The Compliance Risk for Alternative Fund Managers Is Increasing

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The level of compliance risk faced by alternative fund managers is increasing and will increase even further in the next two years, according to a new study by Ocorian and Bovill Newgate, a market leader in regulation and compliance services for funds, corporations, capital markets, and private companies. More investment is urgently needed to address the problem.

The international study among senior executives and senior compliance and risk management executives of alternative fund management firms, which collectively manage around $132.25 billion in assets under management, found that nearly nine out of ten (88%) believe the level of compliance risk their organization faces will increase over the next two years. Of these, more than one in ten (11%) believe the increase will be dramatic.

This increase in risk comes against a backdrop of under-resourced compliance teams and an already high level of fines. Of those surveyed, two-thirds (64%) say their compliance management team is already under-resourced, and more than half of them (34%) feel they are significantly under-resourced. Additionally, the number of fines and sanctions is already high: 67% of respondents admit their organization has already been subject to fines or sanctions for risk and compliance in the past two years. Another 9% admit to having received a request for information or a visit from the regulator in the past two years.

Matthew Hazell, Co-Head of Funds, UK, Guernsey, and Mauritius at Bovill Newgate, said: “Our survey shows a worrying context of fines, sanctions, and under-resourced compliance teams within alternative fund managers, against which nine out of ten respondents believe the level of compliance risk their firms face will increase further in the next two years. It is encouraging that the leaders of these firms recognize these future challenges and know they must act now to stay one step ahead.”

The Ocorian study reveals that the top three areas where alternative fund managers believe they need investment over the next 24 months to address the problem are technology (58%), systems to manage processes and procedures (57%), and hiring relevant and knowledgeable staff (53%).

Matthew added: “Companies must have a deep understanding of their own compliance and risk needs and any possible changes to these through growth or organizational change, to invest wisely in the right systems, processes, and people to protect themselves against these future risks.”

“We recommend following a three-lines-of-defense approach to protect your business: firstly, implementing solid procedures, policies, and training; secondly, thoroughly monitoring these; and finally, reviewing and questioning through independent audit,” he added.

Ocorian’s three-lines-of-defense approach to addressing risk and compliance challenges includes, firstly, creating clear and solid frontline processes and procedures, complemented by both online and in-person training programs for staff. Additionally, they call for building and enhancing a comprehensive compliance oversight function that monitors and evaluates processes and procedures, as well as advises and supports staff and senior management to meet the firm’s obligations. Thirdly, they recommend seeking the review and questioning of the companies’ AML framework through annual independent audits.

World Heritage, Taxes, and a Trip Through Europe: Martín Litwak’s Column

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I visited Greece and Italy. In Italy, I explored Rome, Naples, the Amalfi Coast, the Isle of Capri, Bari, Matera, and Alberobello, known for its Trulli, a symbol of the Apulia region.

The Trulli are traditional houses found in the Itria Valley, in Alberobello, notable for their conical stone roofs. They are charming, beautiful, and picturesque. But they also have a story behind them. Is it real history? A legend? Are legends just real stories amplified by word of mouth? Is real history truly real?

Let’s set those doubts aside and move on. The little houses are divine. Everything is divine, but the story of the Trulli, somewhat unclear, tells us they were erected in the Middle Ages. Their name comes from “tholos,” a Greek word meaning “dome” or “cupola.” Initially, the houses were completely made of stone, from the floor to the tip of the cone that now serves as the roof. And the houses were built and demolished according to tax needs. How is that? Patience, I’ll explain.

The houses were built dry, that is, by placing one stone next to another and one on top of another, without any type of mortar, mud, or support other than the stone itself (a waterproof stone called “chiancarelle”). This gave the house some instability but also the possibility of being easily demolished thanks to a vault located in the center, which, when removed, caused the building to collapse. And that’s what their inhabitants, mostly farmers, did.

When taxes of the time went up, the farmers would demolish their stone houses upon hearing of the imminent arrival of the tax collector. This way, they avoided the new settlement tax imposed by the Kingdom of Naples: without a house, without property, there was nothing to pay. At least until the next inspection.

In a way, it’s the same logic behind irrevocable and discretionary trusts today, right? Without property, there’s nothing to pay…

Anyway, let’s get back on track.

When the tax collector’s visits ceased in the 14th century, the houses, which had already adopted the white walls we see today, were rebuilt with mortar to achieve greater stability.

In Alberobello, the most well-known Trulli are considered a UNESCO World Heritage Site. A beautiful recognition for houses built to meet a demand that persists to this day: tax reduction.

Now that I think about it, perhaps the properties in the United Kingdom with some of their windows bricked up since the window tax was introduced in 1696 should also be declared World Heritage Sites.


There’s also the case of French buildings with mansard roofs (attic style), which were also designed to protect their occupants from certain taxes.

I write this while finishing this dream trip and think about the current leaders’ inability to satisfy a centuries-old, logical demand. It happens in Europe, it happens in America, it happens everywhere. In some places, at least, high tax pressure doesn’t demand so much fiscal effort. In most places, regardless of the existing pressure, the effort is discouraging. And that’s why we do, in some way, what the inhabitants of Alberobello did. They, given the possibilities provided by evolution, sought to prevent the taxman from taking the fruits of their labor. They succeeded by tearing down their own houses. Today, we do it by structuring our assets.

