What can politics do to your portfolio?

Market Recap

• Equity markets rose modestly this week alongside some softer economic data and shortened holiday trading.

• The S&P 500 rose 2%, with tech and communication services leading. The index pushed above 5,500 for the first time and finished the week at a record high.

• Meantime, the TSX added 0.8%, with materials leading.

The Fed

Last week, the minutes from the U.S. Federal Reserve’s (Fed) June meeting were released, and they included committee members’ reaction to a drop in the Personal Consumption Expenditures (PCE) price index, which the Fed uses to measure inflation. According to the minutes, the Fed “judged that although inflation remained elevated, there had been modest further progress toward the 2 percent goal in recent months.”¹This language caught observers by surprise, as it strikes a more dovish tone than what they’ve said previously. Needless to say, that’s a positive sign for investors. What remains unclear is whether there was enough movement in the data to accelerate the Fed’s rate easing schedule. Inflation numbers have certainly improved. Job openings have also diminished and unemployment claims are starting to creep higher. But if you were hawkish before, we’re not sure there’s enough there to change your opinion. The data and language of the minutes indicate that the likelihood for a rate cut in July has probably increased, but we still think it’s unlikely. In our view, September is the most likely month for rate cuts to commence.

Bottom Line: We’ll be surprised if the Fed cuts interest rates in July, but the minutes from June confirm that we’re likely to get at least one rate cut sometime this year.

Election volatility

With the U.S. presidential election in flux following the first debate and elections in France and the U.K. reshaping European politics, how is election-related volatility likely to play out in the coming months? We view it as an important factor for markets, but not necessarily for the long term. Presidents and prime ministers do not shape policy on their own—they generally need to work with the legislature (be it parliament or congress) in order to pass their proposals, and the composition of that legislature determines the ease with which they’re able to get their agenda enacted. In the United States, election years tend to be good for markets as incumbents use whatever levers are at their disposal to increase their winning chances. Looking ahead, we see geopolitical tension—in the form of war or trade disputes—as a legitimate risk for U.S. markets. Changes to immigration policies under a potential Trump administration could also impact growth, as could new tariffs if they were to be enacted. Domestically, the market could continue to be bullish under a Trump presidency, but the geopolitical risk factors could rise. Across the pond, results of the second round of voting in France are still being tabulated at the time of this writing. The U.K. general election is in the books, however, as Labour swept to a resounding victory. Given the political uncertainty we’ve seen in the U.K. recently—five Prime Ministers in the last five years—we think this election could yield greater stability. That would be positive for economic growth, though the country also needs some rate cuts given the relatively weak state of the consumer.

Bottom Line: We don’t expect election volatility to be a significant long-term concern for markets, though depending on election outcomes, geopolitical tension could rise.

Factor rotation

Are markets due for a factor rotation? We think so. In fact, we’ve already implemented something of a rotation, moving our Value position to slightly overweight (+1). That said, we don’t expect the top tier names to fall out of favour. The Nvidias of the world still look attractive; it’s the second tier of Growth names that could be impacted by a rotation to Value. The artificial intelligence (AI) story is likely to continue in the near term regardless of the state of the consumer, because it’s big corporations that are investing in it. The middle part of that growth cycle, when consumers begin to play a greater role in revenues, is where things could change, but we’re not there just yet. With rate cuts on the horizon, Financials are poised to do better, assuming loan loss provisions don’t increase much further. Overall, we anticipate movement to areas with lower price-to-earnings (P/E) multiples, as investors pare back their exposure to non-leading areas of Growth and rotate to sectors that could provide some downside protection in the case of a slowing economy. A similar rotation could happen from U.S. equities into other markets, though we wouldn’t expect it while the key mega cap companies continue to dominate.

Bottom Line: A rotation into areas with lower P/E multiples is likely, but it won’t mean that we’ll be moving completely out of Growth and completely into Value.

Positioning

For a detailed breakdown of our portfolio positioning, check out the latest BMO GAM House View Report, titled Shifting to Neutral: The Case for Optimistic Caution.