PERSPECTIVES
MARKET AND ALLOCATION
Our experts monthly overview
OUR CENTRAL SCENARIO
Deputy Chief Executive Officer,
Chief Investment Officer
OFI INVEST ASSET MANAGEMENT
The voters have spoken. Donald Trump will be the 47th president of the United States. What’s more, the Republicans have retaken the Senate and will very likely keep control of the House of Representatives, which would give them a clear path for rolling out their programme. The markets’ shortterm reactions are what we had expressed in our pre-election outlook: a rally by US equities, higher bond yields, and gains by the US dollar, and just the opposite for European assets.
But, most importantly, the cloud of uncertainty surrounding the election is no longer hanging over us, particularly now that the risk of a prolonged period without a clear winner has de facto been lifted. This might have included, as in 2021, legal recourse or even civil unrest, as occurred with the Capitol riot in 2021. The relaxation of tensions showed up in the VIX volatility index, which fell by 25% when the election results were announced.
Now that they have some visibility, the markets are likely to ponder the financial impact of Trump’s flagship measures, including the introduction of draconian customs tariffs, corporate tax cuts, the deregulation of certain sectors (banking and energy in particular), and immigration laws.
Against this backdrop, and pending the actual inauguration, on 20 January 2025, US markets are likely, in the short term, to price in a more inflationary and more pro-growth environment. While the US Federal Reserve’s expected 2024 rate cut trajectory is unlikely to be affected, the Fed is likely to raise its 2025 target rate, meaning higher US long yields and a steepening in the yield curve.
Our scenario suggests that the US equity markets are likely to outperform in an environment that is more pro-business and offers clearer greater visibility, including in the tech sector, with Elon Musk likely to be part of Trump’s future team. With this in mind, we are raising our weighting of US equities.
European rates are likely to head in the opposite direction, with weaker economic activity steering the European Central Bank towards more shortterm rate cuts and, hence, a lower 10-year German yield. On that basis, we are moving to a long position on European bonds, with the corporate bond segment in particular benefiting. Euro zone equities, in contrast could take a hit but will no doubt be protected by their low valuations and, in some cases, their US-based business activity.
However, this short-term trend will soon be challenged as campaign promises are implemented and by the chronological order in which that happens, as well as the medium-term impact of protectionist or immigration measures. Likely foreign policy shifts and fiscal deficit issues will also be new sources of volatility.
OUR VIEWS AS OF 08/11/24
The ECB’s and Fed’s rate-cutting cycles are underway, but their monetary policies are likely to diverge, driven, on the one hand, by Donald Trump’s victory in the US and, on the other hand, by greater risks to growth in Europe. With the rise in bond yields in October, bond markets’ performances are now in the red, with the exception of high yield, which continues to ride a compression of spreads. Bond yields looked a little low to us last month, but they now look more attractive, particularly in the euro zone. We are therefore moving to a positive stance on duration to track this upward movement. Meanwhile, we are lowering our cursors on breakeven inflation, which rose considerably on the month; emerging debt in local currencies, which could be hit by a strong dollar; as well as the money market. We are sticking to a neutral stance on investment grade and high yield corporate bonds, which we still like for their carry opportunities.
Clearly, the election of Donald Trump and, even more importantly, the Republicans’ control of the House of Representatives, will have various impacts on the equity markets. If they implement their programme as is, no doubt that domestic US companies will benefit from the announced rise in protectionism. Chinese companies will be impacted, but they could also benefit from the stimulus plan that could be expanded after the change in US administrations. However, Europe, which looks disunited and more vulnerable and could be left “holding the bag”. For these reasons, and although relative valuations are more attractive in Europe, we prefer the US market, which, at least in the short term, should benefit from the “Make America Great Again” effect, pending clearer visibility on the consequences.
The election of Donald Trump and a Congress that will very likely be Republican at first triggered an appreciation of the dollar, owing to the planned protectionist and fiscal policies. The EUR/USD fell as low as 1.07 dollar on the day after elections. The risks continued to be downward, due to the intensity of the Fed’s monetary easing. Hence, our slight overweighting of the dollar vs. the euro.
MACROECONOMIC VIEW
TRUMP 2.0 AND THE (LIKELY) RED WAVE
Head of Macroeconomic Research
and Strategy
OFI INVEST ASSET MANAGEMENT
The markets’ initial reactions are as expected: a victory by Donald Trump was expected to boost US equities more than bonds, due mainly to his plans for tax cuts and a protectionist policy. Will these reactions last? The answer to this still depends on how much, and how fast, Trump’s programmes are implemented, and there is little certainty at this point. For, in the longer term, a full-on Trump scenario could end up less favourable to equities and more favourable to bonds, owing to growth obstacles, protectionism and less immigration(1).
