The Global Political Pendulum

Steadily slowing inflation data has revived expectations for rate cuts this year.

The Global Political Pendulum: Summary

Recent tragic events provided a terrible wake up call to focus the nation on politics: though equity markets largely shrugged off the Trump assassination attempt, it was a stark reminder that political risk is real.
Jerome Powell confirmed that we have seen improvement in the inflation towards the Fed target: in addition, the labor markets have weakened enough that the likelihood of an interest rate cut is now higher.
Bad news is good news for equities as long as it is not too bad: expectations for more rate cuts this year in addition to steady earnings growth all year add up to a rosier equity outlook for now.

Market Performance as of June 28, 2024 | Source: Bloomberg

Market Review: Fed Clouds Clearing

The economy continued to show signs of slowing as falling real incomes are driving lower consumption and slowing bank lending is driving lower business investment. As the soft-landing narrative set in, fed funds futures markets began to price in two cuts this year in November and December for a total of 50 bps to a target range of 4.75% to 5.00%1. That sparked and sustained a rally throughout the month in U.S. large cap growth equity to the detriment of all other segments of equity. U.S. Large Cap Growth equity returned 6.98%1 on a total return basis for the month compared to -0.65%1 for U.S. Large Cap Value over the same period. In addition, U.S. Large Cap equity outperformed mid cap and small cap at 3.59%1 versus -1.58%1 and -2.28%1, respectively. All in all, the markets rewarded risk in all forms: beta, valuation and volatility.

International equities lagged U.S. equities in dollar terms as the dollar strengthened throughout the month on the back of a rate cut by the European Central Bank in early June. The MSCI EAFE Index returned -1.59%1 while MSCI Europe returned -2.16%1 and MSCI Japan returned -0.67%1 all in U.S. dollar terms. In local currency terms, Japan fared better than Europe. That said, in keeping with the beta theme, Emerging Markets equities outperformed U.S. equities, even as Chinese equities dragged performance down. The MSCI Emerging Markets Equity index returned 3.96%1 despite the MSCI China Index returning -1.90%1.

The U.S. yield curve shifted down as expectations for a rate cut continued to build. While that heralded positive performance across the yield curve and across the capital stack, the inherent inverted shape of the yield curve remained intact, still largely calling for a slowdown. Unlike the equity market, bond markets rewarded quality with Treasuries and Mortgages outperforming Credit and High Yield bonds.

Real asset performance was mixed for the month. Broad real estate was mildly positive for the month with industrial and Retail real estate significantly outperforming a recovering office sector and a lagging hotel sector. Commodities performed poorly as the slowdown in China manifested a drag in industrial metals pricing. Oil rebounded for the month but was the only bright spot in the commodities space.

Going Forward: The Global Political Pendulum

The start of July has been packed with political shocks and surprises starting with the first announcement of the French election results on June 30 when the far-right party National Rally shocked Europe by winning the first round of legislative elections, the first time since the far right has held as much political sway in France since World War II. July 4 brough the next major shock when Labour Party candidate Kier Starmer won the British election for Prime Minister, breaking fourteen years of Conservative Tory leadership. Then, in what can only be described as whiplash, the second round of the French elections saw the left wing New Popular Front win the majority of seats in the French Parliament, settling France’s political power just left of center. Meanwhile, after years of increasing political violence which included the shooting of U.S. Congressman in 2017, a kidnapping plot against a state Governor in 2020, the attack on the U.S. Capitol in 2021 and the assault on the husband of a U.S. Congress woman in 2022, the U.S. experienced an assassination attempt on former President and presumptive Republican nominee, Donald Trump on July 13, 2024. Then, Donald Trump announced J.D. Vance as his running mate and to cap off a month of non-stop news, Joe Biden withdrew his bid for presidency, throwing his support behind Kamala Harris. What is abundantly clear in all of these headlines is that public trust is low, the desire for change is high and nothing about elections can or should be assumed.

Equity Markets

U.S. equity markets took the political noise in stride with hardly a blip in performance on the Monday following the Trump assassination attempt. With an upbeat earnings season kicking off and a goldilocks style soft landing in the making, the equity market continued to march higher despite continued evidence of an economic slowdown. We believe this is likely because alongside the economic slowdown, inflation has also finally shown significant signs of progressing toward the Fed’s desired 2% target, raising optimism for as many as three rate cuts this year now expected to start as early as the September meeting. Any concerns about moderate earnings growth are being offset by hopes for valuation support. However, make no mistake, rate cuts would support current valuations, underscoring the fact that rate cuts are essentially priced into equities. Looking at long term averages as a guide, equities could be at least 20% overvalued and vulnerable to any shift in risk appetite.

Bond Markets

U.S. 10-year treasury yields have fallen all month as the yield curve has pivoted around the ten year with the longer end rising modestly. Overall, the inversion of the yield curve continues to suggest an economic slowdown that doesn’t seem to want to reveal itself. While the dynamics of the inversion are unsustainable, the phenomenon continues to wreak havoc on bank earnings, which are expected to slow through year end. Credit risk has fared well with high yield outperforming this year. Treasury risk does seem to contemplate the heavy debt burden while corporate and high yield spreads do not contemplate anything other than a goldilocks style slowdown with monetary support by the fall. That said, the balance of risk still favors bonds over equity at the margin with equity risk facing a much steeper fall should valuations collapse. Absent a collapse, momentum favors equities.

