Chief Investment Strategist
The past week has seen three key drivers running through equity markets. Technology stocks have had a strong performance up 5.5% pulling US equities into pole position for the past week and close to overtake Japanese equities as the top performing region this year. The move higher in US technology stocks has in particularly been driven by Nvidia rising to the top spot in global equity markets (more on that in the next section).
Macron’s surprise snap election in France has taken everyone by surprise and pushed the France-Germany 10-year yield spread to 78 basis points, the highest level since 2012 when the euro crisis was still brewing. The options market in EUR is also clearly expressing a negative view and concerns of depreciation post the French election (first round) on 29-30 June. In addition, the key French equity benchmark, CAC 40, is worst performing index this year highlighting the pessimistic view investors have on French equities. The ripple effects from the French election, and the likelihood of a Le Pen victory, have pulled European equities down and effectively put them on the side line for now while the rally in equities continues in the US.
The last driver has been the risk of Japan being put on the currency manipulation list by the US government as its currency continues to weaken. As a result, Japanese equities were down 2.5% the past week, the worst performing market, as the market is anticipating that the BOJ will be forced to move on policy rates and also more aggressively than currently priced.
In terms of long-term equity return expectations not much has changed. European equities still have the most interesting return expectations with emerging markets remaining at the bottom. On a sector level, the energy, health care, financials, and information technology sectors are the most attractive.
The biggest single stock story this week is the rise of Nvidia to briefly become the most valuable company in the world. Microsoft has recouped the top spot ahead of today’s trading session. Over the past 20 years, Nvidia shares have risen 61,051% including reinvestment of dividends corresponding to an annualised return of 37.8% compared to 10.2% for US equities. As we wrote in our equity update on 7 June, the rise of Nvidia and other mega caps has pushed the S&P 500 Index to historical index concentration levels that mathematically will lead to lower returns in the future as upper end of the index will not forever grab a higher index.
With volatility pushed to extreme lows and the market rallying it worth remembering that rallies will come to an end. This time things might unravel in a bigger way than what most investors believe. A recent Bloomberg Odd Lots podcast called The Big Trade Underneath the Strangely Calm Surface of the S&P 500, options experts discuss a big trade on Wall Street called “the dispersion” trade which is effectively a trade where traders go short the VIX Index (using futures) while simultaneously buying call options on a group of single stock names. If correlations among US stocks remain low and the VIX Index remains low then the trade makes a lot of money. In the podcast, it is mentioned that this trade has the size to upset markets in a big way if there is a shock that pushes the VIX Index higher in a short time span. So while the gains in US technology stocks feel good there might be trouble brewing underneath the surface.
Last week we wrote about the EU tariffs on Chinese EVs as the global trade war continues to heat up. Germany and the China-EU business chamber were fighting to pull the measures in the other direction, but the hard truth is that the car industry is a national security interest for Europe, and there are a lot of evidence that China is subsidising its car industry. Canada has said this week that it is also planning tariffs on Chinese EVs.
This week, Berkshire Hathaway announced that it is trimming its position in BYD, China’s largest EV maker, to 6.9% from 7.02% indicating that the US investment firm is considering its Chinese assets. The geopolitics discussed above will continue to unravel global supply chains and trading relationships in the years ahead. In that process the most intensive export-driven countries such as China, Germany, and South Korea will suffer. Berkshire Hathaway’s move on BYD will likely end in the US company divesting all assets in China and instead focus on its Japanese assets and potentially look at India in the future.
Previous weekly equity market updates
2024: The wasted year
Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
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