Day: June 1, 2024

Investing.com – European equities have fallen from recent highs over the last couple of weeks, and Bank of America Securities sees further downside for the region’s benchmark Stoxx 600 index into the first quarter of next year. 

Europe’s main stock index, the pan-European STOXX 600, soared to a record high in early May, as risk appetite was bolstered by growing bets on interest rate cuts in the region and a strong earnings season.

The Stoxx 600 index closed at 516.50 on May 30, below its 525.33 record high.

However, analysts at Bank of America Securities pointed out, in a note dated May 31, that equites have fallen back since mid-May, largely on the back of a significant rise in the U.S. 10-year real bond yield, the discount rate for global equities, as better-than-expected macro data has triggered concerns that an overheating economy might force central banks to tighten further.

Over the past 18 months, a sharp acceleration in global growth momentum – driven by the U.S., and, more specifically, by U.S. consumption – has liſted the global 12-month forward EPS to new record levels, while helping to compress the global equity risk premium to a 20-year low. 

“If U.S. growth indeed now starts slowing in response to the lagged impact of higher rates and a fading fiscal boost, this would be consistent with higher risk premia and lower EPS expectations ahead,” the bank said.

This is BoA’s base case, with its analysts expecting the recent soſtening in U.S. growth momentum to intensify, consistent with the behavior of the economy at the late stage of an aggressive tightening cycle. 

It remains negative on European equities, saying its “macro assumptions are consistent with nearly 15% further downside for the Stoxx 600 to 450 by Q1 next year – as well as nearly 15% downside for European cyclicals versus defensives.”

BoA acknowledges a key risk to its base case, a scenario in which fading inflation comes first, with the soſtening in growth momentum playing out more slowly, a positive for equities as it removes the higher-for-longer rates concerns.

“That said, both developments we expect – soſtening growth and fading inflation – are ultimately consistent with more dovish central banks and, hence, lower bond yields. This motivates our overweights in rates-sensitive assets, including growth versus value stocks, quality versus the market and bond-proxy sectors like luxury goods, soſtware, chemicals and real estate, while leaving us underweight financials,” BoA added.

According to Strategas analysts, historical data shows that a Republican-controlled Congress yields the strongest earnings growth for the S&P 500.

The analysts noted that “a Republican congress on average has resulted in the strongest earnings growth for the index with an average of 15.5% earnings growth under a Republican sweep.”

This insight comes from Strategas’ Washington Policy team, which tracked data illustrating equity market performance under various partisan control configurations in Washington.

Recent inquiries from clients led to an analysis focusing on fundamentals, revealing the superior earnings growth associated with Republican congressional control.

The Strategas note also highlighted the potential for increased market volatility as the upcoming election approaches and even after it concludes.

“While it is not uncommon for election years to see a pickup in volatility as the election approaches, the elevated vol expected following the election is worth watching,” they stated.

The analysts suggested that market concerns might be growing over the possibility of not knowing the election outcome on election night, a scenario that could significantly affect market stability.

Investors are advised to be cautious as the election season unfolds, keeping in mind the historical performance patterns associated with different partisan control configurations and the potential for heightened market volatility.

According to analysts at Bank of America Securities, a best-case scenario for stocks involves slowing GDP and accelerating earnings growth.

In a research note Tuesday, the investment bank said the equity cycle feels different than the macrocycle today.

“While GDP and the labor market seem to be slowing, earnings are accelerating (LTM EPS +3% YoY),” notes BofA. “Moreover, BofA’s three quantitative models all suggest a strengthening upcycle in equities.”

With first-quarter earnings for the S&P 500 97% done, the EPS has beat consensus by 3%, rising 7% year-on-year. BofA highlights that while the Magnificent 7 led the beat, the other 493 still delivered, with all 11 sectors except for Healthcare topping expectations.

“Historically, a slowing GDP + accelerating EPS backdrop has been the best macro environment for stocks,” they add. “The divergence is mainly coming from improving manufacturing vs. slowing services, in our view. With a manufacturing recovery underway, improving fundamentals should continue to support the market.”

With the possibility of Donald Trump returning to the White House, market analysts are evaluating the potential impact of a new round of trade wars.

According to Evercore ISI, a second Trump administration would likely reintroduce volatility into the markets.

