Equity markets retreated last week, following their strong run of late, with global equities down 2.0% in local currency terms and 1.5% in sterling terms. Bonds, by contrast, were little changed.
UK and US equities both fell around 1.2% in sterling terms while Europe and Emerging markets were down 2.5% or so. However, the biggest divergence in performance was between US small cap and the Magnificent Seven tech stocks.
US small cap gained 1.7% while the Magnificent Seven were down 4.6%. This continued the rotation away from the tech sector which started the previous week and leaves small cap up 15% relative to the Magnificent Seven over the last couple of weeks.
The swing was boosted last week by reports that the US was considering imposing tougher restrictions on semiconductor exports to China. Trump’s comment that Taiwan should pay for its own defence also didn’t help, given the country’s essential role in the global semiconductor industry.
We continue to believe small cap in the US (and also in the UK where they too outperformed a little last week) have more upside in the medium term than the mega-cap tech stocks. Small cap should see earnings growth pick up over the coming year, closing much of the large growth gap and allowing investors to focus on their much cheaper valuations.
The majority of the Magnificent Seven release their earnings results over the next couple of weeks and this will be critical in determining whether, near term at least, this rotation has further to run. The US earnings season is of course far from unimportant for the market overall and is well underway. So far, estimates are coming in slightly higher than forecast and S&P 500 earnings are anticipated to show a healthy gain of 11% on a year earlier, up from the 8% increase posted in the first quarter.
On the economic front, it was a quiet week in the US with the only development of note being a larger than forecast gain in retail sales in June. This went some way to alleviating concerns which had started to emerge that increased financial strains in low income households were leading to a marked slowdown in consumption. GDP growth now looks set to recover to an annualised pace of 2-2.5% in the second quarter from a sluggish 1.4% in the first quarter.
Politics, however, remained centre stage with the Republican convention and Trump’s selection of JD Vance as his vice-presidential running mate. The latter was seen as Trump reinforcing his appeal to his core base rather than trying to widen his support.
Then on Sunday, President Biden finally bowed to calls to step aside as the Democrat candidate. Whilst Biden endorsed Vice President Kamala Harris to succeed him, this is not a done deal and his successor will ultimately be decided by the delegates at the Democratic National Convention in August.
In the UK, the June inflation numbers came in a tad higher than expected. The headline rate was unchanged at 2.0%, in line with the Bank of England’s target, but underlying inflation pressures remained considerably more elevated. The core inflation rate (which excludes food and energy prices) was 3.5% while inflation in the services sector, where inflation pressures tend to be stickiest, was unchanged at a high 5.7%.
The latest labour market data also showed underlying inflation pressures easing only slowly. Growth in average earnings excluding bonuses in the year to May remained a high 5.7%, albeit down from 6.0% in April. All said and done, this crop of data means the first rate cut now looks slightly more likely to occur in mid-September rather than at the start of August but it is a close call.
Elsewhere, the European Central Bank as expected left interest rates unchanged on Thursday. Rates are likely to be cut again later this year but ECB President Christine Lagarde was non-committal as to whether they would be lowered at the next meeting in September.
Finally in China, the five yearly meeting of the Communist party reiterated its long standing policy goals of modernising industry, expanding domestic demand and curbing debt and property sector risks. But it was disappointingly light on concrete new initiatives to achieve these lofty goals such as measures to support the consumer.
This coming week, the highlights for the market will be Alphabet (Google)’s earnings on Tuesday, the global business confidence numbers on Wednesday and the US growth and inflation numbers on Thursday and Friday.
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