In the years when a new US president is elected, there is often a summer rally. Typically, July is the month when the media pays more attention to the election. This is due to the Republican and Democratic conventions that take place in July and August.
This year, however, the debate between Trump and Biden provided earlier coverage. Coupled with the assassination attempt on Trump last weekend, this provides early clarity on the outcome of the US election. Trump is poised for victory.
Furthermore, a combination of falling inflation and declining interest rates, along with positive surprises in corporate earnings, will define the market in the coming months. This is an ideal combination for a further summer rally.
Political uncertainty decreases
Never before have there been as many elections as this year. Elections in the UK and France are now behind us. While the outcomes may not be the most optimal for financial markets, they still adhere to the adage, «possession is nine-tenths of the law.»
After the elections, there is clarity and uncertainty dissipates. Usually, the stock market can then rise. The most important election, of course, is the US presidential election in November this year. Until a few weeks ago, the two candidates were neck and neck. Trump initially had a lead, but Biden began to fare better. However, since the debate between Trump and Biden, the current president has been inebriated with confidence. Even within the Democrats, there is considerable doubt about Biden.
Following the attack on Trump, Biden’s chances have become very slim. After such attacks, the victim normally garners a lot of sympathy. Furthermore, US elections revolve around money, and the events of last weekend will undoubtedly fill Trump’s campaign coffers. Figures like Elon Musk and Bill Ackman immediately offered their support to Trump.
Financial markets also have a clear preference for Trump, partly due to his policies of lower taxes, cheaper oil, and deregulation.
Rate cuts on the horizon
Last week, it became evident that the Federal Reserve will soon begin cutting interest rates. It is now clear that the higher-than-expected inflation figures in the first three months were merely incidental. For two consecutive months, inflation figures have been lower than expected. Until recently, the Fed stated it wanted further confirmation, but by now focusing more on a possible downturn in the economy, the central bank is signalling that interest rates may soon be cut.
The first Fed rate cut is likely to occur in September, and thereafter, the Fed’s policy body may use every meeting until the summer of 2025 to cut interest rates. Due to the «longer high» period, the market has been anticipating such a rate cut for some time, reinforcing the feeling that now is the time, given the positive effect on the stock market. Additionally, other central bankers are holding off on further rate cuts until the Fed makes its move.
It was unusual for the ECB to cut interest rates before the Fed, but as a result, the ECB must now wait for the Fed to take the next step. China and Japan are also creating more monetary policy space. Typically, emerging markets benefit most from interest rate cuts by the US central bank.
Corporate profits on the rise
Ultimately, what matters for the stock market is the development of corporate profits. In the first quarter, the surprise was much better than expected. There has not been such a significant positive surprise since the corona crisis. However, all the earnings growth came from the Magnificent Seven.
This quarter, the Magnificent Seven will contribute about half of the earnings growth. This indicates that there will also be more earnings growth in other sectors, a positive development that could broaden the market and reduce valuation differences between the Magnificent Seven and the rest of the market.
Ahead of the second-quarter reports, earnings valuations were barely revised downwards. Including the usual positive surprises, earnings growth could exceed 10 percent for the first time. Moreover, based on valuations, this is the first of five quarters in which profits rise by more than 10 percent.
This profit growth is not limited to the United States. In the next two weeks, half of European companies will publish their results, with expectations of earnings growth similar to those in the US. Initial results from Asia are also positive. For instance, TSMC has risen 75 percent to a market capitalisation of more than one billion dollars this year, thanks to earnings growth.
The combination of rising profits and falling interest rates is obviously a major plus for the stock market. Added to this are decreasing political uncertainties, suggesting that instead of the usual summer dip, a summer rally is imminent.
This summer rally is not the end of a cycle, but rather the beginning. The current environment resembles that of the mid-1990s. With strong productivity development, there are then still some good stock market years ahead.
Han Dieperink is chief investment officer at Auréus Asset Management. Earlier in his career, he was chief investment officer at Rabobank and Schretlen & Co.