“We believe Trump 2.0 would mean the return of trade-related market volatility and we would not be surprised to see markets start pricing some of that risk soon,” the Evercore team stated.

Trump’s proposals include sweeping measures such as a 10% across-the-board tariff on all U.S. imports and a 60% tariff on all imports from China. These measures are notably more extensive than the tariffs imposed during his first term and those maintained by President Biden with strategic adjustments. The extreme starting points of these proposals suggest Trump is serious about using tariffs more broadly.

Even if the proposals serve as a negotiating tactic, tariffs would still increase significantly under Trump 2.0. Evercore highlights a subtle but noteworthy shift in Trump’s approach to trade deficits, implying a serious intent to use tariffs on a more sweeping basis, an adjustment exemplified by former U.S. Trade Representative Robert Lighthizer’s comments on the need for balanced trade over superficial fair trade.

If implemented, even a scaled-back version of these proposals could push U.S. tariffs to levels not seen since the 1940s, Evercore cautioned.

As a result, this potential for increased tariffs could lead to considerable market uncertainty, similar to the volatility observed during the 2018-2019 trade disputes. Evercore ISI also pointed out that trade policy uncertainty can trigger significant market volatility as investors struggle to interpret policy statements and predict foreign retaliation.

During Trump’s first term, the S&P 500 experienced a cumulative 11% decline on days of major trade policy announcements, underlining the sensitivity of markets to such events. A second term could see similar patterns, with the introduction of more aggressive trade measures against China and other countries.

The Evercore analysis believes that, while markets partly or fully recovered within five trading days following many announcements, the initial uncertainty contributed significantly to observed volatility.

Moreover, the implementation process of these proposals “would not be straightforward or predictable,” Evercore notes, adding to market uncertainty.

“As we saw in 2018-19, trade policy uncertainty can trigger market volatility, as investors may struggle to interpret Trump’s statements and their impact and to predict foreign retaliation. And while this piece focuses on tariffs, there will be a host of other trade issues up for debate,” the investment bank added.

While markets are currently pricing little risk of a new round of trade wars, the prospect of Trump’s return and his aggressive trade proposals could lead to significant market volatility.

As such, investors should be prepared for potential disruptions and closely monitor the evolving political landscape.

“Given Trump 2.0’s potentially far-reaching plans on trade, we believe markets could begin pricing trade-related risks across a range of areas,” Evercore wrote.

As former President Donald Trump faces a criminal conviction for concealing a hush money payment to an adult film star, questions arise about his eligibility to run for president again.

The U.S. Constitution outlines specific requirements for presidential candidates, but criminal convictions are not explicitly addressed, leading to speculation about whether Trump could legally hold office if he wins the 2024 election.

The U.S. Constitution requires that a presidential candidate be at least 35 years old, and a resident of the United States for at least 14 years. It does not mention criminal convictions as a disqualification, which means that, legally, Trump can run for president despite his conviction.

There are historical precedents for candidates running for office while facing legal issues. As highlighted in a Reuters report, Eugene V. Debs, a five-time Socialist Party candidate, ran for president in 1920 while imprisoned for anti-war activism.

Debs received nearly a million votes despite his incarceration, showing that legal troubles do not necessarily preclude a presidential bid.

It is not yet known what sentence, if any, the judge will determine. As a first-time offender convicted of a nonviolent crime, Trump is unlikely to face prison time, the report states.

In New York, individuals with no prior criminal history who are convicted only of falsifying business records typically receive punishments such as fines or probation. The maximum sentence for Trump’s crime is between one and one-third to four years in prison, but those sentenced to prison time for similar offenses usually serve a year or less.

If sentenced beyond a fine, Trump might be placed under home confinement or subjected to a curfew rather than imprisonment. As a former president with lifetime Secret Service protection, ensuring his safety in prison would be complex from a logistical point of view.

Alternatively, Trump could also be released on bail while appealing his conviction.

Although the hush money case is considered the least significant of the four criminal prosecutions Trump faces, the guilty verdict could impact the election.

Opinion polls suggest a conviction could cost him votes, particularly in tightly contested battleground states. According to an April Reuters/Ipsos poll, one in four Republicans said they would not vote for Trump if he were found guilty in a criminal trial, and 60% of independents indicated they would not support him if convicted.

