Why Does Japan’s Latest Election Result Cause Nervousness in the Markets and Political Uncertainty?

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Impacto de elecciones en Japón en los mercados

Although the market and investors are focused on next week’s election in the U.S., these are not the only relevant elections we have witnessed this past week. Three days ago, the Japanese went to the polls, resulting in a new political landscape: the Liberal Democratic Party, a conservative party, lost the elections and with it its majority in the House of Representatives. According to experts, this electoral setback does not signify the fall of the coalition government, but it does introduce a degree of political uncertainty, leading to market volatility.

This situation, combined with the divergence in monetary policy between the United States and Japan, has driven the volatility of Japanese equities. “Japanese equities have been very volatile over the past three months. Initially, the divergence between U.S. and Japanese monetary policies led to a swift unwinding of yen carry trade positions (where investors borrow in yen and invest in higher-yielding foreign assets) and a sharp appreciation of the currency. Later, uncertainty around domestic politics became the main driver of equity market volatility, culminating in the call for early general elections last Sunday, October 27,” note experts at Schroders.

Starting with the election result on Sunday, Kaspar Köchli and David A. Meier, economists at Julius Baer, explain that the reprimand of the Liberal Democratic Party (LDP) has introduced an uncommon element of uncertainty into Japanese politics. “With expectations for more aggressive policies declining, the Japanese yen further weakened against the U.S. dollar, in line with our non-consensus view, while the Bank of Japan (BoJ) is likely to maintain its stance a little longer,” they state.

To understand why the election result equates to market volatility, Julius Baer economists explain that with Prime Minister Ishiba committed to staying in office, it is likely that a minority government will be formed, led by the current coalition and with some opposition parties (such as the Innovation Party and the Democratic Party for the People) cooperating on an ad-hoc basis.

“Although the election result is unlikely to bring about significant changes in fiscal and monetary policy, the reduction in the coalition’s administrative power could pressure for increased fiscal spending, as proposed by some opposition parties. These proposals include cash payments for low-income households, which Ishiba has already announced, and extended subsidies for electricity and gas, according to Komeito’s manifesto. A reduction in the consumption tax could also be considered until real wage growth is more stable,” they add.

However, RBC BlueBay expects that financial markets may remain somewhat unstable due to political uncertainty in Japan. From its perspective, this will have little impact on the economy or the Bank of Japan (BoJ). “The initial indications suggest that the upcoming round of spring wage increases, known as Shunto, could again exceed 5%, in a context of high corporate profitability and continued labor shortages,” notes the firm. From this point of view, RBC BlueBay continues to see the BoJ on track to raise interest rates in January or December. In fact, it believes the latter option may be gaining strength with the yen under some pressure in recent days.

Japan at a Political Crossroads

As Janus Henderson recalls, capital markets reacted unfavorably to policies implemented by the DPJ between 2009 and 2012. “Therefore, the prospect of opposition parties like the CDPJ coming to power has raised concerns about possible market risk aversion. Conversely, if the LDP remains in charge, the capital market could gradually focus on identifying undervalued assets and recognizing strong corporate performance,” explains Junichi Inoue, head of Japanese equities at Janus Henderson.

In Inoue’s opinion, as Japan faces political instability, the need for a strategic response, particularly one that addresses concerns of low-income groups, is becoming increasingly evident. “The country now stands at a crossroads, contemplating three possible paths forward: forming a coalition government with an opposition party, navigating the complexities of a minority government, or seeing the Constitutional Democratic Party of Japan (CDPJ) lead a coalition with other opposition entities. Given the significant policy discrepancies among these opposition parties, the likelihood of a unified opposition seems slim,” he points out.

According to his analysis, a decision on the new government framework is expected within a month, amid market instability. “Since August, market trends have been unpredictable, and this trend is expected to persist until a stable government is established,” warns the expert.

The BoJ and its Monetary Policy

When analyzing the Bank of Japan’s (BoJ) monetary policy, investment firms agree that the gradual increase in interest rates in a context of rising inflation will largely remain unchanged. “Although political uncertainty may influence the timing of rate hikes, the BoJ can afford to wait given the low risk of inflation surging. We expect the BoJ to keep rates on hold this week and for the governor to avoid giving strong signals about a hike in December, as we anticipate the next hike only in March,” acknowledge Julius Baer economists.

In Lazard Frères Gestion’s view, conditions are favorable for the Bank of Japan to continue normalizing its monetary policy, reinforcing its confidence that deflation has ended: “In Japan, GDP is growing at a moderate pace, but this is against a backdrop of a population declining by 0.5% per year. This means that per capita GDP continues to grow at a good pace. Business confidence among companies most exposed to the domestic economy is also buoyant. Wages are rising at the fastest pace in the past thirty years, which has not prevented corporate profits from rising significantly. Inflation has returned to positive territory,” they hold regarding their view of the country.

Köchli and Meier, from Julius Baer, focus on the fact that the further decline in expectations for aggressive policies further weakened the yen after it had already experienced a decline just a few weeks ago with Prime Minister Ishiba’s retreat from his comments on the preference for a BoJ adjustment. “This is happening against a backdrop of yen strengthening due to the recent unwinding of carry trade positions. We have been skeptical of this strength due to the persistent divergence in monetary policy and consider our non-consensus forecast confirmed, with policy being only one component, albeit the least important. We maintain our 12-month target for USD/JPY at 160,” they state.

