formed by either the RN or NFP, with only a portion of their fiscal campaign promises being implemented. This scenario likely leads to a higher fiscal deficit than expected, raising concerns about debt sustainability among market participants. Consequently, French Government Bond (OATS) might widen, as GILTS did during the Truss fiasco. Still, I wouldn’t expect this to cause a contagion to the rest of the eurozone, and the euro would likely remain relatively stable. We will find out shortly.

UK – More Good News on the economy but too late to save Rishi…

Britain’s economy has shown a more robust than expected recovery, bouncing out of recession with the highest growth in over two years. Last week, the Office for National Statistics reported a GDP increase of 0.7% in the first quarter, up from the initially estimated 0.6%. This growth was driven by robust services output and consumer spending. The Bank of England has revised its growth forecast for the second quarter of 2024 from 0.2% to 0.5%, reflecting an optimistic outlook for continued economic momentum.

Prime Minister Rishi Sunak will hand over an economy in good shape when Britain goes to the polls on Thursday. We are seeing a significant rise in services output, particularly in professional services and scientific research, as well as stronger trade and consumer spending. Living standards in the UK have climbed for two consecutive quarters, reaching levels last seen at the end of 2021, driven by rising wages and falling taxes. Household disposable income, even adjusted for inflation, is still on the rise, and this, above all other factors, is supportive of the economy and, in turn, domestic-focused equities.

But as we approach voting day on Thursday, Britain is on the verge of a potential once-in-a-generation political shift. Polls indicate a landslide victory for Keir Starmer’s Labour Party and a severe defeat for Rishi Sunak’s Conservatives after 14 turbulent years in power.

This transition would represent an extraordinary comeback for Labour, transforming from its worst performance since before World War II in 2019 to potentially surpassing its previous peak under former leader Tony Blair in just one election cycle. Some pollsters predict Starmer could enter 10 Downing Street with near-total dominance. Regardless of your political disposition, let’s hope he does a good job, and as a fellow old boy of Reigate Grammar School (a few years above me, I hasten to add), I wish him the very best.

Will Joe Biden even run for President ?

I couldn’t finish this ‘Market Matters’ without reflecting on the televised debate between Trump and Biden last week. Of all the 300 million Americans, are these the best two that can be found? It is utter madness. In one corner, a convicted felon and certifiable narcissist, and in the other, an elderly gentleman who is so obviously past his prime and increasingly cognitively and numerically challenged that you wouldn’t let him run the bridge club in a care home. It was painful to watch, and President Biden’s debate performance was simply terrible. While Biden remains committed to running, his performance has sparked discussions among Democrats about the viability of his campaign. Meanwhile, Trump’s energetic and aggressive debate style has bolstered his position, making him the clear bookies favourite. The most interesting thing is that the odds of Gavin Newsom and Michelle Obama becoming President have fallen sharply.

Biden spoke at a campaign rally in North Carolina, where, to be fair to him, he did a much better job. He stated, ‘I would not be running again if I didn’t believe with all my heart and soul I can do this job.’ He acknowledged his physical and communicative limitations but emphasized his ability to lead and make truthful decisions.

Democrats are exploring contingency plans to replace President Joe Biden as their presidential nominee, but it would be difficult to do so without his agreement. If Biden steps aside voluntarily, the Democratic National Committee (DNC) would follow established procedures to select a new nominee. But if he remains in the race, any challenger would need significant delegate support to initiate a nomination change, and time is running out. A brokered convention, with no clear nominee, could occur, involving super-delegates who could influence the outcome.

It promises to be an interesting week ahead, with the results of the UK and French elections. On Friday, we have American Independence Day and US job numbers.