This week, 100 companies from the S&P 500 will report on their business situation and outlook, followed by 290 next week, and we see some catch-up potential in companies that have not been in the spotlight in recent weeks and months.
Equity markets: Time for the laggards to catch up
While US ‘big tech’ companies still benefit from a strong long-term fundamental outlook, we see several reasons for some of this year’s lagging equities to catch up in the coming weeks.
Following the US consumer price index release, US equities experienced a sharp momentum sell-off on Thursday’s trading session. This year’s leaders, particularly the US information technology (IT) behemoths, were down while rate-sensitive cyclical sectors such as US regional banks and small caps rallied strongly. The lower inflation outlook alongside lower bond yields should help alleviate the pressure due to higher funding costs in those segments.
While we continue to recommend holding exposure to the US megacap IT companies given the still strong long-term fundamental outlook, we see catch-up potential for some of the market’s laggards for several reasons.
- First, after such a phenomenal outperformance of the Magnificent 7 (M7), sentiment and positioning indicators appear stretched for this cohort.
- Second, the earnings growth advantage of the M7 versus the rest of the broad market is expected to narrow over the coming quarters, which has historically led to a broadening out of equity market leadership.
- Finally, the recent increase in the odds of former president Trump winning the US presidential election in November should translate into an additional tailwind for cyclical sectors with high exposure to the domestic economy. Meanwhile, a new Trump administration is expected to take a harsher stance against some of the bigger IT names.
US inflation: Easing prices boost confidence in rate cuts
The weaker US inflation data for June strengthens the case for a rate cut at the September Federal Open Market Committee meeting. The decline in inflation was broad-based, as it came across all major categories of the consumer price index. Together with softer economic data, including a cooling of the labour market, this has increased confidence that inflation will trend lower in the coming months. We have lowered our forecast for US inflation to 3% in 2024 and 2.2% in 2025. We still expect the Federal Reserve to cut rates in September and December.
US headline inflation slowed to 3.0% year-on-year in June, with lower energy and goods prices contributing to the decline in inflation. Shelter inflation, the average cost of housing, has been an important contributor to elevated inflation in the past. This slowed markedly in June, and other services prices also exerted less upward pressure on inflation. This long-awaited slowdown in shelter costs has been particularly helpful in boosting market confidence that the decline in inflation is real and sustainable.
Core inflation slowed only marginally to 3.3% in May. Both data points were slightly weaker than expected and reinforced the view that inflation is continuing to fall, albeit in a still volatile and unpredictable manner.
What does this mean for investors?
For now, we recommend keeping exposure to the US IT behemoths, but allocating fresh capital in cyclical stocks such as small and mid-caps and industrials. However, given the risks of higher bond yields, a focus on quality is warranted at this stage.
Otherwise, it is like every summer: many investors are in the mountains or by the sea rather than at their desks, leading to the usual summer lull in the market. Whether the earnings season threatens to turn this into a summer storm remains to be seen. Therefore, it is not the time for major portfolio adjustments, although individual opportunities always arise.