According to BCA Research analysts, President Joe Biden has largely exhausted his political capital. The firm states that any significant negative developments from this point “could destroy his presidency.”

Despite managing some successes, such as negotiating bipartisan budget deals and the Fed achieving a soft landing, BCA says Biden’s administration is struggling with weak popular support.

“We slightly favor the Biden administration for reelection (55% odds), but we are putting it on watch for a downgrade,” BCA Research noted.

The analysts highlighted that ongoing issues, including inflation, foreign policy crises, and the prosecution of former President Trump, are adversely affecting Biden’s approval ratings and election prospects.

As the U.S. election cycle intensifies over the summer and fall, election risk and policy uncertainty are expected to generate volatility and a risk premium in U.S. stocks and corporate bonds.

BCA Research suggests that investors should favor defensive sectors, low-beta assets, and long-duration bonds until the election uncertainty is resolved over the next five months.

Biden’s recent efforts to regain political capital appear to have fallen short, leaving his administration vulnerable to further setbacks. The bottom line, according to BCA Research, is that the political and economic landscape will remain uncertain and volatile as the election approaches.

The US bond market continues its volatile performance in 2024, with Treasury yields recently reaching four-week highs. However, despite near-term strength, UBS strategists believe bond yields are likely to end the year lower, due to several macroeconomic factors.

Primarily, US inflation is among the key catalysts influencing bond yields. According to the latest data from the Federal Housing Finance Agency, US house prices edged up just 0.1% month-over-month in March, down from a 1.2% rise in February. On an annual basis, prices increased by 6.7% in March, compared to 7.1% in February.

According to UBS, the softening housing market and the slowing price trend in new rental leases hint at a further inflation slowdown.

“Hard data continues to suggest that inflation should trend lower for the rest of this year following April’s encouraging print,” they noted.

The Federal Reserve’s monetary policy is another crucial factor that may contribute to a decline in bond yields. While Minneapolis Fed President Neel Kashkari indicated that further rate hikes are not yet ruled out, the overall tone from the Fed remains patient.

Kashkari mentioned that the odds of the Fed raising rates “are quite low,” aligning with recent Fed communications and Chair Jerome Powell’s view that the central bank’s next move is unlikely to be a hike.

“With a softening labor market and slowing economic growth, we continue to expect the Fed to start policy easing in September, with a total of 50 basis points of rate cuts this year,” strategists wrote.

In addition, UBS’s team believes that the pace of the Fed’s balance sheet runoff is set to taper. Starting next month, the Fed will slow its quantitative tightening (QT) efforts, reducing the monthly cap on the sale of US Treasury securities from $60 billion to $25 billion.

This reduction in QT is likely to lower upward pressure on real rates, contributing to a decrease in bond yields.

“We believe this should reduce upward pressure on real rates and drive the next leg lower in yields,” UBS continued.

Also, the growth in the US economy is another factor that will make an impact. As highlighted by UBS, the world’s biggest economy is showing signs of slowing, with a softening labor market and reduced economic momentum, further supporting the case for lower yields as investors seek safer assets amid economic uncertainty.

“We continue to believe that US sovereign yields should end the year lower as inflation and economic growth slow and the Fed cuts rates in the last months of the year,” strategists said in the note.

“We expect the yield on the 10-year US Treasury to fall toward 3.85% as the year progresses, underpinning our most preferred view on fixed income,” they added.

In a note to clients this week, analysts at Evercore ISI noted that US house price expectations for the next five years have just surged to a 16-year high. The firm questioned whether the Federal Reserve would take the metric into consideration.

They noted that the FHFA (Federal Housing Finance Agency) index increased just +0.1% month over month in March but was still up +6.7% year over year.

Meanwhile, the Case-Shiller Index, a closely watched barometer of U.S. housing prices, rose +7.4%.

“This directly lifts Consumer Net Worth and helps lift consumer confidence. Both help lift consumer spending,” wrote analysts at Evercore ISI. The firm said lower mortgage rates, which have trended down over the last month, are helping homebuilders.

This has helped to explain why the Evercore ISI homebuilders survey has improved recently.

Despite the positives, analysts at Evercore ISI highlighted that the last time the house price expectations for the next five years measure was this high, ie, in 2007, “the Great Recession was just a few months away.”