In this regard, Gilles Moëc, chief economist, and Chris Iggo, CIO Core Investment Managers at AXA IM, point out that markets expect the BoJ to raise another 25 basis points or so over the next year. “U.S. interest rates will remain more than 300 basis points higher than those in Japan next summer, based on current market forward prices. In real terms, U.S. short-term rates will remain around 1%, while Japanese short-term rates will remain negative by approximately the same amount,” they conclude regarding the divergence between both monetary institutions.

The Fed Is Expected to Pursue a 25 Basis Point Rate Cut Regardless of the Election Outcome

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Expectativa de recorte de tipos por la Fed

Although all eyes are on the vote count in the U.S. to confirm Donald Trump’s victory, the market faces a relevant event between today and tomorrow: a new Fed meeting. According to investment firms’ assessments, a new 25 basis point cut is expected, given macroeconomic data showing a strong economy and declining inflation.

For Allianz GI, the Federal Reserve surprised the market by starting its rate-cutting cycle with a larger-than-expected 50 basis point reduction. In the opinion of Michael Krautzberger, Global CIO of Fixed Income at Allianz Global Investors, with this move, the Fed signaled a significant shift in its monetary policy strategy, once again prioritizing employment, which is one of its two main responsibilities, along with price stability, under its dual mandate.

“The projections from the September Fed meeting showed a median forecast of additional 50 basis point cuts by the end of the year and another 100 basis points in 2025. The forward rate markets have largely reflected this outcome, with a terminal rate for this cycle around 3.5%. Thus, these Fed measures have increased, at least for now, the likelihood of a soft landing in the U.S. in 2025, although historically, this is a rare outcome,” explains Krautzberger.

Experts agree that the labor market slowdown and moderation of inflationary risks allow the Fed to continue gradually reducing its policy rate. “The FOMC will likely continue lowering its target for the federal funds rate, as the current target range of 4.75%-5% remains quite restrictive. After a bold initial 50 basis point cut, the FOMC indicated that it would proceed gradually and be data-dependent. Current data fully justifies a 25 basis point cut at Wednesday’s meeting. Future data, and particularly any shifts in economic policy in light of the U.S. election results, will determine whether the Fed continues with 25 basis point cuts after the November meeting and brings rates to a more neutral level of 3.5% by mid-2025,” adds David Kohl, Chief Economist at Julius Baer.

25 or 50 Basis Points

According to Benoit Anne, Managing Director of the MFS Investment Management Investment Solutions Group, the Fed still has work ahead. Anne acknowledges that current macroeconomic conditions allow the Fed to begin the anticipated easing cycle but notes it might be too early to celebrate. In fact, Anne observes lingering anxiety following recent labor market developments, signaling limited room for further deterioration before recession risks become a major concern again.

“We are far from reaching the goal, namely, a federal funds rate starting with a 3 and not a 5. This week, the market seems divided between the possibility of a 25 or 50 basis point cut, with a 36 basis point cut already priced in. Our Chief Economist, Erik Weisman, leans toward a 25 basis point cut this month, although he believes the Fed should opt for 50, but it seems like a difficult decision. The 25 basis point move appears reasonable, as the Fed may want to avoid any action that might be perceived as panic-driven. Ultimately, we believe persistence and stability in future rate cuts, while maintaining flexibility for more aggressive policy if the macroeconomic context deteriorates, is crucial,” he argues.

Bank of America is more assertive, predicting a 25 basis point cut: “We expect the Fed to cut rates by 25 basis points at its November meeting. The FOMC statement should change little, except for policy action language and the new target range. We also do not anticipate major shifts in Chairman Powell’s message. He is likely to downplay much of the October labor data weakness but may highlight downward revisions to August and September payrolls as cause for concern. The November meeting should not be a major event; elections have far greater implications for markets overall, and even for the Fed’s policy path.”

In their latest report, the institution notes that since the Fed is unlikely to deliver any surprises in November, attention should quickly shift to Powell’s signals for the December meeting. “Once again, we expect Powell to emphasize data dependence and provide limited forward guidance. While we see rising risks for the terminal rate, it is likely too soon for Powell to open that door,” states Bank of America.

Uncertainties Ahead

However, Christian Scherrmann, U.S. Chief Economist at DWS, believes uncertainties remain. “In particular, we remain cautious about inflation prospects. Since labor market weakness seems to be more a product of data quality and volatility, inflationary pressures—while receding—remain a significant factor. We also believe demand remains sensitive to lower interest rate expectations,” Scherrmann points out.

Another source of uncertainty is yesterday’s elections. According to the DWS economist, there is a high probability of no clear picture of who will be president and what Congress will look like. “With all these uncertainties, central bankers still have to fly with an eye on the economy, and we expect data dependence to be the central message of the press conference, likely with a slightly hawkish tone. But with current interest rates still well above what can be considered neutral, the Fed certainly has room to maneuver at the November and December meetings. For the December meeting, it may be harder to determine if we will see another cut or if the Fed will pause in normalizing monetary policy. By then, at least, we should have a clearer idea of what to expect from lawmakers.”

In this regard, Michaël Nizard and Nabil Milali, managers at Edmond de Rothschild AM, add: “We must remain alert to the risk to the Fed’s independence, given Trump’s stated desire to interfere in the institution’s decision-making, although it will be difficult for him to challenge Jerome Powell’s presidency before his term ends in 2026.”

