Portfolio Perspectives, June 2024

Equity markets: caution is still warranted 

Equity markets continued the climb since our last edition of Portfolio Perspectives with the world index returning 2.3% in euro terms. Better inflation data from the US brought forward interest rate cuts in the US again buoying the US bond market and with it the equity market. The AI theme continued to push markets up – and Nvidia results was main focus over this period.

The inflation reports from the US were encouraging with a notable step down in core services inflation. At the last reading, euro area inflation came in higher than expected at the core and headline level although the journey is still downwards.

Growth indicators were slightly weaker over the last few weeks led by softer data on US consumption. The data from the euro area is still encouraging but this is mainly driven by sentiment indices rather than the hard data. China is still being held back by a slowing consumer sector.

The US equity market led during the period due to improved interest rate expectations and its high exposure to the ‘New Economy’ sectors (IT and Communication Services). These were the strongest sectors driven by very good results from semi-conductor companies (Nvidia, Broadcom etc.) as the build out of the IT infrastructure to enable AI tools continues at a rapid pace. We do seem to have left earnings downgrades behind us. Over the last month, there was an increase in global earnings growth for 2024, the first time this has happened this year.

The euro area now faces some uncertainty as the European Parliament elections prompted a snap election in France. The implications of the outcome are likely to be regional affecting the relative attraction of the euro area rather than undermining global equities.

The backdrop to equity markets has been improving during the year; the global economy remains robust and is expected to deliver close to trend growth this year and next. This is now feeding through to earnings forecasts and profit momentum could be starting to turn upwards. But equity markets have moved to reflect these developments. Interest rate expectations remain volatile, and these have the potential to undermine equity markets and thus caution is still warranted. 

Bernard Swords,
Chief Investment Officer

What central bank policy means for fixed income markets

This month’s Asset Allocation committee meeting discussed the muted performance of fixed income markets in May and the subsequent weakness following the important central bank meetings in early June.  There were no changes to overall strategy or the investment mix but, as always, the importance of looking at the macro picture and remaining flexible to adapt to significant market changes was highlighted.

Looking at market performance, the euro area bond market performance for the month of May was muted, returning just 0.04% according to the Bloomberg Euro Aggregate bond index. Euro area bonds grappled with stickier inflation and stronger growth data over the month. As a result, investors pulled back on their pricing of rate cuts and in turn, bond yields rose marginally in the euro area. The German 10-year yield ended the month of May up slightly to 2.66%. The first week of June did see a 25-basis point cut from the European Central Bank, but the commentary from officials highlighted that the cutting cycle may be more gradual than initially expected with only two further cuts now expected before 2024 year-end. In early June, bond yields rose slightly further despite the rate cut.

Across the Atlantic, Fed commentary remained hawkish during the month of May, but rate cut repricing did not reverberate as negatively as in the euro area. US Treasury bond yields actually fell modestly on the month  and the US bond market aggregate returned 1.55%, according to the Bloomberg US Aggregate bond index. The Fed’s decision at their June meeting to hold off on cutting rates until further economic weakening becomes visible was widely expected and caused little disruption to yields.

Despite May’s outperformance by US bonds, the euro area is still outperforming the US (on a hedged basis) year-to-date. In our view, value remains in lower and mid duration exposures, and we remain overweight corporate bonds relative to government bonds as economic growth and corporate fundamentals remain positive.

Moyah Flanagan,
Fixed Income Strategy

Why we are not altering allocations at present

In May, we made a number of strategic changes within our equity positioning. In particular we focused on reducing the overweight position in Consumer Staples and reinvesting this in the Technology sector in an effort to align our exposure with the benchmark. We had a particular focus on increasing exposure to mega cap stocks.

Following on from these changes, the fundamental backdrop has not changed a lot over the last month:

• The global economy is robust with the growth rate close to trend.
• The inflation journey is becoming slower but is still downward.
• Interest rate expectations have moved towards higher for longer, in particular in the euro area.
• Valuation of equity markets is above average but not materially so.
• Earnings momentum could be starting to turn upwards.

Markets have moved to price in any changes in the outlook noted above, so we do not see any glaring opportunities thrown up over the last month and hence we are not altering allocations at present.

Sarah Quirke,
Head of Investment Solutions