Financial Bulletin – May 2024

Key Takeaways:

After several months of equity markets serenely rising higher, investors were forced to reappraise the situation and the rally stalled during April. At one stage, the S&P 500 suffered six negative days in a row which is quite a rare event.    

The US economy grew by much less than expected in the first quarter of the year (according to initial estimates), whilst at the same time inflation surprised to the upside for the third month in a row.

Expectations for the timing of the first US interest rate cut were pushed further out again and some commentators began to openly wonder if the Federal Reserve may be able to cut at all this year. 

Elsewhere, the UK economy looks very likely to have exited recession in the first quarter of the year as recent surveys point to reasonable growth.

In contrast to the US experience, inflation in the Eurozone looks to be sustainably close to 2% and members of the European Central Bank hinted at rate cuts in the near future.  

Over the last 6 months, the FTSE 100 returned 10.70%, the S&P 500 returned 18.13%, whilst the Euro Stoxx 50 returned 20.54%. In the process, the FTSE 100 hit an all-time high during April.

The Japanese Nikkei 225 returned 20.93% over the same period.

The broad emerging markets index returned 11.06% in US$ terms.

US 10 year government bond yields rose substantially during the month, whilst the price of gold reached an all-time high on the back of sustained buying from the People’s Bank of China.  

> Chart of the month –

US spending spree (US consumers have spent almost all of their pandemic savings):

Economic Review

The picture of the US economy was murkier than usual as several indicators were contradictory. Whilst the headline rate of growth fell significantly, this was mainly due to more volatile elements (such as inventories) which could bounce back next quarter. The confusion was only added to when some measures of the labour market pointed to a definite slowdown (such as job openings) whilst others suggested business as usual. Whatever the true state of the US economy it is certainly not in as good a position as it was at the back end of last year.

Digging beneath the headlines was also important when it comes to inflation. Whilst inflation has now exceeded expectations for three months in a row there is no longer a broad-based rise in prices; the problem is confined to specific areas such as car insurance.

Nevertheless, following the release of the inflation figures, the bond market started pricing in only one or two rate cuts this year, with some commentators suggesting no cuts at all as a distinct possibility.

In contrast the situation in the Eurozone looks clearer cut as inflation fell to just 2.4% in March. The core inflation rate, which excludes energy, has now fallen for eight months in a row suggesting that disinflationary pressure is not just an energy story.

With inflation now close to target and the Euro Area economy effectively stagnant since the second half of 2022 it was no surprise that members of the ECB put rate cuts firmly on the table.

Whilst the performance of the UK economy also remains fairly lacklustre it is, at least, growing again after a recession in 2023. The latest surveys suggested that the services sector accelerated in April, potentially setting the scene for a decent second quarter. Average wage growth was lower than expected which could further assure the BoE that the chances of a wage-price spiral are diminishing.

Further afield the ‘higher for longer’ stance of the US Federal Reserve is having a significant impact on the value of the Japanese Yen, which fell to the lowest level since 1990 against the Dollar. Having just started to turn the tide economically, the Japanese authorities seem quite sanguine about a weaker currency and the positive effects on their exports.

Unfortunately, the weak Yen is also undermining the competitiveness of China’s exports at a time when China’s leadership is trying to emphasise exports as a route out of their current weakness (industrial  production grew by less than expected in March). It was therefore no surprise that rumours of a devaluation in the Chinese Yuan began to circulate during April.

Financial Markets and Corporate News

Stock markets finally seemed to pause for reflection in April after a strong 6-month rally. As the initial catalyst for the rally was the prospect of consistent rate cuts during 2024, it would make logical sense that the postponement of rate cuts should dampen sentiment.

It was also noticeable that even the largest companies in the world saw huge one day swings in their share price on the back of positive or negative earnings announcements. This suggests that investors are becoming more selective over which companies deserve a high rating.   

Over the last 6 months, the FTSE 100 returned 10.70% (reaching an all time high in April), the S&P 500 returned 18.13%, whilst the Euro Stoxx 50 returned 20.54%.

The Japanese Nikkei 225 returned 20.93% over the same period.

The broad emerging markets index returned 11.06% in US$ terms.

The US 10 year Treasury yield rose significantly during the month and this seemed to drag the UK 10 year Gilt yield higher. Gold reached an all time high before giving up some of the gains.

The Investment Association (IA) UK Gilts sector returned 4.35% over 6 months, whilst the IA Sterling Corporate Bond sector returned 6.82% and the IA Sterling High Yield sector returned 7.45%.

Looking Ahead

Time will tell whether the US economy truly is entering a weaker phase or whether this quarter’s figure was a blip based on temporary factors. However, if it is the case that the economy is weakening at the same time that inflation remains robust, then this would be the worst of both worlds for investors as company earnings would come under pressure whilst the Central Bank struggles to ease policy.  

The critical question is whether a softer economy (and in particular a softer labour market) reduces inflationary pressure. If it does then the Fed will feel more comfortable about reducing rates and the market may turn out to be too pessimistic on the prospects for rate cuts. As alluded to in the chart of the month the US consumer will surely struggle to keep spending at the rate it has.

For the moment we still have a largely two-speed developed world as the UK and Eurozone economies warrant rate cuts sooner than the US. The challenge for the BoE and ECB is that they do not want to move so far ahead of the Fed that their currencies begin to weaken significantly and they effectively import another inflation shock. This is particularly true of the BoE.

On the subject of currency weakness, the fate of the Yen could lead to significant impacts down the road. If the Chinese feel forced to devalue their currency as a result, then this will likely prompt a response from the US in terms of tariffs, almost certainly in the case of a Trump Presidency. This is therefore something to keep an eye on, as China is hugely important for global inflation.     

In equity markets it is noticeable that the ‘magnificent 7’ group of companies, which drove so much of the gain in the S&P 500, is effectively no more. Several members of the group are now in the red since the start of the year whilst several others have performed broadly in line with the market. This speaks to investors becoming more selective and, potentially, the rally ‘broadening out’.  

There remains quite a stark valuation difference between US large cap companies on the one hand and Emerging Markets and the UK on the other. For US companies to justify this higher premium they must keep meeting earnings expectations.