Additionally, Roger Aliaga-Díaz, Vanguard Global Head of Portfolio Construction and Chief Economist Americas, reminds that the central theme of economic and market outlooks for 2024 was that interest rates above their pre-pandemic levels are here to stay. In his view, this implies that for the Fed, the neutral rate—the projected level of interest rates that theoretically keeps the economy in equilibrium without overheating or overcooling—is higher than in the previous decade.

“We consider factors such as rising structural fiscal deficits and an aging population to conclude that the nominal neutral rate hovers around 3.5%. I would expect the Fed to raise its estimate even further through 2025. As the Fed lowers its target for the federal funds rate from the current range of 4.75%-5% over the coming months, it will ease its grip on an economy no longer facing the imminent threat of runaway inflation. Finding the right balance in the pace of rate cuts is the toughest task for any central bank. Moving too slowly increases the risk of a hard landing; moving too fast raises the risk of rekindling inflation. Naturally, the Fed has focused intensely on finding a middle ground or a soft landing,” Aliaga-Díaz comments.

What Do Voters Prefer?

Finally, it is difficult to fully separate this Fed meeting from yesterday’s elections. Deborah A. Cunningham, Chief Investment Officer of Global Liquidity Markets at Federated Hermes, notes that voters would prefer to avoid a central bank move this week, but the significant cut essentially demands some action to preserve credibility. “If they reduce the target range by a quarter point, as we expect, they could keep rates stable in December before easing again in January, continuing a cut/no-cut pattern for several meetings,” she explains.

In her view, the presidential elections are creating significant disruptions, but regardless of who wins, inflationary policies are likely to be enacted. “This meeting is more decisive for the front end of the yield curve. Interestingly, the uncertainty stems as much from the Fed’s 50 basis point cut in September as from the analysis of recent data. While Fed Chairman Jerome Powell is unlikely to have any regrets, some policymakers may lament the size of the cut, based on the flurry of speeches and appearances since then,” argues Cunningham.

Trump Returns to the White House, and the Market Repeats the 2016 Script, With Increases in Equities and a Stronger Dollar

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Trump regresa a la Casa Blanca

“This will be America’s golden age, it’s an incredible victory.” With these words, Donald Trump, the Republican Party candidate, declared himself the winner of the U.S. presidential elections. Without the official count having ended, Trump reportedly garnered 267 electoral votes compared to the 224 of his Democratic opponent Kamala Harris. Additionally, the Republicans have taken control of the Senate and aim to maintain their slim majority in the House of Representatives.

As expected, following such a significant event, markets have reacted quickly. According to Oliver Blackbourn, multi-asset portfolio manager at Janus Henderson, futures indicate an increase of over 2% in the S&P 500 and 1.7% in the NASDAQ. “However, the most notable parts of the U.S. market are the S&P Midcap 400 and Russell 2000 indexes, with futures showing gains of over 4% and 5%, respectively,” notes the manager.

In his view, perhaps the most surprising result so far is the strength of stock markets outside the U.S. “European and Japanese equities are performing well, and the decline in China is perhaps less than many feared, despite the incoming President’s threats to global trade. The U.S. dollar is generally strengthening as markets consider the potential impact of new import tariffs and further discounted Federal Reserve cuts. U.S. Treasury yields have risen sharply due to both evolving interest rate expectations and the possibility of higher inflation,” explains Blackbourn.

Regarding what to expect next, the Janus Henderson manager considers it likely that markets will begin to think about how rhetoric translates into policy and scrutinize every statement over the coming months for clues. “With the widespread view that both parties will continue running budget deficits, it seems likely that the U.S. economy will remain hooked on fiscal stimulus. The effect this will have on the Fed may take some time to clarify, as the FOMC will be reluctant to consider anything until there is greater political clarity. Markets will have to wait to see if the Federal Reserve is willing and able to address a hot economy,” he adds.

In the opinion of Gordon Shannon, manager at TwentyFour AM (Vontobel boutique), so far markets are repeating the 2016 script following Trump’s victory: equities are rising, while long-term U.S. Treasury bonds are retreating due to expectations of fiscal expansion. “I believe the focus will shift to the inflationary implications of tariffs and immigration control. The Federal Reserve has avoided making comments so far to appear neutral and protect its independence, but its reaction to these policies is key to understanding where asset prices are headed,” Shannon states.

For Stephen Dover, Head of Franklin Templeton Institute, the biggest beneficiaries will be sectors and industries that welcome a more business-friendly regulatory environment, including fossil fuel energy companies, financial services, and smaller-cap companies. “On the other hand, the fixed income market is selling off strongly, with ten-year Treasury yields approaching 4.50%. Fixed-income investors are reacting to the likelihood that tax cuts will not be accompanied by significant spending restraint. The fixed income market also anticipates higher growth and potentially higher inflation. This combination could slow or even halt the Fed’s anticipated rate cuts,” adds Dover.

Finally, Martin Todd, senior manager of Global Sustainable Equities at Federated Hermes, believes the immediate market reaction has been one of relief. “On the eve of the election, there was great concern about the possibility of a prolonged and tightly contested election, given how close the polls were. There are many different opinions on which sectors, business models, and geographies are winners or losers under a Trump administration and a ‘red sweep.’ But this depends heavily on the time frame. Understanding the medium- to long-term implications for equities is incredibly difficult, given the many second-, third-, and fourth-order (and so on) consequences of each policy announcement,” Todd argues.