Commodities

Meanwhile, oil prices have been the primary loser in the economic slowdown, particularly as China slows faster than anticipated. In addition, the sudden death of hardliner Iranian President, Ebrahim Riasi, on May 21 paved the way for Masoud Pezeshkian to become President of Iran on July 6, considered less of a hardliner and more focused on reviving the Joint Comprehensive Plan of Action, or the JCPOA. This could provide more downward pressure on oil if Biden remains in office and this gains any traction in Washington. That said, if Trump were to be elected President, the chances of reviving the JCPOA and lifting sanctions against Iran are minimal. Finally, the Biden administration is making progress towards a ceasefire in Gaza. Though there are still significant gaps, the trend is positive. This all paves the way for a slump in commodities that could last through year end.

Net View

While equities continue to pose the greatest downside risk, they also continue to perform with healthy momentum. The lack of volatility continues to make hedging effective in keeping exposure while protecting downside risks. We remain tilted to US stocks over international stocks. We continue to keep exposure to credit to offset equity risk and collect healthy yields.

Past performance is not an indication of future performance. The information provided in this newsletter is for informational purposes only and should not be considered investment advice or a recommendation to buy or sell any types of securities. There is a risk of loss from investments in securities, including the risk of loss of principal. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be profitable or suitable for a particular investor's financial situation or risk tolerance. Asset allocation and portfolio diversification cannot assure or guarantee better performance and cannot eliminate the risk of investment losses.

The information contained herein reflects Lido’s views as of the date of this newsletter. Such views are subject to change at any time without notice due to changes in market or economic conditions and may not necessarily come to pass. Lido has obtained the information provided herein from various third-party sources believed to be reliable but such information is not guaranteed. Certain information contained in this document constitutes “forward-looking statements,” which can be identified by the use of forward-looking terminology such as “may,” “will,” “should,” “seek” “expect,” “anticipate,” “target,” “project,” “estimate,” “intend,” “continue,” “believe,” the negatives thereof, other variations thereon or comparable terminology. Due to various risks and uncertainties, actual events or results or the actual performance may differ materially from those reflected or contemplated in such forward-looking statements. Any forward-looking statements or forecasts are based on assumptions and actual results are expected to vary from any such statements or forecasts. No reliance should be placed on any such statements or forecasts when making any investment decision. Lido is not responsible for the consequences of any decisions or actions taken as a result of information provided in this newsletter and does not warrant or guarantee the accuracy or completeness of this information.

Index Definitions:

MSCI ACWI covers approximately 85% of the global investable equity opportunity set. The index is based on the MSCI Global Investable Market Indexes (GIMI) Methodology—a comprehensive and consistent approach to index construction that allows for meaningful global views across all market capitalization size, sector and style segments and combinations.

MSCI EAFE Index measures international equity performance and is comprised of the developed markets outside of North America: Europe, Australasia, and the Far East. (Source: MSCI)

MSCI Emerging Markets Index is a free float Adjusted market capitalization designed to measure equity performance in global emerging markets and covers 800+ securities across 23 markets and represents about 13% of world market cap. (Source: MSCI)

The Barclays U.S. Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, U.S. dollar-denominated, fixed-rate taxable bond market. The index includes Treasuries, government-related and corporate securities, MBS (agency fixed-rate and hybrid ARM pass-throughs), ABS and CMBS (agency and non-agency). (Source: Barclay’s)

The BofA Merrill Lynch U.S. High Yield Master II Index value, which tracks the performance of U.S. dollar denominated below investment grade rated corporate debt publicly issued in the U.S. domestic market. (Source: BofA Merrill Lynch)

The Russell 3000 Index measures the performance of the largest 3,000 U.S. companies representing approximately 98% of the investable U.S. equity market. (Source Russell)

The Russell 2000 Index measures the performance of the small-cap segment of the U.S. equity universe. The Russell 2000 Index is a subset of the Russell 3000® Index representing approximately 10% of the total market capitalization of that index. It includes approximately 2000 of the smallest securities based on a combination of their market cap and current index membership. (Source Russell)

The Russell 1000 Index measures the performance of the large-cap segment of the U.S. equity universe. It is a subset of the Russell 3000® Index and includes approximately 1000 of the largest securities based on a combination of their market cap and current index membership. The Russell 1000 represents approximately 92% of the U.S. market. (Source: Russell)

The S&P 500® is a market value weighted index that includes the 500 leading U.S. based companies and captures approximately 80% coverage of available market capitalization. (Source: S&P Dow Jones)

Dow Jones Industrial Average™ was introduced in May 1896, is a price-weighted measure of 30 U.S. blue-chip companies. (Source: S&P Dow Jones)

MSCI AC World Ex U.S.: A market-capitalization-weighted index maintained by Morgan Stanley Capital International (MSCI) and designed to provide a broad measure of stock performance throughout the world, with the exception of U.S.-based companies. The MSCI All Country World Index Ex-U.S. includes both developed and emerging markets. (Source: MSCI)

Barclays U.S. Universal: Unmanaged index comprising U.S. dollar-denominated, taxable bonds that are rated investment grade or below investment grade. (Source: Barclay’s)

HFRX Global Hedge Fund: The HFRX Global Hedge Fund Index is designed to be representative of the overall composition of the hedge fund universe. It is comprised of all eligible hedge fund strategies falling within four principal strategies: equity hedge, event driven, macro/CTA, and relative value arbitrage. (Source: HFRX)

The Alerian MLP Infrastructure Index is a composite of energy infrastructure Master Limited Partnerships (MLPs). The capped, float-adjusted, capitalization-weighted index has 25 constituents that earn the majority of their cash flow from the transportation, storage, and processing of energy commodities. (Source: Alerian)

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The Global Political Pendulum