Source: Tatton Investment Management, "Tatton Weekly" 31/05/2024

Optimum Wealth Management Optimum Wealth Management

Capital markets were in a dreary mood again this week, with global stocks generally ending the week down between 0.5 and 1%. That almost exactly tracks US stocks, with the S&P 500 losing just under 0.3% through the week. UK equities fared a little worse by comparison, down 0.8% but with a slight pickup into Friday that made the week’s losses milder. There was no obvious trigger to these falls, and little sign of wider market stress. As such, considering the previous monthly and year-to-date gains for investors, this week’s action felt more like consolidation through month end rebalancing, following various indices hitting new all-time highs in May. Looked at in that light, the backdrop looks more reassuring than worrying for long-term investors: previous returns seem to be solidifying, and against improving earnings outlooks, stock valuations look less stretched than they did earlier in the year. That bodes well.

Trump trials but no market tribulations.

It may sound odd to say there was no obvious cause of market losses just after Donald Trump became a convicted felon. He once again made history by being the first former US president to be convicted of a crime, after a New York jury found him guilty on 34 counts in the “hush money” trial. But Trump’s legal troubles have never had that big an impact on US stocks, let alone global markets, and that did not change this week – with the bigger chunk of the S&P’s falls coming before Thursday night’s verdict.

Currently, the trial’s conclusion looks unlikely to have any impact on Trump’s chances in the electoral rematch with President Biden. Most Republican supporters are unwavering and consider all the former president’s legal cases to be political persecution, while Democrats already considered him a criminal. The “hush money” case is seen as highly unlikely to result in prison time for Trump, and the more serious cases – for attempting to overturn the 2020 election and mishandling secret documents – are unlikely to be resolved before November. Still, it could have an impact in key swing states, where a less vocal but election-deciding middle of society could be put off by a criminal running for the US Presidency.

That is not to say US politics has no impact on its economy – far from it. As we wrote last week, Americans’ perceptions of the US economy are dramatically more negative than the real economic data, and one of the key reasons is that political allegiance (i.e. ‘is my preferred president in office?’) has a massive impact on economic confidence and inflation expectations. Despite unemployment being at historic lows, nearly half of Americans think unemployment is at its highest in 50 years, according to a recent Harris poll.

These perceptions are bizarre when compared to the strength of the US economy – particularly because resilient US consumers have been the key drivers of this lasting strength. Recent consumer confidence numbers have been lower, and it is possible that this could disrupt the US growth story as we get closer to the election. Or, more likely, it could just gently slow the economy,  as emotions expressed through surveys and actual behaviours seem to have diverged of late. With the election outcome still too close to call, though, market attention will remain firmly on the interest rate setting US Federal Reserve (Fed).

Increasing realism about rates.

Thankfully, expectations about Fed policy have stabilised in recent weeks. There was an outsized move in markets’ implied rate expectations in the first three months of the year, when persistent growth and sticky US inflation pushed the timeline for rate cuts further away, and short-term bond markets priced in greatly fewer cuts for 2024 overall. Those expectations have not moved much recently, though, in line with the fact that US growth, consumer confidence and inflation data have all softened.

Bond markets suggest the Fed will cut rates just once, by 25 basis points, by the end of this year. More importantly, markets seem to have accepted that this is a fair level for an economy which is gently slowing, but remains fundamentally strong. As shown by recent corporate earnings reports, the benefit of this prolonged strength is profit – from which equities ultimately derive their value. As we wrote last week, the result is a fairly healthy system of checks and balances on markets, allowing them to grow without overheating and threatening a damaging correction.

Interestingly, while the US is gently decelerating, Europe seems to be gently accelerating. Eurozone inflation came in above forecast in May and higher than the previous month, with headline and core numbers picking up to 2.6% and 2.9% respectively. Markets do not think this will deter the European Central Bank from cutting rates at its meeting next month, but bets for further cuts have been scaled back.

No obvious exuberance in markets.

European stocks were a little choppy after the inflation print, but did not fall dramatically. That is a good sign, and again suggests that markets are tuned in to the growth benefits that usually come with inflation, rather than just worrying about interest rates.

Backing this up is the fact that the stocks that were previously the big winners – and particularly those that seemed to have become overextended – were the worst performers this week. On Thursday, shares in Salesforce (US) fell 20% after the company disappointed earnings expectations for the first quarter. Profit growth was $9.13 billion, against expectations of $9.17bn, but what gave the stock its worst day in 20 years was not this small miss, but investors’ realisation that the company is no lower growing at 20% annually but just 10% now.

That speaks to a harsh investor reaction, but it also tells us that markets are laser focused on profits and fundamentals. Only companies who can prove they have significant and sustainable earnings potential are being rewarded with above average valuations. That is good news, considering that, earlier in the year, the main fears were about whether markets had become overexcited and stretched equity valuations into bubble territory. Clearly, markets are still very discerning and that bodes well for sustainable returns. With the growth outlook firming up and a more realistic outlook for rates (with cuts delayed or reduced) we seem to have returned to a goldilocks environment of not too hot and not too cold, just right. This week seemed a more dreary end to a decent month than feels justified, but the message is positive: returns are based on fundamentals, and the fundamentals are improving.

The Tatton Weekly is provided for information purposes only and compiled from sources believed to be correct but cannot be guaranteed.  It should not be construed as an offer, or a solicitation of an offer, to buy or sell an investment or any related financial instruments. Any opinions, forecasts or estimates constitute a judgement as at the date of publication and do not necessarily reflect the views held throughout Tatton Investment Management Limited (Tatton). The Tatton Weekly has not been prepared in accordance with legal requirements designed to promote independent investment research. Retail investors should seek their own financial, tax, legal and regulatory advice regarding the appropriateness or otherwise of investing in any investment strategies and should understand that past performance is not a guide to future performance and the value of any investments may fall as well as rise and you may get back less than you invested.

Any reader of the Tatton Weekly should not use it as a guide or form the basis of a decision relating to the specific investment objectives, financial circumstances or particular needs of any recipient and it should not be regarded as a substitute for the exercise of investors’ own judgement or the recommendations of a professional financial adviser. The data used in producing the Tatton Weekly is for your personal use and must not be reproduced or shared.