Currency movements

Since yesterday, a segment of the market appeared to lean towards his victory, although investment firms acknowledge that what remains important is how proposed policies are implemented and the power balance between the Senate and Congress. According to Ebury, yesterday’s massive emerging market currency sell-offs and the dollar’s rise were a prelude to Trump’s likely victory.

“The markets are not only positioning for a comfortable Trump win in the Electoral College but also for the prospect of a Republican-controlled Congress, which is key to determining the incoming president’s ability to push for policy changes within the U.S. government,” Ebury analysts note.

Experts from the firm add that “we are witnessing massive emerging market currency sell-offs as investors price in higher U.S. tariffs, elevated geopolitical risks, and greater global uncertainty under a Trump presidency.”

As in 2016, the biggest loser of the night so far has been the Mexican peso, which has fallen more than 2% against the dollar. Meanwhile, according to Ebury, Central and Eastern European currencies are also being significantly affected amid fears over European security, while many Asian currencies closely tied to China’s economy are trading down more than 1% overnight.

“The major currencies seem to have found some footing for now, and the dollar’s upward movement has perhaps been a bit more contained relative to expectations. However, we wouldn’t be surprised to see another episode of dollar strength as European markets open and final results confirm what appears to be a historic election victory for Trump and the Republican Party,” predict Ebury analysts.

Assessing the results

“The question of a Trump victory will be decided in the House of Representatives election, where Republicans are also leading. Voters likely punished the Democratic presidency of Biden due to high living costs, a legacy of the coronavirus pandemic, concerns about Middle Eastern policy, and a perception of Harris’s unclear profile, which failed to garner voter support despite a strong economy,” explains David A. Meier, economist at Julius Baer.

In the opinion of Samy Chaar, chief economist and CIO at Lombard Odier in Switzerland, if Republicans control both chambers of Congress and the White House, we could expect a more dynamic U.S. economy, with growth above potential and inflation higher than the Federal Reserve’s target.

“It is likely that interest rates will also exceed pre-election expectations. The race for the House of Representatives will determine whether campaign promises can be fully implemented. A divided Congress would impose some limits on the President. The issue of tariffs is key for global trade and Fed easing prospects,” states Chaar.

For the Lombard Odier economist, this has major implications for financial markets: “Macroeconomic fundamentals remain a driver for investments. We foresee that high-yield credit and gold will perform well. Global equities, including U.S. stocks, also have potential upside over the next 12 months as earnings rise and margins remain high. In the U.S. market, the financial, technology, and defense sectors are expected to perform well under a Trump administration.”

According to the Julius Baer economist, betting markets have massively tilted in favor of a Trump victory, with implied odds approaching 90%, while the prospect of a Harris victory has almost dropped to zero. “Markets are pricing in the greater likelihood of a Trump victory, with the U.S. dollar strengthening beyond the euro/dollar 1.08 mark and currencies from economies potentially impacted by higher tariffs falling,” he adds.

Implications of a Trump administration

Investment firms are already evaluating the impact of Trump’s return to the White House. For example, David Macià, director of Investments and Market Strategy at Creand Asset Management in Andorra, believes that the most relevant market implication is the promised tax cuts, which should initially boost economic growth, stocks, and the dollar. “Trump’s policies are inherently inflationary and expand the already high deficit, so market-traded interest rates are also expected to rise. The aggressive tariff hikes promised by the Republican candidate should weigh on companies that export to the U.S., especially if they do not have factories on American soil (many European companies may suffer initially). The weight these companies have on European indexes suggests they may again lag behind,” states Macià.

Creand AM sees the potential for stocks to continue on an upward trajectory. “The American economy remains unusually strong, and unlike when he won in 2016, markets now know exactly what to expect. The starting point is the only obstacle, as valuations are high, but this has little correlation with short-term price behavior,” adds the firm’s representative.

For Johan Van Geeteruyen, CIO of Fundamental Equity at DPAM, investors can look to cyclicals (financials, energy, etc.) and certain technology companies as possible beneficiaries, while tariffs and geopolitical tensions pose risks to specific sectors. “Ultimately, Trump’s policies may foster a favorable environment for U.S. equities, especially if deregulation, domestic manufacturing, and fiscal policies create incentives for growth. However, headline risks—ranging from fiscal uncertainties to trade disruptions—could create periods of volatility, affecting both domestic and global markets,” Geeteruyen notes.

Finally, according to a summary by Blair Couper, CIO at abrdn, in the long term, a Trump victory is likely to mean a laxer regulatory environment, an escalation in trade tariffs, and potential attempts to repeal components of the Inflation Reduction Act (IRA). According to abrdn’s expert, it is also likely that the share prices of U.S. companies with supply chains in China will react negatively, while domestic manufacturing and small and medium-sized U.S. companies may perform better.

“With President Trump at the helm, the U.S. also faces elevated inflation risks due to these policies, so we are likely to see a reaction from interest-rate-sensitive sectors and a strengthening dollar. Sectors such as financials (i.e., banks) could perform well if rates remain elevated for a longer period. While areas like real estate and growth stocks could be negatively impacted by longer duration, this may be offset by a generally positive market outlook driven by his policies, so we still need to see whether these sectors are negatively impacted or not,” Couper concludes.

Artificial Intelligence is Everywhere

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Artificial intelligence everywhere
Photo courtesy

The capabilities of artificial intelligence are advancing with the investment focus expanding from computing power to include additional layers of the technologies used to build web or mobile applications. As a result, we are finding more opportunities to invest in stocks of companies that are leaders or beneficiaries of AI.

