We hope you’re all extremely well and are enjoying the anticipated onset of summer anticipation? We are certain it will begin soon?? Regardless of temperature, it’s always an exciting time of year for this author as the sporting calendar really kicks into gear with Wimbledon, The Open golf, The European Championship Football tournament and, of course, the Olympics, all just round the corner. Of course, it’s not just sport that will keep us entertained over the summer, there’s plenty to chew over on the political front. This is not just domestically either, with the news flow on the other side of the Atlantic proving worthy of a Netflix drama.

Quickly recapping on markets and we note, following a difficult April, stock markets enjoyed a recovery in May, delivering firmly positive performance across most developed markets, though Japan and Emerging Market indices struggled. After a blistering first quarter in stock markets, we observe volatility has increased of late, as impressive growth threatened a return of inflation, delaying expectations for interest rate cuts. Never-the-less, year to date performance remains in eye-catching territory.

But could political development play an increasing role in fuelling volatility moving forward? Actually, we think not. From a global perspective, news of Donald Trump’s ‘guilt’ in his ‘hush money’ trial, has and will garner the most attention. Yet, despite the gravity of the headlines, markets remained unfazed, recognising (perhaps remarkably) events aren’t impeding Trump’s ability to run for President nor damaging his chances of winning!

In a similar vein, the surprising and dramatic announcement of a domestic, summertime General Election is also having little impact on markets. Whilst a deeply personal event for many of us, investors are alert to the size of polling leads which, despite historic inaccuracies, are pointing decisively toward a change in government. With only the size of a majority being (keenly) debated, investors are taking comfort from a Labour campaign that offers a steady hand on the economy; reaffirming both their ‘business friendly’ credentials and their respect for public finances.

Of course, it seems clear any new Labour government would harbour fairly radical ambitions, wishing to employ far greater state involvement and spending, however, there is constant reassurance of caution in the way such policies may progress; keeping market practitioners in a benign mood.

Pivoting to stock market fundamentals then, and after a succession of US CPI upside surprises, markets enjoyed considerable relief from a (very) marginal downside miss; arresting concerns of a return to interest rate hikes – at least temporarily. Indeed, an interest rate hike does not form part of our base case, with pandemic savings now likely dwindling, and leading US jobs market data, such as a weakening hiring rates and falling quits rates, pointing to a further slowing in wage gains. Absent accelerating wage inflation, it is less probable for an inflationary spiral to take hold and for interest rate hikes to be required.

It is hard to take such a benign view in the UK given stickier wage inflation, however, a generally weaker economic growth environment creates a high bar for a resumption of interest rate hikes. The core view, therefore, is the disinflationary trends in the US can persist and, in so doing, reinstate a (modestly) dovish path for policy, and encourage investors to offer further support to capital markets.

The combination of lower inflation, more accommodative policy and resilient growth has been described as a ‘Goldilocks’ scenario. This analogy refers to an economy which is neither too hot (where inflation and monetary policy are on the rise – setting the economy up for a fall) or too cold (in recession). A ‘Goldilocks’ outcome has often been a favourable backdrop for equities as it points to more durable economic strength. This relationship may not unfold this time; however, it is a driving force behind a positive equity bias.

Markets also enjoyed tailwinds from some sensational earnings performance in May, particularly from companies operating within the dominant, loosely defined ‘AI theme’. This performance, once again, highlights the market’s inability to appreciate how quickly such innovative companies can grow their revenues, showcasing the dangers of relying too heavily upon shorter-term valuation metrics.

Life is not all about the US, however. Given the geopolitical troubles which prevail, the relative hedge UK markets provide against a surging oil price provides helpful portfolio diversification. UK equity market valuation remains highly compelling versus global competitors, which is further bolstered by the strength of collective balance sheets, high level of dividend yield and, increasingly, higher volume of company buybacks. Prospects for better economic performance (versus some very downbeat expectations) look enticing too, as real incomes creep higher as resilient wages overcome persistent but fading inflationary prints.

Emerging Market equities struggled in May. As discussed in prior months, sentiment toward the asset class will likely prove choppy, as levels of Chinese stimulus falls shy of what markets are hoping for, particularly given the scale of its housing market travails. Given how downbeat sentiment is toward the region, however, it may only take an amelioration in the economic backdrop to reignite investor interest. We should also note the success of the Emerging Market asset class does not exclusively rest upon the fortunes for Chinese stocks, with nations such as India and Mexico playing an increasingly important role.

Reflecting upon bond markets and, as we have articulated, a resumption of disinflationary trends, catalysed by weakening (though not collapsing) labour markets, should offer a return to form for the asset class. Indeed, investors should be mindful the disinflationary forces may yet gather pace as the ‘long and variable lags’ of interest rate policy further impact the economy. Whilst certain mortgage deals may allow segments of the economy to avoid the full force of interest rate hikes, not every consumer will be in such a fortuitous position. What is more, many channels of financing, such as credit cards, overdrafts and corporate lending will be much more sensitive to interest rate changes and will continue to bite into the economy as we move through the year. Investors should brace themselves for a more volatile period ahead, therefore, as markets fret between extremes of soft-landing euphoria, inflation resurgence and recession.

Kind regards,

iPensions Wealth Team

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