Cazenove monthly market update - 6th September

Markets quickly recover from growth scare

Global equities rose an unremarkable 0.1% in August. Few would have expected this benign outcome earlier in the month, when the MSCI All Countries World Index fell 6% in a matter of days and Japanese stocks lost close to 20%. Since then, investors have been reassured by US economic data and the Federal Reserve’s suggestion that the “time has come” to cut US interest rates. Global equities have quickly returned towards all-time highs. While the latest bout of volatility may be over, there has been a change in market dynamic. US stocks other than the “Magnificent 7” have been performing better than the technology giants in recent weeks. This is in sharp contrast to the first half of the year, when the rest of the market struggled to keep pace with the technology sector. The sell-off has also resulted in something of a disconnect between equity and bond markets, with the latter anticipating a much sharper slowdown than the former.

How far will interest rates fall?

Since disappointing hiring figures sparked last month’s sell-off, subsequent data has painted a more positive picture of the US economy. Corporate earnings have also generally met or exceeded expectations, supporting the recovery in equities. However, bond markets are now anticipating that US interest rates will be cut by just over 2% by the end of 2025. Given that inflation remains a significant concern for the Federal Reserve, many economists view this as unlikely unless there is a more meaningful slowdown. Schroders’ economics team, for instance, expect the Fed to cut interest rates far more cautiously, with cumulative cuts of just 1 percent by the end of 2025. Cutting too far or too quickly could risk a second wave of inflation, forcing central banks to raise interest rates and destabilising both equity and bond markets.

US election too close to call

Kamala Harris has revitalised the Democrats’ prospects in November’s US election and polls suggest they have a roughly 50% chance of winning the election. From an economic perspective, a Harris victory may not significantly change the economic outlook, given her support for many of Joe Biden’s policies and the likelihood that she will have to contend with a divided Congress. A Trump victory could prompt a more significant change to the economic outlook. His focus on tax cuts and deregulation could mean growth is slightly higher than under Harris, while the promise of tariffs and anti-immigration policies could also result in higher inflation. Neither candidate has provided much reassurance on US government debt, which is on an unsustainable path. Both will be counting on the continued quiescence of the bond vigilantes.

Positioning

We took advantage of the sell-off in early August to slightly increase our global equity allocation. Our overall equity exposure remains broadly in line with our long-term strategic target. In our view, global growth remains relatively healthy, notwithstanding pockets of weakness in China and Europe, and should be supported by interest rate cuts in the US and Europe. At the same time, equity valuations remain high relative to other asset classes and, in the case of the US, relative to history. We remain overweight bonds, with a slight preference for shorter-dated bonds, given uncertainty around the pace and extent of interest rate cuts. We still like some alternative assets and have benefited from this year’s rally in gold and other commodities. However, the relative appeal of alternatives has fallen as interest rates have risen and we are now slightly underweight the asset class at a portfolio level.

Source: Cazenove Capital