In our new paper Artificial intelligence is everywhere, we provide an overview of the AI theme and how it is enabled by cloud computing and foundational science and technologies including semiconductors1. It touches on some of the recent advancements as well as the risks and challenges of developing and using AI.

AI is supported by foundational science and technologies such as:

  • Cloud computing: Essential for training and hosting AI models
  • Internet of Things: Collects data necessary for AI applications
  • Semiconductors: Provide the computing power for AI
  • Cybersecurity: Protects AI systems and data
  • Renewable energy: Helps ensures sustainable power for energy-intensive AI operations.

Use cases for AI are expanding rapidly and include code generation and documentation  for developers; automating customer requests; summarising medical reports and simplifying sales and marketing workflow. Such applications improve productivity and efficiency.

Recent advancements in AI technology include making new large language models capable of complex reasoning and problem-solving; making user interactions with AI models more intuitive; and the arrival of next-generation semiconductors to support AI training and inferencing2.

Harnessing the cloud

Cloud computing with advantages including lower costs, scalability, enhanced security and access to advanced technologies provides the necessary infrastructure and resources for AI development and deployment. Thus, investment in digital infrastructure is crucial for supporting AI initiatives. This includes datacentres, networking equipment, and storage systems. There is also growing demand for cooling systems, energy efficiency, and renewable energy sources to power AI datacentres.

The three major US cloud service providers grew cloud revenue by more than 30% over the last four years, surpassing USD 180 billion in combined revenue in 20233. Despite this, there is still a long growth runway: only about 20% of total workloads has migrated to the cloud.

Cloud service providers, large enterprises and government entities are investing heavily to build and equip the datacentres required to support AI initiatives. Our outlook for investments in digital infrastructure over the next several years is positive.

Today, most of the capital investment is focused on computing power, driving demand for semiconductors. Providers of server computers and other datacentre equipment are seeing robust growth. Some of the focus is likely to shift in favour of investment in networking and storage equipment to support training and inferencing of large language and other AI models.

We expect the long-term returns of developing and deploying AI technology to be attractive. Companies that expand beyond the infrastructure layer and create new applications or services are likely to see higher returns on investment. However, the high cost of components is a key variable.

 

Key investment opportunities

Here are the main areas:

Developers: companies creating AI innovations; cloud service providers training and hosting AI models; semiconductor companies

Foundational technologies: high bandwidth memory and networking chips; semiconductor capital equipment and materials suppliers; foundries; providers of networking and data storage systems; providers of energy efficiency and alternative energy solutions, such as cooling and solar panels

Data providers: companies with proprietary data sets that can be used to train AI models and provide competitive advantages

‘Beneficiaries’: Companies leveraging AI to improve products and services.

Challenges and risks

These include stricter regulations, for example, on copyright and data rights slowing innovation and demand for AI infrastructure.

There is also a need to avoid bias, produce accurate outputs, and ensure that real content can be distinguished from fake information.

Finally, AI systems and data need to be protected from cyberattacks.

Conclusion

Arguably, artificial intelligence is the most significant technology theme since the dawn of the internet age.

As AI technology advances and becomes more pervasive, we believe the investment opportunities among publicly traded equities are broadening. Capitalising on the positive trends while avoiding potential pitfalls will require an active approach to investment management.

 

Opinion article by Pamela Hegarty and Derek Glynn, BNP Paribas AM

The Rise of Small and Micro Caps: Investors Will Increase Their Allocation Over the Next 12 Months

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Small and micro-cap investments

A global study by New Horizon Aircraft reveals that fund managers are increasingly interested in small and micro-cap stocks. The report, based on a survey of fund managers from the U.S., Canada, Europe, the Middle East, and Asia, with a total of $82.4 billion in assets under management, concludes that 76% of respondents anticipate that institutional investors’ exposure to small and micro-cap stocks will increase in the next six to twelve months. Furthermore, one in three (34%) fund managers believes allocations could increase by 25% or more.

For retail investors, the trend will be similar: 83% of surveyed fund managers expect retail investors to increase their allocation in the next six to twelve months, with 52% indicating that the allocation could rise by more than 25%, and one in eight (12%) suggesting that exposure to small and micro-cap stocks could increase by more than 50%.

“One in three fund managers describes the current level of institutional investor exposure to this type of asset as underweight, with 21% of respondents describing the allocation to micro caps as slightly underweight and 11% describing it as extremely underweight. The current level of exposure is described as overweight by 4% and 23%, respectively. A similar outlook is seen with retail investors, with fund managers describing the allocation of this group to small and micro caps as underweight (32% and 27%, respectively) and as overweight (17% and 13%, respectively),” the report notes.

In the opinion of Brandon Robinson, CEO of Horizon Aircraft, this analysis shows that fund managers believe institutional and retail investors’ exposure to small and micro-cap stocks is lower than it should be. “However, with anticipated interest rate cuts and expected improvements in market conditions, fund managers foresee investors significantly increasing their allocation to small and micro-cap stocks. As the economy recovers, small and micro-cap companies may have greater growth potential than large-cap companies due to their smaller revenue bases and agility in seizing opportunities. This has historically made them more attractive to investors driven by the potential for high returns and accelerated earnings growth in the coming 12 months,” he explains.

