MARKET INSIGHT – September 2024

MARKET INSIGHT

Prime Partners’ monthly analysis of global economic and financial market news.

An almost cost-free warning…but a word of caution

Like the temperature on the shores of Lake Geneva, the tension on the financial markets rose several notches at the beginning of August. In the space of a few sessions, almost half the gains of the major equity indices were wiped out, against a backdrop of staggering readings like the VIX index peaking at 65 on Monday August 5 and the Nikkei 225 closing the session down 12%.

It goes without saying that such nervousness was hard to anticipate and that, fortunately, the underlying reasons for this outburst have more to do with the psychology of investors, particularly the more speculative among them, than with any sudden deterioration in the macroeconomic environment that we may have missed. The V-shaped rebound that followed during the month is the best proof of this. Nevertheless, it would be wrong to dismiss the warning given by the markets at the beginning of August as an isolated incident.

Investors often say afterwards that the best strategy would have been… to do nothing. In this particular case, the “tantrum” seen at the beginning of August would indeed have gone unnoticed by those who had not been paying attention to the stock market over the past four weeks. The major equity indices will end the month close to equilibrium, or even slightly up. Earnings releases for the second quarter, including Nvidia’s eagerly-awaited results at the very end of August, tell us several things. The first is that, overall, the US economy is holding up well, albeit with a few more nuances than some quarters ago, when its vigor surprised us. Consumers are not on the defensive, but they are being selective and postponing certain purchases. The second lesson to be learned from this earnings season is that virtually none of the major technology companies managed to capitalize on the good figures they delivered. Investors have become very demanding, and their expectations are now difficult to meet even in the face of excellent results. Finally, and perhaps the most important lesson of recent weeks, the “Magnificent 7” were not the driving force behind the S&P 500, after two quarters of clear outperformance against the… 493 other stocks making up the index.

The “Magnificent 7” were not the driving force behind the S&P 500, after two quarters of clear outperformance against the… 493 other stocks making up the index

In terms of macroeconomic data and monetary policy, August was also a busy month. It was the publication of higher-than-expected US unemployment figures that set things alight at the beginning of the month. The specter of the Fed lagging behind the US economy, and of a potential “hard landing” by the latter, suddenly reappeared.

The sector rotations we had already witnessed in July turned into a rapid correction, as described above. Fortunately, market participants found some comfort in the retail sales figures, which were finally reassuring about consumer health. Then again, we find it difficult to completely ignore certain indicators relating to the US economy. The publication of the ISM services index (whose recent incursions below the 50-point mark are a cause for concern) in early September, followed by US employment figures, will be two key data points to keep an eye on.

August is also the month when the world’s central bankers gather in Jackson Hole, a small Wyoming town whose website champions the region’s wilderness with the slogan “Stay Wild” … Let’s not see it as premonition. Jerome Powell’s speech was eagerly awaited, as monetary policy regained its throne in the minds of investors after having relinquished it to corporate results.

Unsurprisingly, Mr. Powell confirmed his message that the time had come to start cutting interest rates in the United States. The FED’s next meeting in mid-September will most likely be marked by this announcement. We anticipate a 25-basis point cut and believe that a second reduction of the same magnitude could take place by year-end. 2025 should see a continuation of this process.

However, let us not assume that the path is all mapped out (and the future of the equity markets crystal-clear). The Federal Reserve will remain highly dependent on developments in the US economy. Employment, consumer spending and, of course, inflation are all parameters that will determine the future course of monetary policy.

On the European side, one might be tempted to remember only the immense success of the Olympic Games during this summer of 2024. At the time of writing, President Macron has still not appointed a prime minister, although the announcement now seems imminent. The fact remains, however, that the chosen candidate is unlikely to meet with unanimous approval, and that forming a government, and then taking charge of the French ship, will be tricky.  Germany, for its part, remains in the doldrums, still penalized by the more industrial orientation of its economy. Further interest-rate cuts by the ECB will in any case be a welcome boost for the Franco-German duo, which is currently showing little sign of being the locomotive of the old continent.

A word on China, where nothing new has emerged this summer. The economic slump remains very real, and sometimes even deeper than we thought in recent months. The latest example was the publication of figures for Pinduoduo, parent company of the famous TEMU low-cost e-commerce platform. After attempting to reassure investors, Chairman Lei Chen indicated that the global environment was deteriorating and generating “significant uncertainties” for the company. This was all it took for the share price to lose 30% of its value at the market open.

Apart from this example, China faces a serious demographic problem. The aging of its population and its impact on the current workforce is not to be taken lightly, and is causing the Chinese economy a great deal of trouble. We therefore continue to steer clear of Chinese equities, whose valuations seem to us to be in line with current economic reality and not very attractive.

Our asset allocations passed the stress test at the beginning of August with flying colors. The construction of our portfolios over the last eighteen months, aimed at limiting volatility without entrusting the entire performance to equities alone, proved to be as robust as we had hoped.

It will be interesting to follow the arguments put forward by the FED regarding the start of its easing cycle and, perhaps even more so, to observe how investors interpret them

We are heading into the end-of-summer period with a more defensive stance. The uncertainties felt by investors as to the extent of the US economic slowdown proved to be serious in August, provoking significant market reactions. In addition, it will be interesting to follow the arguments put forward by the FED regarding the start of its easing cycle and, perhaps even more so, to observe how investors interpret them.

Jerome Powell’s statements in mid-September will have to reassure the markets that lower interest rates are the “reward” for months of fighting inflation while preserving growth, and not a support measure for an economy that is slowing sharply.

Our decision to adopt a slightly more cautious stance in the weeks ahead has prompted us to leave our current portfolios unchanged. We are postponing the idea of adding a small/mid-cap strategy, which we mentioned in this newsletter last month. Lower interest rates are only part of the recipe favoring this type of companies. Dynamic economic growth is also necessary, and the uncertainties surrounding it have increased.

A well-diversified allocation to bonds, coupled with defensive alternative strategies, enabled us not to be overly concerned about our exposure to equities during the brief correction phase at the beginning of August. Cash and gold also reinforced the “safety cushion” we like to have in portfolios.

While the economic slowdown seems to be taking hold, or at least the markets’ fear of it, we are moving serenely into the latter part of the year with our current allocations, which are performing well while allowing us to sleep soundly.