The ECB has cut interest rates this week and the US is expected to follow next week. James Klempster discusses the different challenges facing them, however, with low economic growth for the former and stretched stock market valuations for the latter.
Hello. It's Friday 13th of September. I thought we'd pause for just a few moments and reflect on what's been going on in markets over the last couple of weeks. There has been lots of news, lots of interesting stuff going on - presidential debates, and we had the first amateur spacewalk during the course of the week. And on the subject of gravity, we've got the European economy certainly struggling to defy gravity as well, so let's start with that.
We had the second 25 basis point cut by the ECB this week. Against that backdrop, you've had inflation coming down to 2.2% – very much sort of in line really with the ECB's targets. That's good news, of course, and it's the second cut we've seen from the ECB in this cycle. The first one took place in June. The background information from Christine Lagarde was a little bit more negative, making the case that growth in the European Union isn't that strong, consumption is looking weak, and the forecasts for GDP certainly next year and further forward, they've shaved off 10 basis points off the annualised expected rate. This is not a massive difference, clearly, but it is important when you're looking at GDP figures that are starting with 1 point something. The bigger issue for the European Union is how to get GDP that begins with a 2 or even a 3 rather than a relatively meagre 1.
This interest rate decision, there was no dissent. Whereas in the previous decision there was one dissenter suggesting that interest rates didn't need to come down. So, there is a direction of loosening in the European Union, reflecting the fact that the economic picture is weakening, but not weak necessarily. But there's no clamour, no rush to aggressively pull down interest rates, which is a slight contrast to the US, which will we come on to in a moment. When you look at our scores of European stocks, we score the European market a neutral 3 out of 5. And as much as there is a bit of a headwind provided by the relatively modest economic growth there, valuations are actually pretty attractive. So those two features balance each other off somewhat and we get an overall score of 3 out of 5 for Europe.
The US
Turning to the US, we had the presidential debate. The result of it was a slight improvement in the odds of a Harris victory, although it still is pretty finely balanced, and with the best part of two months to go, there's plenty of time for one of the two candidates to err in one way or another.
When it comes to election cycles, as we've made the case regularly in these videos, they create a lot of noise, they create some sort of volatility in markets, but their long-term impact tends to be relatively modest. If you think about major stock markets around the world, it's a basket of big companies that happen to be domiciled in the country in question. And the purpose of the management of those businesses is to reward shareholders regardless of the political winds. And you know, we've got decades, if not centuries of data that point to just that being possible. There have been many different political environments clearly in in the last hundred years, and over that time, on average, stock markets have done pretty well.
The other issue in the US of course, is next week's Federal Reserve meeting and the potential for an interest rate cut. It seems very much a done deal that an interest rate cut will happen. The question remains whether it will be 50 basis points or 25 basis points. At the start of this week, it looked fairly settled that we would see a 25 basis point cut, the sort of entry level size of cut if you like. But even as of today, there is not quite a 50% chance of a 50 basis point cut being priced in. So there's still a finely balanced argument either way. The argument in favour of a more aggressive rate cut is essentially that the economy is doing all right, but behind the scenes it is starting to weaken off. And so it's a bit like your car is coming up to traffic lights – if you have got your foot on the brake, which is restrictive monetary policy essentially, you might want to ease off just before you come to a complete halt so you don't get that final jamming stop. Essentially what the argument in favour of having a bigger interest rate cut in the first round would be to more meaningfully take your foot off the brake and reduce the risk of that jolting halt at the end. Generally, though the US economy remains in reasonable shape. The inflation figures are continuing to come down. Employment is sort of robust, but it's those finer margins that people are still really focusing on as to whether we get a 25 or 50 basis point cut. And it is still very much in the balance, in terms of the odds of those two happening. Having said that though, it remains the case that the market is anticipating more than 100 basis points of cuts to the end of this year. And with only three meetings over that period, the implication is that in one of those three meetings you will have a 50 basis point cut in terms of the current market pricing.
Overall, the economy remains in reasonable shape. Valuations in contrast to the European Union are stretched in the US, particularly in certain sectors. The stocks that have done very well, the 'Mag 7', which we've managed to get this far into the video without even mentioning, are stretching out valuations across the index. And so contrasting to Europe, the economic situation is a bit better in the US, marginally better let's say, the valuation side of things is actually marginally worse. So, in a similar way to the European market, we score the US a 3 out of 5 also. But we do like US smaller companies, where we have a 4 out of 5 score there. That's it from me. We'll see you next time and have a good weekend when you get there.
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