Stock markets continued to rally in the second quarter led by the US market. The S&P 500 rose by 4.21% to reach a historical high of 5,460. Outside the US, UK and Emerging Markets equities also performed well, up 3.6% and 5.0% respectively in the quarter. Europe (ex UK) equity markets were performing well until President Macron called snap parliamentary elections in France following the strong performance of the French Far-Right party in the European Parliament elections. The decision led to a selloff in French and Eurozone equities. Europe ex UK equities ended the quarter flat.
In the UK and Europe, politics have taken centre stage. In the UK, the snap general election called by Prime Minister Rishi Sunak has delayed the first interest rate cut. As UK inflation continues to slow down, there is scope for multiple rate cuts in the coming year which should help boost the economy. The prospect of a decisive win for the Labour party and a more stable political environment in the UK together with an improved economic environment could lead to a re-rating of UK assets following years of downward pressure since the Brexit vote.
As the UK looks like entering a more stable political environment, France and other European countries are facing increased political turmoil with the rise of far-right parties in European Parliament Elections. Emmanuel Macron’s shock decision to call for a snap general election has increased the risk of the French Parliament being dominated by the Far-Right Party or the newly formed leftwing coalition. Both sides have promised significant increases in government spending which would worsen the French fiscal crisis. The outcome of the French parliamentary elections will not be known until the second tour on 7th July, but it is likely that there will be a split Parliament which may lead to prolonged political and economic uncertainty and could increase instability in the European Union.
On the economic front, we expect some positive news flow in the coming months as inflation comes down closer to the 2% target in the US, UK and Europe allowing central banks to lower interest rates. The European Central Bank has gone ahead with a first rate cut and the Bank of England should follow soon after the general election. Lower interest rates should help support an economic recovery in the UK and Europe. In the US, the economy continues to perform well, helped by large fiscal spending and the excess savings accumulated during the pandemic which amounted to $2.1tn in 2021 (7.8% of GDP). The excess savings have now been mostly used up and therefore consumer demand may slow down in the coming year. Any negative impact of slower consumer demand should be offset by lower interest rates in the short term.
Although interest rates are expected to come down in the coming year, it’s not clear at what level they will settle in the longer term. Inflation is expected to remain higher than in the past twenty years due to geopolitical and trade tensions between the US, EU and China (e.g. US and EU tariffs on Chinese electrical vehicles), the additional costs of onshoring and large spending on climate change mitigation. Higher inflation expectations combined with high government deficit and indebtedness are likely to keep interest rates higher than in the last decade with implications for all asset classes.
The US market rally continues to be driven by enthusiasm for Nvidia and other large technology companies expected to benefit from the rapid growth in Artificial Intelligence (AI). Nvidia the designer of Artificial Intelligence semiconductors is up 36.7% in the quarter and has now reached a market valuation of $3tn, around 50 times its 2024 sales. The strong performance of a handful of large technology companies is masking weaker performance from the rest of the US stock market. US value stocks and US smaller companies’ stocks are down 2.1% and 3.2% respectively in the last quarter.
There is increasing concern about the US stock market performance being driven by such a concentrated number of companies. In a recent Bloomberg Markets survey (end of June 2024), 52% of respondents thought that the S&P500 was the most overpriced asset class.
Source: JP Morgan Asset Management – Guide to the Market UK Q2 2024 – 27 June 2024
Some market commentators are comparing the current market performance to the dot-com bubble in 1999/2000. At the time, investors were betting on the rise of the internet and ascribing huge valuations for any company expected to gain from that theme. This led to a sharp rise in the stock market and then decline when the reality failed to meet the heightened expectations. The internet did end up becoming a significant disruptor and allowed the growth of the current mega cap companies such as Meta, Amazon and Alphabet but it took much longer than the market expected.
The risk is that the same situation may be repeating with Artificial Intelligence (AI) as companies take longer than expected to generate sustainable returns from AI applications. Nvidia is currently the main beneficiary as companies race to build AI infrastructure. However, any slowdown in AI spending or emergence of new competitors could lead to a quick reversal in Nvidia’s valuation given the current lofty expectations. Some market analysts have compared Nvidia’s meteoric rise to Cisco Systems in the 1990s. Cisco was then seen as the main beneficiary of investment in telecommunication networks in anticipation of a rapid growth in internet traffic. Between 1995 and 2000, Cisco’s revenue grew by 850% from about $2bn to $19bn and its market value surged to $500bn (26x 2000 sales) making it the most valuable company in the world at the time. The growth in internet applications ended up being slower than expected and after rising from $2 in 1995 to $79 in March 2000, the Cisco share price collapsed by 88% over the next two years down to $9.50 and still hasn’t returned to the highs reached at the time.
In this environment, we favour a diversified exposure to equities with significant allocation to UK small and mid-cap equities which should benefit from lower interest rate and a UK economic recovery, significant allocation to the more attractively valued Europe ex UK, Japanese and Emerging Market equities and a preference for value and income stocks in the US.
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If you have any questions regarding the above, please don’t hesitate to contact PK Wealth via investments@pkgroup.co.uk or +44 (0)20 8334 9953
The information in this document does not constitute advice or a recommendation and is for the information of the recipient only. Past performance is not a reliable indicator of future returns. The value of investments and the income derived from them can go down as well as up and you may not get back the amount invested. PK Wealth Ltd is a limited company registered in England and Wales (number 08991126) and is authorised and regulated by the Financial Conduct Authority.
