If we were playing golf, we’d be taking a break at the Halfway House. So, as we head towards the end of June, it’s time to sit down with a metaphorical cup of tea and a Mars bar to assess how the first few holes have gone and how we might approach the back nine.
The investment course has been kind to us so far in 2024. But there are some tricky holes ahead and achieving a decent score by the end of the year will require us to address three questions.
First up is the politics in this Year of the Election. There have already been some surprises (India, Mexico, France), and it’s all still to play for in the UK and in America. The vote that matters more is in the US. Question one, then, is who will win the US election and how will the market respond?
Neither Donald Trump nor Joe Biden is popular. But it’s close and the fate of Presidents seeking re-election since Ronald Reagan has been heavily influenced by macro trends in the months leading up to the vote. Consumption growth, employment data, inflation and GDP are the indicators to watch.
There is a clear correlation between positive readings on these and Presidents winning a second term. For President Biden to stay in the White House for another four years, the US economy might need either a soft landing (mild slowdown, falling inflation) or no landing at all (continued growth, moderate price rises). We put a 70% probability against one of those two scenarios and just 30% on a mild or more serious recession.
What’s less clear is how investors will respond. Our analysis of how the market performs under different electoral outcomes in the US tells a similar story to our number crunching on the UK market under different governments over the past 60 years. Elections affect sentiment in the short term. But, as we learned in 2016, they tell us less about the longer-run direction of the stock market.
This year was also expected to be the Year of the Interest Rate Pivot and I expect monetary policy to be a bigger driver than politics. While some countries or regions have started the process of cutting interest rates (the Eurozone is the most consequential so far), others have still not begun. The US is holding fire - and for good reason. The American economy remains stronger than expected at the start of 2024 and a cut in the cost of borrowing is hard to justify. The second key question is, therefore: will US interest rates start to fall this year and how far?
Interest rates likely to stay higher for longer than we hoped six months ago. It’s not clear where the neutral rate lies (not too hot, not too cold), but wherever the end point is it will take some time to get there. We are unlikely to get more than one rate cut in the US before the end of the year. Remember, the market was expecting six quarter point cuts at the start of 2024.
That might be better for share prices than it looks because the incentive to seek other homes for your money is less today than it was. Yes, you can expect to beat inflation with the income you can earn on a Treasury, or even cash. But the price you pay for that certainty of income is a lack of capital growth. And if inflation stays persistently higher than target, you will need some growth to keep your head above water in real terms.
Question three focuses on market leadership. Five stocks have accounted for 60% of the S&P 500 Index (Index)’s year to date return. Microsoft, Nvidia, Alphabet, Amazon and Meta have risen by a collective 45% and now comprise a quarter of the value of the whole Index. That’s been justified by earnings growth - up 84% in the first quarter, year on year, compared with 5% for the average stock in the US benchmark.
Profit forecasts for those five shares in 2024 have risen by 38% while those for the other 495 stocks in the Index have fallen. But the gap is forecast to narrow, according to Goldman Sachs. Next year the Fab Five will grow their earnings by 19% versus 11% for the average stock. In 2026 it’s 13% against 9%. This matters because the headline Index trades on 21 times expected earnings while the equal weighted index is valued at just 16 times. If the gap between the two narrows because the expensive market leaders get cheaper (rather than the rest of the market catching up with them) then the second half of 2024 could be hard work.
As we gather our thoughts in the Halfway House, we can look back on a positive start. The best performing stock markets in America and Japan have delivered between 15-20% in the first six months alone. The second tier - UK, Europe, emerging markets - have already secured a decent 6% or 7%. Even China is back in positive territory. Copper, oil and gold have all provided investors with a double-digit return. Even the laggards - property and government bonds - have not really lost you any money this year.
So, it’s been a tidy front nine. The investment equivalent of a couple of birdies and a string of pars. But, as any golfer will know, things can change dramatically at the turn. A change of leadership could alter the valuation arithmetic of the market. Higher-for-longer interest rates could be the sign of an economy in good health but also the precursor of a nasty slowdown. The aftermath of elections on either side of the Atlantic may be volatile. It’s not over until your card is signed and submitted.
Tom Stevenson is an investment director at Fidelity International. The views are his own.