TIMING AND SEQUENCE OF THE MESURES WILL BE DECISIVE IN THEIR IMPACT ON US GROWTH
Third-quarter US growth was robust, at 2.8% annualised, with a strong contribution by consumption, which is showing no sign of slowing down for the moment. Normally, the resorption of excessive demand on the labour market - there is now, on aggregate, just one job offer per unemployed person - should cause US households to lower their pace of consumption. That was our basic assumption in forecasting a softlanding of the US economy in 2025.
What about Trump’s policies? The standard fiscal multipliers for tax cuts are low, particularly when growth is near potential, and they tend to fade after one year(2).
If Congress’s priority is passing the tax cuts, the upward boost to growth from fiscal easing could, at first, offset the negative impact of higher customs tariffs and a tougher immigration policy. In a second stage, the latter two could take precedence. If so, growth could remain close to its potential in 2025 and 2026.
LITTLE OR NO IMPACT ON FED MONETARY POLICY IN THE SHORT TERM…
Regarding inflation, the various price indices provided in national accounts (the GDP deflator and the personal consumption expenditure deflator) suggest that third-quarter inflation was already below 2%. Between now and yearend, base effects are unfavorable, but disinflation is so far still on track. So the main risk is customs tariffs, which in the best case, are unlikely to be applied until the second quarter 2025. That means that the initial effects on inflation will not show up until the second half of the year. That’s why we expect the Fed to continue to gradually lower its key rates until at least early 2025.
…NOR ON THE ECB’S MONETARY EASING
Euro zone growth was higher than expected in the third quarter (0.4% non-annualised), at 0.8% in Spain, 0,4% in France, 0.2% in Germany, and 0% in Italy. However, we mustn’t read too much into these figures. When adjusted for the impact of the Olympic Games in France and the highly volatile Irish figures, the pace of growth in the euro zone was no doubt closer to 0.2% or 0.3% and is being driven by household consumption. Household consumption remains a key item for the moderate recovery to continue in 2025, until investment can take over.
Total inflation rose in October to 2.0% (from 1.7% in September). Base effects are now weaker in energy; disinflation is over in goods; and inflation in services remains high. This poses no risk to hitting the 2% target next year. However, increased inflation late this year, continued aggressive wage negotiations, particularly in Germany, and economic activity that is not as bad as expected in some quarters suggest that the balance of power will be more even between the ECB’s hawks and its more dovish members. At this point, we forecast rate cuts of 25 basis points at the next few meetings.
INTEREST RATES
THE PRE-TRUMP WORLD
Co-CIO, Mutual Funds
OFI INVEST ASSET MANAGEMENT
October was highlighted by the US presidential election and the markets’ gradually pricing of a Trump victory into bond prices. Trump indeed campaigned on a platform deemed especially inflationary and pro-US growth (at least for the short term). This sent US 10-year Treasury bonds from 3.73% in early October to 4.28% at the end of the month. On the day after the elections and Trump’s victory, the yield was back to its highs of early July, exceeding 4.40%. The Republicans’ victory did not cast doubt on the 25 basis point cut flagged for November by the US Federal Reserve. However, the trajectory of future rate cuts was revised, with the terminal rate now pegged at about 3.75% in mid-2025, up from the 3.00% forecast about one month ago. With September inflation confirmed at 2.4% and core inflation at 3.3%, Jerome Powell will probably have to incorporate into his inflation and growth forecasts the potential impacts of higher customs tariffs and a corporate tax cut.
TENSIONS ON LONG BOND YIELDS
In the euro zone, the ECB lowered its deposit rate, as expected, from 3.50% to 3.25% in October.
The market is still pricing in a rate cut in December and gradual cuts thereafter, despite the slight uptick of inflation in October to 2.00%. Unlike in the US, the economic context in Europe is darkening and does not justify any fundamental revision of the ECB’s rate cut trajectory. On the month, the Bund yield rose from a low of 2.03% to a high of 2.38% and continued in early November to above 2.40%, thus tracking the Fed. We spoke of a “bull steepening” last month to describe the curve in the wake of falling short-term rates. We are now on a bear steepening driven by an increase in long-term rates. We believe this trend could continue and are accordingly gradually raising duration in portfolios, particularly in Europe, where we see little justification for rates that are far higher.