The Growth of Active ETFs Is Unstoppable: Their Assets Have Reached $1.05 Trillion Globally

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Crecimiento de los ETFs activos

The ETF market shows great strength worldwide, as do actively managed ETFs, which achieved assets of $1.05 trillion as of the end of September, surpassing the previous record of $1.01 trillion set at the end of August 2024. This figure indicates that assets have increased by 42.5% so far in 2024, rising from $737.06 billion at the end of 2023 to $1.05 trillion.

According to ETFGI, flows show that this type of vehicle recorded net inflows of $26.50 million in September, bringing total inflows for the year to $240.14 billion. “This year’s record cumulative inflow of $240.14 billion is followed by cumulative net inflows of $113.80 billion in 2023, and the third-highest record was $106.90 billion in 2021. This was the 54th consecutive month of positive net inflows,” the report states.

Additionally, the report highlights that in the United States, where actively managed ETFs can use semi-transparent or non-transparent models, only 52 of the 1,659 actively managed ETFs use a semi-transparent or non-transparent model, representing only $14 billion of the $791 billion invested in these strategies.

In light of this data, Deborah Fuhr, managing partner, founder, and owner of ETFGI, notes: “The S&P 500 index rose 2.14% in September and is up 22.08% so far in 2024. The developed markets index, excluding the U.S., increased by 1.26% in September and is up 12.53% in 2024. Hong Kong, with a rise of 16.51%, and Singapore, with a rise of 7.43%, saw the largest increases among developed markets in September. The emerging markets index rose by 7.72% in September and is up 19.45% in 2024. China, with an increase of 23.89%, and Thailand, with an increase of 12.43%, registered the largest gains among emerging markets in September.”

As of the end of September 2024, according to ETFGI data, the global actively managed ETF/ETP industry included 2,962 ETFs/ETPs, with 3,679 listings, assets of $1.05 trillion, offered by 485 providers across 37 exchanges in 29 countries. By strategy type, globally focused equity ETFs saw net inflows of $15.49 billion in September, raising cumulative net inflows for the year to $139 billion, surpassing the $76.15 billion in cumulative net inflows in 2023. Meanwhile, actively managed fixed-income ETFs attracted net inflows of $10.19 billion in September, bringing cumulative net inflows to $86.36 billion, significantly more than the $36.20 billion in 2023.

A substantial portion of these inflows is attributed to the top 20 active ETFs by new net assets, which collectively captured $12.75 billion in September. The BlackRock Flexible Income ETF (BINC US) led with the highest individual net inflow, capturing $1.58 billion.

Fundamentals or Market Sentiment: The Ongoing Gold Rally, Under Debate

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Debate sobre el rally del oro

Gold prices have hit new highs. Midweek, the ultimate safe-haven asset reached $2,753 per ounce, marking a 33% increase for the year. According to experts, geopolitical tension stemming from the Middle East explains this surge.

At the start of the week, Ned Naylor-Leyland, gold investment manager at Jupiter AM, noted that the recent rise in gold prices was primarily due to futures contracts rather than physical demand or central bank purchases. “This is a crucial distinction as it highlights the nature of the gold market and how the dollar price of the yellow metal is driven not by physical trends but by futures market activity.”

He also pointed out that gold has gained prominence as central banks seek a buffer against the financial stability risks posed by rising geopolitical tensions, as well as events like the global financial crisis and the coronavirus pandemic. “Around one-fifth of above-ground gold reserves are held by central banks,” Naylor-Leyland added.

In contrast, Carsten Menke, Head of Next Generation Research at Julius Baer, believes this price surge has more to do with market sentiment than fundamentals. “The impressive rally in gold continues, with prices surpassing $2,700 per ounce last week. When looking for factors driving this rally, it appears to be mainly momentum and market sentiment. The position of short-term speculative traders and trend followers in the futures market recently reached one of the highest levels on record. Such extreme euphoria is typically a warning signal, as it shows a certain detachment of prices from fundamental factors,” Menke argues.

He explains that the U.S. dollar and U.S. bond yields have risen again as expectations for rate cuts have tempered. As a result, he notes that already moderate inflows into physically-backed gold products have slowed even further. “Gold buying in Asia remains weak, as indicated by Chinese imports, physical deliveries, and domestic price premiums. India’s gold imports have also normalized after high volumes in response to a surprising cut in import duties,” the Julius Baer expert added.

Short-Term Outlook

Despite this debate over the drivers behind gold’s price growth, there is a consensus on its positive short-term outlook. Marcus Garvey, Head of Commodities Strategy at Macquarie, agrees that gold’s “practically steady” rally continues, once again outperforming other assets. “While recent gains have not been explosive, the pace has been faster than estimated in our base scenario in September, when we updated forecasts, projecting an average price of $2,600 per ounce in the first quarter of 2025, with potential to advance toward the $3,000 per ounce level,” he indicates.

Macquarie maintains that challenging budget outlooks across developed markets are now a key feature of the bull market.

“Clearly, the upcoming U.S. elections contribute to uncertainty in this area. The scope and potential effectiveness of stimulus measures from Chinese authorities remain unclear, but if they succeed in significantly boosting the domestic equity or real estate markets, or both, it could dampen Chinese demand for gold,” Garvey argues.

“We continue to see a solid fundamental outlook for gold,” says Menke, explaining, “A further cooling of the U.S. economy and the prospect of lower interest rates in the U.S. could attract more Western investors to the market. The same applies to the U.S. presidential elections, which are reportedly prompting gold purchases by major investors who believe that, regardless of who reaches the White House, the U.S. dollar will be under pressure due to rising fiscal deficits.”

