Politics have been the focus of investor attention over the last week at the expense of economic data. The latest big development was the recent US presidential debate, which was widely viewed as having gone poorly for President Joe Biden. There is currently widespread speculation about whether he will now withdraw from the race. Any market reaction has been difficult to perceive, however, as the election itself is still many months away.
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Elsewhere, the results of the first round of the French parliamentary election were largely in line with forecasts. That alone was a relief for the markets after numerous surprises recently, beginning with the outcome of the EU elections in early June. The day after the first round saw French equities rally and government bond spreads decline modestly relative to German Bunds (see Exhibit 1).
Whether this relative calm continues is questionable, in our view. The high number of constituencies where three candidates are still in the running means it will be difficult to predict the outcome of the second round this Sunday.
So, what about the economic news?
Away from politics, recent data has been mixed. After surprisingly weak US core consumer price index (CPI) inflation (2% month-on-month annualised in May), the core personal consumption expenditures (PCE) index confirmed the trend by rising by just 1% in the same month.
This follows the rather higher levels seen in the first part of this year. Whether inflation continues at this rate will be crucial to the performance of US growth stocks, in our view.
One key reason for the good returns of the US NASDAQ index to date is the view that the US Federal Reserve could cut policy rates sooner as inflation appears to be declining. If inflation rebounds in June, these equity market gains could be partly at risk.
It is not just politics that have been weighing on eurozone equities. June’s purchasing manager data released so far showed a slower rate of expansion for the services sector (and an outright contraction in France), while most of the eurozone countries are also seeing a contraction in the manufacturing sector.
Confirming the soft data, retail sales growth was negative month-on-month in both France and Spain. This is surprising insofar as consumers would be expected to be more confident and willing to spend with the unemployment rate at historical lows and robust real wage growth.
Perhaps it is because the wage gains have partly come from one-off bonuses, as opposed to permanent wage increases, that consumers have been saving at least part of the extra money.
PMI data for China showed the economy growing at a rather lacklustre pace and the property sector still acting as a drag. The figures came in below expectations and the manufacturing sector (at least as measured by the official PMI series) is still contracting.
The upcoming Third Plenum will likely see further stimulus announced by the government, which we believe is necessary if the economy is to grow at the 5% rate the government has targeted.
Equities are beginning to diverge
A characteristic of markets in the first part of the year was that equities tended to move up or down in tandem, if not always to the same degree. More recently, however, performance has started to diverge (see Exhibit 2).
As noted, the US NASDAQ index has been boosted by low inflation and rising market expectations of US policy rate cuts. Japanese equities have benefited from further weakness in the yen. Emerging market equities (excluding China) have also been on the up, though this has been driven primarily by the performance of Taiwanese and Indian markets.
The laggards have been Europe and US small-cap equities. Investors in the US Russell 2000 index may be hoping that any tariffs following a Trump election victory will boost the market as they did during the first Trump administration.