In recent weeks, Moody’s and Fitch have kept France’s rating at Aa2 and AA-, respectively, but while downgrading its outlook from stable to negative, due to the worsening in public accounts.
CORPORATE BONDS STILL SOLID
Against this backdrop, investors have drastically dialed back their exposure to government bonds while raising their exposure to corporate bonds, which offer additional yield. The high yield credit market once again performed well, at 0.51% on the month, vs. -0.75% in investment grade, which was hit by rate trends. Without the rate impact, the credit market was solid in October, with credit spreads stable in investment grade and narrowing once again in high yield. This, in spite of a busy primary market in high yield. We had moved to a more neutral stance last month in the asset class, deeming credit spreads very narrow and below their historical average. Even so, we remain constructive for the medium term, as yields remain high in both investment grade and high yield, especially with the central banks’ inflation outlook near 2%. With the ECB’s ongoing rate-cut cycle, we are also slightly lowering our views and exposure for the money market, which nonetheless remains worthwhile, particularly as a place to park cash pending later increased weightings of markets deemed riskier, such as the equity markets.
This is where the MOVE (ICE BofA Move Index), a measure of volatility, stood on interest rates, up by 40 basis points on the month.
| BOND INDICES WITH COUPONS REINVESTED | OCTOBER 2024 | YTD |
|---|---|---|
| JPM Emu | - 0.94% | 0.98% |
| Bloomberg Barclays Euro Aggregate Corp | - 0.31% | 3.51% |
| Bloomberg Barclays Pan European High Yield in euro | 0.51% | 7.54% |
EQUITIES
NOTHING SCARY HERE!
Co-CIO, Mutual Funds
OFI INVEST ASSET MANAGEMENT
The equity markets have just proven once again, if there was any need to, that they don’t care about politics and geopolitics. The only thing they do care about is companies’ earnings, their valuations relative to interest rates, and the lack of uncertainty.
With this in mind, Donald Trump’s victory and, on top of that, the victory of the Republican party – which will now control the presidency, the House of Representatives and the Senate – will spare the equity markets prolonged quarrelling of all types and a standstill in the economy. This was expressed in the rally by both US and European markets as soon as the official outcome was announced. Of course, it is still too early to say what the new administration’s impact will be – not until we know whether its deeds will rhyme with its campaign words and promises. If so, this would mean a sharp rise in customs tariffs that would hurt major European and Asian exporters and would help domestically focused US companies.
But in this case, why did European luxury stocks soar with the election results? No doubt because the old adage “buy on the cannons, sell on the trumpets” once again proved to be true.
LESS UNCERTAINTY IS GOOD FOR EQUITIES
In Asia, the reactions were, at first, more mixed. In Japan, although its monetary policy is unlikely to change, the yen’s weakness vs. the dollar (like other currencies) is thought to be good news for its exporting companies, beyond the likely increase in US protectionism.
Chinese markets’ reactions were more mixed. China is clearly in the line of fire of the new Trump administration’s planned customs tariffs. These will come on top of an already very challenging economic situation, marked by a notable slowdown in investment spending and consumption. A Chinese stimulus plan is expected to be announced in the coming days. Depending on its extent, the Chinese market may continue to rally and could also pull the European markets in its wake, as these are still just as dependent on China’s political decisions.
A NEW DYNAMIC AFTER THE US ELECTIONS?
Although the US elections were the big event of this autumn, let’s not overlook the many corporate earnings reports released in recent weeks. US reporting season was, on the whole, quite good, but we would have preferred to see a few more positive top-line surprises. US economic agents appear to have taken a wait-and-see attitude during this pre-election period. Households are still disinclined to pull the trigger on heavy spending with interest rates still so high, and companies also seem to have been cautious faced with extremely high political uncertainty.
Now that the Republican red wave has pummeled everything in its path, it is not unlikely that we will see a rebound in economic activity in the short term, as the election results have removed some uncertainties, at least on the political front.
We are therefore tactically raising our stance on US equities by a notch in the run-up to yearend. US corporate earnings growth is projected at +10% in 2024, and at almost 15% next year. The future announcements of the administration that will take office in January will tell us whether this objective will be harder or easier to achieve and will provide an initial indication of the market trends for 2025.
