MARKET INSIGHT – October 2024
MARKET INSIGHT
Prime Partners’ monthly analysis of global economic and financial market news.
The start of a new phase in monetary policy
Awaited like the Messiah, the FED’s famous “pivot” finally took place on September 18. Jerome Powell and his colleagues even cut interest rates by an unusual 50 basis points, a magnitude previously reserved for times of crisis. The communication surrounding such a move, which was anticipated by part of the market, was key in order to avoid injecting a hint of nervousness into traders’ minds and preventing the perception of a lag between a monetary policy potentially rigid for too long and an American economy slowing faster than expected.
In this exercise, Mr. Powell was reassuring. He accompanied this major rate cut with a positive view of the current state of the US economy, particularly as regards inflation. The Federal Reserve is now more confident about the general price level in the United States, and that the 2% inflation target will soon be reached. On the other hand, it has revised upwards its unemployment forecast for the end of the year to 4.4%. This means that the FED will be keeping a close eye on US employment and offering companies a less restrictive monetary environment, in the hope of sparing them the need to lay off workers.
“We’re there at last”, one might say. A phase of falling interest rates has officially begun, including in the United States, and should theoretically extend over several quarters in order to gradually loosen the monetary stranglehold required by the fight against inflation of the last two years. Given that economic dynamics are by no means an exact science, this is no time for blissful optimism. But like Jerome Powell, we see a growing sense of victory over inflation. Although there is a risk that it will not fall as low as it has over the last two decades, it is no longer the key factor to watch over the coming months.
Employment will be the main focus of attention from now on, because even if joblessness remains low in the US, it has been rising slowly in recent months, and certain economic releases may legitimately cast doubt on the true extent of the slowdown in Uncle Sam’s economy.
Employment will be the main focus of attention from
now on, because even if joblessness remains low in the US, it has been rising
slowly over the past few months
Indeed, the financial markets did not over-celebrate the FED’s announcement. The month of September, which is notoriously bad for stocks, did not see the S&P 500 soar.
To sum up, our views over the last few months remain unchanged by the FED’s first move: optimism, yes, but also caution, in an environment that remains uncertain and in which we have seen significant sector rotation over recent weeks, sometimes with a propensity for sudden wild swings, as was the case at the beginning of August.
On the other side of the Atlantic, there is really no cause for celebration. Indeed, the situation in Germany and France, the former “star couple” of the European economy, is hardly encouraging, even if we should not to fall into excessive alarmism.
The weight of Germany’s manufacturing sector, led by the automotive industry, continues to undermine European economic momentum. Added to this is a growing awareness of France’s rapidly deteriorating deficit, which the new Prime Minister, Mr Barnier, will have to address promptly. The result is the prospect of higher taxes for French companies in particular. This is hardly likely to please the bosses of the CAC 40, for whom the taxation of certain “super profits” is regularly mooted. Conversely, the countries of southern Europe, led by Spain, are currently looking much better… There is almost a whiff of revenge for the years 2010 and the European debt crisis.
For once, and because there is never a dull moment when it comes to financial markets, it was Chinese equities that enjoyed (by far) the most rewarding month of September. In the second half of the month, Beijing announced a series of measures aimed at revitalizing the country’s economy, which is in the throes of a profound real estate crisis and plunged into a slump regularly mentioned in this newsletter. At this stage, we feel it would be premature to assert that the world’s second-largest economy will return to its pre-Covid growth trajectory following these announcements, which, while substantial in scope, are still a long way from a massive stimulus plan of the kind seen in the USA post-2008.
This brief economic overview of the past month does not lead us to change our central scenario for the end of the year. Equity markets are trading at high valuations, but we do not believe that they are significantly out of touch with reality. We therefore remain convinced that the “soft landing” of the economies orchestrated so far rather brilliantly by central bankers will continue.
On the other hand, we expect potential shake-ups to occur within the major equity indices, led by the S&P 500. The sector rotations we evoked earlier are unlikely to disappear, especially as the end of the year is set to be extremely busy. And what could top the first week of November, which, in addition to numerous quarterly results, will see the verdict of the US presidential election, a FED meeting and the publication of ISM and unemployment figures. A sure recipe for volatility.
On the bond front, the signal given by market participants following the cut in US interest rates was also far from exuberant. Long rates even rose in the US after Jerome Powell’s announcement. It seems likely to us that part of the reason for this is the glaring absence at this stage in the programs of Kamala Harris and Donald Trump of any willingness to address the growing deficit problem. A fiscal stimulus and additional federal spending could thwart the FED’s rate-cutting process by reinvigorating inflationary pressures somewhat. In economics, and especially when it comes to debt matters, it is often said that there is no problem… until there is one.
Finally, it is important to remember that the geopolitical context remains very tense, with no sign of improvement. Financial markets have become accustomed to the conflict in Ukraine and, even if nuclear threats are a thing of the past, there are hardly any hints of progress on the horizon. Only Donald Trump’s coming to power could, in his own words (vague though they may be), mark a turning point, the nature of which we do not yet know.
In economics, especially when it comes to debt
matters, it is often said that there is no problem… until there is one
The situation in the Middle East, meanwhile, is deteriorating, with the fighting spreading to Lebanon in addition to the Gaza Strip. Although Israel’s military superiority over Hezbollah is clearly in evidence, an extension of the conflict, particularly with Iran, cannot unfortunately be ruled out.
We enter the final quarter with the same asset allocation principles that have been our strength for the past 18 months. Sector diversification for equities, quality of bond issuers and confidence in decorrelated alternative investments will remain our mantras in Q4. Potential future upheavals do not call into question the current construction of our portfolios. The major jolt at the beginning of August, followed by a rally in equity markets back to their highs, enabled us to verify by practical experience that our portfolios were capable of absorbing shocks, and then capturing a subsequent upward bounce.
We are also not ignoring the signals sent out by both the sharp rise in gold prices and the record level of assets held in money market products, mainly in dollars. Quite to the contrary, our allocations give due weight to these assets, which in fact constitute two important elements of the portfolio structure we believe to be appropriate at present.
The cautious optimism reflected in our allocations has produced results that we consider satisfactory this year, combining good performance with low volatility. The FED’s first “jumbo” rate cut and the uncertainty surrounding the outcome of the US presidential election are not, at this stage, grounds for excessive fear. A choppy market does not necessarily mean a falling market.