The time has come for policy to adjust

We maintain a constructive outlook on equities but proceed cautiously in the short term: despite recent volatility, election jitters, seasonal challenges, and higher market volatility compared to the first half of 2024, we remain confident in a soft landing for the U.S. economy. The beginning of the monetary easing cyle in the US marks the starting point for a normalisation in the yield curve, after more than two years of inversion. The upcoming yield curve steepening – whether via a bull or a bear steepening – will have major consequences for equity investors too.

Market focus has turned from inflation to growth

The synchronized cooling of global activity is ongoing but the pace of negative surprises appears to have stabilized in all major regions. At the current stage stage, markets price aggressive rate cuts over the next year as both the Fed and ECB are easing policy in September and the deflationary environment continues in China.

This is – again – a significant shift in market pricing as late April, markets were barely anticipating one single cut of 25 basis points in the Federal Reserve funds rate in 2024. In our scenario, we believe that the US economy is far from running out of steam. Private domestic demand continued to grow at an annual rate of over 2.5% in the first half of 2024 and private consumption is likely to progress at a 3% rate during Q3. Job creation weakened in July and August, but let’s keep in mind that these figures are volatile.

We think that the speed of US growth deceleration will signal the amplitude of Fed easing, even more so as European growth continues to disappoint, as is Chinese activity. We continue to expect a slowdown in US economic growth (a “soft landing“), but we believe the likelihood of a recession (a “hard landing“) remains low for now.

Regarding inflation, investors have now virtually come to the conclusion that “inflation is dead“ (which is not). We note that the entire breakeven curve in the United States (up to 20 years) has fallen below 2.15%, a level not seen since the pandemic years.

To sum up, the market focus has turned from inflation to growth and monetary easing will adapt according to risks, in particular as concerns about geopolitics still linger.

An open race in the US

Without the shadow of a doubt, we are witnessing one of the most dramatic and chaotic presidential campaigns in modern US political history. One last-minute replacement in the Democratic campaign, two assassination attempts directed against the Republican candidate, several switches in election polls frontrunner, …

Market odds currently show a slight lead of the Democratic candidate in the race for the White House but a Republican Senate, leading to a divided government. As it stands, a divided government should have the least impactful effect on markets as trade, fiscal and immigration policies of Trump / Harris are likely watered down or cannot pass through Congress.

For what it is worth, we note that the YtD performance of US equity markets as of mid-September (around +15%) are clearly ahead of the average of the 4th year in a presidential cycle (around +6%) observed in the past five decades, implying some downside from here. This would be compatible with average behaviours of US stock markets in election years from end-August to Election day, where the average drawdown amounts to nearly 8%. The good news is that investors enjoy an average year-end rally of nearly 3% once the election is over.

Bull steepening or Bear steepening?

If equity investors were to register a pronounced drawdown, it is likely that the shape of the yield curve contains some informational content. As the US Federal Reserve finally starts its monetary policy easing in September, the yield curve has un-inverted. We expect further yield curve steepening from here.

The upcoming yield curve steepening – whether via a bull or a bear steepening – will have major consequences for equity investors too: a bull steepening (i.e. a sharper decline of short-term interest rates than long-term yields) is more favourable for defensive sectors like Healthcare, Utilities and Staples. A so-called bear steepening (i.e. a sharper rise of long-term yields than short-term interest rates) are more favorable to Tech and cyclical sectors like Basic Materials, Energy and Industrials.

Our current equity positioning is somewhat more defensive

The discussed mix of rising growth and political uncertainties support short-term caution, leading us to an overall Neutral stance on equities. We have reduced the risk in our multi-asset portfolios since mid-July, while maintaining our strategic constructive stance on equities.

Within equities, we have chosen to be more defensive in Europe and prefer holding UK equities relative to the Eurozone. In our sector allocation, we also had tactically reduced our exposure to US mega-cap companies and the technology sector while we have increased our exposure to healthcare, which has defensive qualities.

Of note, we are buyers of European Real Estate, which should benefit from lower interest rates, but keep a neutral stance on Small and Mid-caps.

Our current bond positioning benefits from current downward revision in the growth/inflation mix

With regard to our bond exposure, as outlined in our outlook for the second half of the year, we anticipated that the correlation between equities and bonds should revert to negative again as inflation normalises, enabling safe bonds to resume their protective role within a diversified portfolio.