Finally, Julius Baer adds that Chinese investors and the People’s Bank of China should also return to the gold market. “For the former, it’s about the persistent weakness of the economy despite recent support measures. For the latter, it’s the low proportion of gold in its foreign exchange reserves and ongoing geopolitical tensions, especially with the U.S. In this context, short-term pullbacks are likely to be seen as buying opportunities,” Menke concludes.

Securitization and alternative assets: New opportunities for portfolio management

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Nuevas oportunidades en securitización y activos alternativos
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In the current climate of economic uncertainty, market volatility, and increasing geopolitical risks, portfolio diversification has become a priority for asset managers. Traditional strategies based on equity and bond investments have proven insufficient to mitigate the inherent risks of financial markets. Alternative assets emerge as a critical tool here, providing managers with new diversification opportunities to enhance portfolio resilience and profitability, FlexFunds highlights.

Alternative assets encompass investments in real estate, private equity, infrastructure, private debt, commodities, art, and collectibles, among others, characterized by their low correlation with traditional assets. This makes them an attractive option for managers and investors seeking to reduce portfolio volatility and mitigate the adverse effects of economic cycles.

In a high-inflation, high-interest-rate scenario, managers need to explore opportunities outside traditional markets. Alternative assets offer stability and potential returns, helping safeguard investment value during uncertain times. David Elms, head of diversified alternatives at Janus Henderson Investors, highlights that, during periods of economic transition, alternative investments can generate long-term returns independent of equity or fixed-income markets, particularly in bearish conditions.

Today, portfolio managers are increasingly turning to asset securitization to optimize their diversification strategies. This tool enables converting illiquid assets into tradable securities, facilitating distribution among investors. For managers, this approach opens up access to assets that would otherwise be unattainable due to their illiquid nature.

Securitization not only improves the liquidity of underlying assets but also provides an additional source of diversification. According to the II Annual Report of the Asset Securitization Sector by FlexFunds and Funds Society, portfolio managers are more familiar with securitizing traditional, tangible assets such as real estate projects, loans and contracts, and stocks.

One of the main advantages of alternative assets is their ability to generate absolute returns—i.e., positive returns regardless of market conditions. Portfolio managers incorporating these assets into their strategies aim to minimize economic cycle dependency by diversifying their investments into areas less correlated with equity or fixed-income markets.

In line with this, and based on a survey conducted by FlexFunds and Funds Society to over 100 investment and portfolio management experts, the most sought-after assets for securitization include real estate projects, loans and contracts, stocks, bonds, and mutual funds, as shown in Figure 1.

Source: II Annual Report of the Asset Securitization Sector 2024-2025

Figure 1: Assets of greatest interest for securitization

 

In addition to diversification and risk mitigation, alternative assets provide access to sectors undergoing growth and economic transformation. According to the same report, the most common types of alternatives that managers include in their portfolios are detailed in Figure 2.

 Source: II Annual Report of the Asset Securitization Sector 2024-2025

Figure 2: Alternative product in the portfolio

 

However, investing in alternative assets also entails challenges that must be managed carefully. The lower liquidity of these assets, as well as their opacity and lack of regulation in some cases, can increase risks. To mitigate these, rigorous due diligence and an experienced management team are crucial to understanding each alternative investment’s unique characteristics.

From a manager’s perspective, integrating alternative assets into investment strategies represents both an opportunity and a responsibility. The challenge lies in identifying suitable assets that align with investors’ objectives and risk profiles. The selection of these assets should be accompanied by constant portfolio review and adjustment, considering market fluctuations and emerging opportunities.

In this context, FlexFunds, as a leader in designing and issuing investment vehicles (ETPs), facilitates access to international markets, especially in a financial environment where diversification through alternative assets is key. With its securitization program, FlexFunds offers managers the ability to:

  • Issue ETPs at half the time and cost of other alternatives available in the market.
  • Securitize multiple asset classes, including alternatives.
  • Facilitate distribution of alternative assets across banking platforms worldwide via Euroclear.
  • Streamline capital raising from international investors.
  • Simplify the onboarding and subscription process for investors, compared to traditional alternative asset subscriptions.

For further information, please contact one of FlexFunds’ experts at contact@flexfunds.com

Four Secular Trends That Offer Long-Term Certainty Amid Short-Term Volatility

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Tendencias seculares en medio de la volatilidad

“Putting money back to work” was the theme under which Oddo BHF AM recently presented its macroeconomic and market outlook in Madrid for the next four months. Laurent Denize, the firm’s Chief Investment Officer, led the presentation, focusing on three concepts investors should consider to capitalize on market trends: rotation, duration, and carry.

Denize clarified that Oddo’s stance aligns largely with market consensus, with a few nuances. Their outlook comprises four key points: a soft landing for the global economy, a continuation of the gradual trend toward disinflation seen over recent quarters, further interest rate cuts from the Federal Reserve and the ECB, and an increase in geopolitical risk, especially in the Middle East and in the lead-up to the U.S. presidential elections in November. However, Denize emphasized that the elections’ outcome is less concerning than the U.S. fiscal deficit, which he deemed “worrisome.” He also highlighted Germany’s risk of deindustrialization due to its anti-nuclear policy and growing reliance on Chinese imports, and France’s political instability and high government deficit, leading to significant tax hikes.