This is how much Tesla* soared in one trading session, as the market cheered Elon Musk’s support for Donald Trump and the potential benefits flowing from that…
| EQUITY INDICES WITH NET DIVIDENDS REINVESTED, IN LOCAL CURRENCIES | OCTOBER 2024 | YTD |
|---|---|---|
| CAC 40 | - 3,71% | - 0,37% |
| EuroStoxx | - 3,21% | 7,78% |
| S&P 500 in dollars | - 0,93% | 20,56% |
| MSCI AC World in dollars | - 2,24% | 16,00% |
EMERGING MARKETS
CHINA - REBUILDING CONFIDENCE
Chief Executive Officer
SYNCICAP ASSET MANAGEMENT
The Chinese government at last appears to have recognized the extent of the economic slowdown, one that could get worse if Donald Trump is elected. Restoring confidence now looks like the priority.
The Chinese equity market truly became uncoupled from other markets in 2021 after a series of regulations were passed under the “Common Prosperity” plan. The plan had a praiseworthy goal: to correct certain social imbalances, which are weighing on the birthrate in particular. The number of marriages declined from about 13 million in 2013 to 7.6 million last year, and the number of births from 17 million to about 10 million. The population could shrink by 100 million within 20 years, to 1.3 billion, of which 450 million people would be older than 60. The government therefore wanted to slow real-estate speculation to make housing more affordable for young people and families. The government also stepped in to lower education costs by targeting online tutoring companies, and it began to regulate online gaming platforms, among other things. Meanwhile, its language became more security-focused in an already tense geographical environment.
A LOOK BACK AT ON THE NEGATIVE IMPACTS OF THE COMMON PROSPERITY PLAN
These decisions had very negative consequences, including a drop of about 35% of real-estate prices, a collapse in new construction sites, a decline in business morale and consumption, and an increase in an already very high savings rate. Widespread discontent became perceptible and a concern for the authorities. The Chinese equities markets dropped by almost 45% after March 2021.
In reaction, the government reversed course last September. It has already acted on the supply side by lowering interest rates, by reducing mandatory bank reserves, and by easing real-estate regulations. Technical measures were also put through to support the equities market, such as relaxing rules on share buybacks and giving some thought to setting up an equity market support fund. These actions have already triggered a rally of about 30% by Chinese equities from the year’s lows. But the most eagerly awaited measures are in domestic demand.
STIMULATING DOMESTIC DEMAND
The prospect of a new “trade war” with the US may accelerate the transition towards a more domestically-focused economy. Consumption currently accounts for just 40% of China’s GDP, vs. almost 68% in the US. The meeting of the Standing Committee of the National People’s Congress was exceptionally postponed from 4 November to 8 November, no doubt to await the results of the US elections. An ambitious plan is needed, which could mean an increase in the fiscal deficit from about 3% this year to 5% or even 7% next year. The main goal is to recapitalise local governments and the banks, so they can finance the acquisition of unsold properties. Consumption-stimulus plans via coupons are also under review and planned for certain categories of persons – the poorest and those who have several children.
Chinese equities continue to track political trends closely and therefore justify a high risk premium. But we have the feeling that the government’s priority is clear for the coming months. Valuations look relatively low at 2024 P/E of 12 for the MSCI China, with earnings growth forecast at almost 15% in 2025.
This is the October increase in residential real-estate sales vs. September. An initial positive effect of the government announcements?
THE SERVICES ACTIVITY INDICATOR IN CHINA IMPROVED CONSIDERABLY IN OCTOBER.
Morale appears to have improved with the stimulus measures announced by the government. This is encouraging, even though this rebound does not yet signal a trend.
Document completed on 08/11/2024
Carry: a strategy that consists in holding bonds in a portfolio, possibly even till maturity, in order to tap into their yields.
Duration: weighted average life of a bond or bond portfolio expressed in years.
Inflation: loss of purchasing power of money which results in a general and lasting increase in prices.
Inflation breakeven rate: the difference between the yield on a traditional bond (nominal yield) and the yield on its inflation-indexed equivalent (real yield).
Investment Grade/ High Yield credit: Investment Grade bonds refer to bonds issued by borrowers that have been rated highest by the rating agencies. Their ratings vary from AAA to BBB- under the rating systems applied by Standard & Poor’s and Fitch. Speculative High Yield bonds have lower credit ratings (from BB+ to D, according to Standard & Poor’s and Fitch) than Investment Grade bonds as their issuers are in poorer financial health based on research from the rating agencies. They are therefore regarded as riskier by the rating agencies and, accordingly, offer higher yields.
PER: Price to Earnings Ratio. A stock market analysis indicator: market capitalisation divided by net income.
Spread: difference between rates.
Volatility: corresponds to the calculation of the amplitudes of variations in the price of a financial asset. The higher the volatility, the riskier the investment will be considered.
VIX: American volatility index, calculated by averaging the volatilities on call options and put options, on the S&P 500 index.
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