June Update

Economic Overview:

June saw weaker economic data globally, reinforcing the ‘soft’ in the anticipated soft landing and easing concerns that economies like the U.S. might run ‘too hot’ for inflation to decrease. Some developed market central banks have initiated their rate-cutting cycles to support growth as inflation pressures subside, though the pace of policy easing will be more gradual than expected a few months ago. Australia stands as an exception, with inflation appearing more entrenched, indicating a potential bias for further tightening.

For the first time in 4 years, the US unemployment rate has crossed above its 36-month moving average.

In previous economic cycles, every time this has happened a rapid spike in jobless rate followed. This has also coincided with the economy falling into a recession. The unemployment rate has been in an uptrend since April 2023 and is up from 3.4% to 4.0%. Meanwhile, 1.5 million Americans have lost their full-time job in just 6 months.

Source: Sentiment Trader

Political Developments:

Politics took center stage in June with elections called in the UK and Europe. In the UK, the election outcome is less about the victor and more about the margin, given the Labour party's significant lead in the polls. In Europe, the European Parliamentary elections resulted in a decisive shift to the right, prompting a snap election in France, where far-right and far-left parties performed strongly in the first round of voting.

In the U.S., election campaigning is intensifying, but neither candidate is proposing substantial plans to reduce spending or significantly raise taxes to address the ballooning fiscal deficit. This lack of fiscal prudence could potentially spark another period of rising inflation. Historically, volatility increases by an average of 25% from July to November in election years.

Source: Bloomberg, FactSet, BofA

Fixed Income:

Fixed income markets have languished in the first half of the year. Easing inflation pressures and the onset of rate-cutting cycles should lead to lower yields on core government bonds. However, political developments complicate this picture, as markets may reprice the inflation outlook based on the spending plans of incoming governments. Core government bond yields are likely to remain range-bound, and investors should be cautious about adding too much duration to portfolios until the outlook becomes clearer.

Equity Markets:

Equity markets rose in June, with the MSCI World Index up 2.4%, buoyed by better performance in the U.S. and Japanese markets, while Europe lagged. Emerging markets outperformed (4.3%), driven by AI-exposed markets in Taiwan and Korea, which have significant weights in the index.

The narrowness of the U.S. rally remains a focal point, with AI-related stocks dominating performance. Over the second quarter, the U.S. S&P 500 rose 4.3%, but the equal-weighted index fell 2.6%. A broadening of the U.S. market is expected, given the improving earnings outlook in non-AI related sectors and relatively better valuations. Despite political turbulence, the cyclical improvement in the European economy and the over-discounted nature of the equity market provide ample opportunities for active stock selection.

Large tech stocks just keep getting bigger.

The S&P 500 Equal Weight index relative to the S&P 500 is now at its lowest level since the 2008 Financial Crisis. This ratio has accelerated as the S&P 500 has rallied by 14% year-to-date while the equal-weight by just 5%. The disconnect has been driven by the 5 largest stocks which have seen a 32% gain combined this year. Since January 2023, the S&P 500 is up a massive 41% while the equal-weight index is up just 16%. At the same time, Russell 2000 Equal Weight is nearly flat, up just ~3%.

Source: The Kobeissi Letter, The Daily Shot

Australian Economy:

Inflation surged to 4.0% year-over-year (y/y) in May, exceeding expectations and marking the fastest pace of monthly price increases since November 2023. This follows a higher April figure and suggests the full quarterly figure will exceed the Reserve Bank of Australia’s (RBA’s) forecast, increasing the likelihood of a rate hike in August.

The RBA kept the cash rate steady at 4.35% in June, with commentary shifting towards a hawkish stance. The statement emphasized the commitment to returning inflation to target, indicating the RBA's diminishing tolerance for high inflation. The biggest challenge for the RBA will be communicating further policy tightening as inflation is likely to decline due to government subsidies starting in July.

Retail sales were weak in April, with a 0.1% month-over-month (m/m) gain, following a 0.4% decline in March. Speculation about further monetary tightening is likely affecting consumer sentiment and behavior.

The unemployment rate fell by 0.1% to 4.0% in May, but the data was distorted by an unusually high number of people identified as unemployed in April but waiting to start work in May. Comparing the April and May labor market data to March suggests a continuing cooling in the labor market.

House prices continued to rise in June, with the national index increasing by 0.7% m/m and 8.3% y/y. Regionally, price movements were diverse, with Brisbane (1.2% m/m) and Perth (2.0% m/m) showing strength, while Sydney (0.5% m/m) and Melbourne (-0.2% m/m) were more muted. Tight supply is supporting price growth nationally, but an expected slowdown in migration and potential further rate hikes may cool housing market activity.

Sector Performance:

The MSCI World index rose 2.4% in June, with the S&P 500 gaining 3.6%, outperforming the ASX 200's 1.0% increase. European stocks fell 1.4% due to political uncertainty. Japanese equities gained 1.7%, and the broader APAC region outperformed developed markets. The MSCI Asia ex-Japan index rose 3.8%, helping the broader EM equity index achieve a 4.3% return for the month.

The re-rating in equity markets accounts for a significant portion of this year’s returns, with many markets no longer appearing cheap. The U.S. equity market is trading at a forward P/E of 21.0x, while Australia’s 16.8x P/E is one standard deviation above its long-run average. Japanese and European equities are trading in line with their long-run averages at the index level. Rising valuations stress the need for an active approach to find value and avoid traps.

Earnings expectations have remained consistent across markets for 2024, with a projected pick-up in 2025, justifying higher valuations. At the sector level, financials recorded the strongest gain (5.1%) in May, followed by consumer staples (4.6%), utilities (4.6%), and healthcare (4.4%). Materials was the worst-performing sector (-6.5%), while energy (-1.6%) and industrials (-0.2%) also declined.