Short-Term Uncertainties, Constructive Long-Term Outlook

The US earnings season kicks off in a few days' time, with expectations that earnings releases and forecasts will be as strong as those published in the previous quarter. The markets are expecting strong corporate earnings growth of 13% year-on-year. This will be a welcome break, allowing investors to separate themselves somewhat from economic releases, the impacts of inflation and the long-awaited rate cuts.

The real uncertainty in this second half of the year is political. France does not yet have any government prospects (coalition in the centre, government of experts, etc.) at the time of writing, but the trend is clear: the economic programmes presented by the various parties do not suggest any possibility of reducing the current deficits, and augur a high level of uncertainty, a source of volatility for both interest rates and equity markets. After soaring to over 85bps, the spread between French and German government bonds has narrowed to 65bps, although this does not rule out the threat of a second downgrade of France's credit rating by the rating agencies. As for the CAC 40, it is still 4% below its level since the announcement of the dissolution of the National Assembly on 9 June, even though the proportion of revenue generated in France by its members is less than 15%.

Given the low valuation of some French and European equities, it is not impossible that the European market will do well in the second half of the year.

Across the Atlantic, market performance remained heavily concentrated in the technology and communications sectors. Only 5 of the 11 sectors in the S&P500 delivered a positive performance during the second quarter. The volatility of the US market, which is close to historic lows despite political, geopolitical, economic and monetary uncertainties, is bound to increase significantly. The first debate between the two potential presidential candidates has also ushered in a period of doubt for the United States.? Nonetheless, US equities still have excellent potential, particularly in certain sectors that were neglected during the second quarter, such as energy, materials, industrials and consumer staples. The latest economic publications, which point to a slowdown in growth in the United States, open the door to the Fed's famous "pivot" and increase the likelihood of a first 25bps rate cut as early as September.

Emerging markets, meanwhile, could benefit from these US and European uncertainties thanks to their reasonable valuations.

Despite the geopolitical tensions, the volume of world trade has returned to pre-covid levels. However, it is interesting to note that the flow of Chinese exports, which used to be directed mainly towards Europe and the United States, seems to have shifted somewhat towards other geographical areas such as Asia and Africa. This is a good illustration of what is now known as 'friend shoring'. The prospect of rate cuts in the United States is also a catalyst for positive stock market performance in emerging markets.

At the same time, the de-globalisation and reshoring movement initiated under Trump and then accelerated during the pandemic will continue to transform government policies, which for a long time were geared towards supporting demand through massive consumer support. The rise of protectionism, the hardening of economic relations and the emergence of two very distinct blocs threatening American or Western hegemony are likely to favour policies that are more focused on supply and support for production in many strategic areas.

In the medium term, investment flows are likely to be redirected towards the defence, cybersecurity and semiconductor sectors, as well as towards sectors that help to secure energy supplies, foodstuffs and medicines. These sectors are also more resilient in the face of structurally higher inflation, which is likely to be fuelled by the cost of the energy transition, the relocation of industries, and rising labour costs.

Markets have the ability to extract value from periods of uncertainty, which often also turn out to be sources of opportunity. The technology sector, although currently very expensive, remains the spearhead of an American economy that has left the field open to China in industries with lower technological value, such as car production. However, many other sectors will benefit from the changes in the global economic and geopolitical landscape. Selectivity will therefore remain the watchword in the months ahead on equity markets that still have good growth potential.

Nicolas Bickel | Group Head of Investment Private Banking