Thirty-five records for the S&P500 in 2024 suggest just how great the first half of the year has gone.
However, hidden beneath the surface is a far less rosy situation.
The recent French elections, and the American elections in November, are highly relevant. French votes are divided between the extreme right and the extreme left. No less extreme is Trump, who after Biden’s disastrous first debate, and unless he resigns, has a good chance of becoming the first convicted president in history.
Financial markets could begin by celebrating in both cases. Neither Melenchon nor Le Pen will be able to implement their political programmes in France, and there can be no repeat elections within a year. Meanwhile, Trump promises more fiscal stimulus and tax cuts, which should help accelerate growth and corporate profits.
The problem is that the second derivative is bleaker, and highlights one of our main risks as investors: public finances sustainability. Large fiscal deficits in too many countries can only increase under populist governments, and will eventually cause turbulence.
It also complicates the work of central banks, which will find it increasingly difficult to control inflation. Multiple interest rate cuts in 2024 were taken for granted but will probably come to nothing. However, it remains to be seen because at the macro level, cracks are beginning to appear. For example, American consumers seem to be split in two. The most affluent continue to spend freely, but the less affluent part of the population has started to go out less to restaurants or to turn to white labels as a source of relief. Accumulated inflation over the last few years is beginning to take its toll.
On balance, the second half of the year is likely to be more difficult than the first. In fact, so much optimism is somewhat misleading. Stock market indices have been led by a few stocks, usually related to artificial intelligence. In fixed income, credit spread compression has already gone too far. Aggressive interest rate cuts would help in longer duration portfolios, but this probably implies that the economy is going awry, something we should not be celebrating.
Volatility, however, would be welcome. The patient investor sees it as nothing more than an opportunity to invest at better prices. In reality, the windows of opportunity are already more plentiful than they appear. As we mentioned before, we need to pick and choose among the names that have not been fortunate enough to fall under the label of artificial intelligence. We must not forget that the enemy to beat is inflation, that the battle is fought over the long term, and that we should act accordingly.
Date of report: July 10th 2024