Macro update: polls, populists, policy and portfolios

Polls

A busy week looms for politics. Sunday's first round in the unexpected parliamentary election in France, and next Thursday's earlier-than-expected UK election, have made 2024's political diary even more congested.

As we note often, the read across from politics to portfolios may not be that big. What matters to us as citizens does not always matter to us as investors: markets are impersonal, and driven by many moving parts – most notably, the business cycle.

We can imagine things differently. If an RN-led France seemed likely to leave the euro – effectively spelling the end for the single currency – then global stock markets, not just those in Europe, would be hit hard; European bond yields, not just those in France, might surge; and the few outright gainers might include the dollar, US Treasuries and gold.

Similarly, if the incoming Labour administration were to change UK taxation or public spending plans significantly, local financial markets might take more of an interest than they have to date.

But we think neither of these outturns is likely. And looking further ahead to November, even the much more important (to global investors) US presidential poll need not be an investment game changer. It is clearly a high conviction campaign, but perhaps not in the economic sense.

Populists

Populism per se does not necessarily affect the economic outlook. It seems distasteful even to note this, but we write here as investment advisers, and have no mandate to talk about wider issues (unless or until those things have an economic or financial impact). And for now, while we may not like (for what that's worth) Meloni, Weidel, Wilders, Le Pen, Trump, Milei, Modi, Farage et al, we see no anti-business groundswell among their supporters.

And we still doubt voters have become less kind. Instead we suspect they're just fed up with inept, overconfident establishments.

Policy

You think politics is polarised? Welcome to the world of PR economics, in which Megathreats (Roubini, 2022) and crises are always upon us or just around the corner, and business as usual is an oxymoron.

Since 2021, polar views on inflation have been particularly prominent. Confident predictions of runaway wage-price spirals coexist with urgent warnings of monetary overkill and a resumed slump towards deflation. They are sometimes made by the same people – at the same time.

In this context we are the centrist dads, siding with unsensational, incremental progress and the probability of a ‘muddle through’ outcome. On inflation in particular we have had the same views throughout (and before). But because polar views are so prominent, and because we have had to address both ends of the scale at varying times of late, this may not always have been as clear as it could be.

When it is said that 'seventies-style inflation is just around the corner, for example, we argue it won't be that high, because labour and product markets are more flexible than they were. Equally, when imminent deflation is diagnosed, we suggest it won't be that low, because those more flexible markets are still subject to scarcity and differentiation.

The flip-flop is not in our view, but in the argument with which we're engaging.

For sure, we have always seen inflation as a bigger risk than deflation, and feel that 2% targets are more likely to be overshot than undershot. But we have not seen it spiralling out of control, or sticking in double-digit territory. We see Western inflation trending in the 2-4% region for some time – which is where today's core rates in the US, eurozone and UK are currently.

If we're right, this ‘cost of living crisis’, painful and unfair though it was, will not register in the long-term inflation charts. ‘Team transient’ was less wrong than ‘Team permanent’.

This does not mean that we think central banks were right to take the risks that they did, or that rates should be encouraged now to return to their historic lows. But it does mean that – as the Swiss National Bank and now the European Central Bank are demonstrating – there is room for policy rates to ease.

The Bank of England is likely to start cutting rates after the election, and (most importantly for client portfolios) the Federal Reserve is likely to follow suit in the autumn. The exact number of cuts is less important than the cumulative order of magnitude – which, as noted, we think will fall well short of returning them to late 2021 levels.

Portfolios

In this context, the recent mix of declining inflation with ongoing growth is not surprising, and the combination of a slow and modest reduction in interest rates with ongoing corporate profitability which it is delivering can support gains in both major securities markets.

From our top-down vantage point, stocks have been best placed to benefit to date. They are supported by both lower rates and ongoing growth (which has been visible for longer than have the lower rates). But whereas for most of the last decade we have actively shunned bonds, their more normal yields do now seem to offer value, and we can imagine becoming more positive at some stage.

Globally, stocks have not just delivered positive returns at the half-way stage in 2024 – but have now rallied to deliver inflation-plus returns since early 2021. Investors have had to wait for those returns – but then that's why we often argue for taking the long-term view, as short-term market timing is hard to call.

In contrast, bonds have not kept pace with inflation (even the inflation-linked variety, which are largely driven by real interest rates). The UK gilt market, perhaps the extreme case, has lost almost half its real-terms value. But then they were very expensive to begin with.

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