In this context, how can investors safeguard their portfolios? “We’re seeing that flows and market positioning are increasingly important,” Denize commented, pointing to the concentration in markets like the U.S. He believes that “valuations appear attractive, but EPS expectations are unrealistic,” which could lead to a rapid rotation.

Denize describes a landscape of rising volatility, declining liquidity, and investor indecision, yet with rich valuations across many market segments. He suggests these factors explain “the significant yield discrepancy between fixed income and equities,” arguing that “bond positioning doesn’t make sense” given the anticipated curve normalization. “We need to look for duration where it’s cheap, and today, that’s in equities, not debt,” he concluded.

Betting on Secular Trends

To navigate this environment, Oddo recommends focusing on secular investment trends. Denize points to the rise of artificial intelligence (AI) as the first such trend, noting its impact on capex could be pivotal: “We see a valuation gap between less capital-intensive companies and those investing heavily in AI. Interest is shifting from semiconductor manufacturers to software.” He anticipates that AI will drive further growth in trends like reindustrialization and robotics as a means to counter demographic shifts.

Two other secular trends noted by Denize are the growth of the healthcare sector—partly due to AI and scientific advances that enable better diagnostics and new drug discoveries—and the green economy. Specifically, Denize predicts “a rally” in green energy, driven by electrification over other energy sources, and stated, “The market is being very complacent about changes in the energy mix.”

The final secular trend mentioned by Denize is the emergence of new consumption patterns, tied to the widespread adoption of new payment methods. Oddo also anticipates a recovery in the luxury sector by 2025.

Due to these trends, Oddo recommends a defensive positioning for the coming months, favoring stocks tied to utilities, real estate, basic consumption (such as food and beverages), and construction, as they are well-positioned to benefit from both the rate-cut cycle and the trends in electrification and energy transition.

The Quarterly Flows in the European ETF Market Indicate That We Are on Track for Another Record Year

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Flujos trimestrales en el mercado europeo de ETFs

The European ETF industry is on track to reach record numbers in 2024, according to the latest market report from Morningstar. According to its data, the third quarter of the year recorded inflows worth €63 billion, a considerable increase compared to €53 billion in the second quarter. Additionally, assets under management grew by 5.7% during this period, surpassing the €2 trillion mark for the first time. “This increase marks a new quarterly record. Cumulative flows in the first three quarters of 2024 totaled €161 billion, surpassing the 2023 total and the previous annual high of €159 billion recorded in 2021. With one quarter still to account for, 2024 is set to be a record year for the ETF industry in Europe,” Morningstar indicates.

José García-Zárate, Associate Director of Passive Strategies at Morningstar, explains that the European ETF market closed the third quarter with a historic record of €63 billion in net inflows. “Surprisingly, with one quarter still to go, year-to-date cumulative flows have reached €161 billion, surpassing the previous annual record of €159 billion set in 2021. Assets have exceeded the €2 trillion mark for the first time,” he notes.

García-Zárate highlights that most third-quarter flows were directed toward equity strategies, especially U.S. large-cap stocks. “We have observed a substantial increase in interest in equally weighted ETFs in the S&P 500 following market volatility in August. This phenomenon suggests that some investors are concerned about the high concentration in technology stocks in capitalization-weighted indices. There was also an increase in demand for U.S. small-cap ETFs as investors look for tactical opportunities in the context of the interest rate cut cycle, moving away from large-caps. On the other hand, active ETFs, which have gained significant attention, attracted €4.8 billion, representing 7.7% of all ETF flows during the quarter. Although this segment is experiencing triple-digit organic growth rates, it still starts from a very low base: active ETFs represent only 2.2% of total assets in Europe.”

Key Trends

In terms of trends, Morningstar’s report shows that most assets, €1.42 trillion (71%), remain invested in equity strategies. In fact, these strategies captured €41 billion in the third quarter, slightly above the €40 billion in the second quarter. One of the most notable figures is that U.S. large-cap equities remain the most popular market exposure, although there has been a significant increase in interest in ETFs following equally weighted indices, especially the S&P 500. “These ETFs have gained popularity as a risk management tool amid concerns over excessive market concentration,” the report highlights.

Fixed-income ETF assets closed the quarter at €427 billion, accounting for 21.3% of the total. According to Morningstar, bond ETFs attracted €18.8 billion in the third quarter, up from €11.4 billion in the second quarter. “Investment-grade corporate debt ETFs and fixed-maturity bonds were favored, while inflation-linked bond strategies saw outflows,” the report indicates.

Meanwhile, ESG ETFs captured €7.5 billion in the third quarter, compared to €5 billion in the second quarter. According to the report, this increase was driven by a rise in flows toward ESG bond ETFs, while flows into ESG equity ETFs remained practically unchanged at €3.6 billion. “Flows into ESG strategies represented 12% of total ETF flows in the third quarter, up from 9.4% in the second quarter,” the report states.

Finally, active ETFs captured €4.8 billion in the third quarter, slightly above the €4.7 billion in the second quarter, representing 7.7% of all ETF flows during the period. “Strategic beta ETFs recorded net inflows of €3.2 billion in the third quarter, led by equally weighted equity strategy ETFs, while thematic ETFs saw outflows of €1.6 billion in the third quarter, with the largest outflow recorded in the energy transition ETF subgroup,” the report notes as other notable trends. One constant trend is the leadership of iShares, which topped the provider rankings in the third quarter with quarterly flows of €24 billion, followed by Amundi with around €8 billion, Xtrackers with €7.5 billion, and Vanguard with €7 billion.