We Favor U.S. Equities and Do Not See a Tech Bubble, Says BlackRock

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BlackRock (WK)

BlackRock presented its investment scenarios for the coming months to the media in Mexico, in the context of what it described as “volatile markets that nevertheless offer great opportunities for financial asset managers.”

“We believe that risks can be taken in the markets at this time; although we have high interest rates, which could justify a common investor maintaining their investments in fixed income, with levels that, for example, in Mexico reach 11% annually and in the United States 5% when two years ago they were at 0%, we consider that if we do not see the broader context that dominates the markets today, we miss out on investments that can be very good, for example, the performance of the S&P500 has yielded an accumulated benefit of 18% this year, not to mention that in 2023 it delivered more than 20%,” said José Luis Ortega, Director of Active Investments at BlackRock Mexico and a member of the fund’s investment committees in the region.

“These interest rate levels that we see both in Mexico and in other parts of the world can sometimes lead us to see ‘mirages’ and miss out on equally or more profitable investments, passing up opportunities to maximize benefits for investors,” said Sergio Méndez, General Director of BlackRock Mexico, who was also present at the media meeting.

There Is No Tech Bubble, We Favor U.S. Equities

“Is there a bubble?” managers and investors ask themselves in light of the stock market’s performance on Wall Street, specifically in the technology sector, which reported a 22.56% gain for the year as of Friday’s close. The BlackRock specialist responds.

“One of the stocks that have led this growth is Nvidia’s. Two years ago, it was below $20; by 2023, it had already recorded a 100% gain, trading above $40, and many people thought we were in a bubble with that performance, but it is currently trading at $130. And if we look at Nvidia’s valuation today with projected future earnings, it is not more expensive than it was two years ago,” explained the head of investments at BlackRock Mexico.

“The amount of profits that this chip company linked to artificial intelligence is generating justifies those valuations, which is why we do not believe there is a tech bubble. We consider the valuations to be justified and believe that the good performance of the technology sector can continue, which is why when we apply it to portfolios, we particularly like having exposure to equities, especially in the United States, due to this technological theme that we believe will continue to be important going forward,” said José Luis Ortega.

The BlackRock executive compared the 2001 versus the current scenarios in Wall Street’s technology sector; he recalled that in 2001, the dot-com collapse was caused by a bubble inflated solely by expectations, with valuations of companies that had nothing concrete. Today is different; the technology industry now does valuations based on recorded profits, making prices more solid.

“We maintain a positive view on taking risks, favoring equities at this time, particularly those in the United States, although we also like other regions like Japan and the United Kingdom, as we believe their valuations are very attractive in both markets. In Japan’s case, we have a central bank with a monetary policy that, while likely to normalize, will not become restrictive, providing significant support to the Japanese stock market,” said the BlackRock executive.

In the debt segment, the investment manager warns that they will continue to seek to capitalize on the short-term income generated, as it is undeniable that 11% in Mexico and 5% in the United States versus 0% a few years ago is very attractive. It is impossible to pass up the opportunity to have investments generating such levels of return with virtually no risk.

However, the fund’s director of investments in Mexico reiterated their desire to capitalize on the equity opportunity they foresee, especially in the United States, as this will allow for more attractive returns for their portfolios in the time horizon.

Be Agile

Despite the current central scenario being linked to risk-taking due to the optimism they perceive in the equity markets, especially in the technology sector, BlackRock also warned that they must remain agile, constantly reviewing the structure of their investment portfolios to make the best investment decisions in changing scenarios.

For example, the great revolution of artificial intelligence will likely be a deflationary factor for the world in the long term, but while all those investments and technological developments are being realized, significant inflationary forces are very likely in the short and medium term.

Therefore, it is important for investment managers to remain agile to capitalize on opportunities that may arise while simultaneously protecting portfolios from inherent risks. Today, it is not possible to stick with a fixed portfolio or investment.

3 Factors Likely to Drive Fixed Income Markets in the Near Future

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So far this year, the macro backdrop for fixed income markets has been ever changeable, reflecting the uncertainty and volatility that investors have had to navigate. The market narrative has been a roller coaster, jumping from one concern to the next, month after month. As we reach the halfway point of the year, it is crucial to understand the factors that are shaping these markets and how they affect fixed income investment decisions.

To shed light on these issues, we enlist the expertise of Colin Finlayson, fixed income portfolio manager for Aegon Asset Management’s strategic global bond strategies. With an insider’s view, Colin analyzes three key factors that are driving fixed income markets today: inflation, economic growth and the interest rate policies of the major central banks. His analysis will give us a better understanding of the underlying dynamics and how these may influence fixed income investment strategies in the coming months.

Starting with inflation, what have you seen so far this year and what are your expectations for the second half of the year?

Inflation has probably been the most important news so far this year, especially in the United States. We have seen the steady decline in inflation become a bit slower and stickier. And this has raised some concern about the degree of interest rate cuts the Fed will be able to implement this year. The Fed’s preferred measure, the underlying PCE deflator, has been moving gradually lower. But the question is whether it is moving enough for the market.

Across the Atlantic, the story is quite different. Inflation has been surprising to the downside fairly steadily in Europe, and the UK is seeing inflation return to the Bank of England’s target, having recently hit 11.1%. This continued decline in inflations is help give some confidence to fixed income markets and is offering support to the outlook for government bonds and therefore broader bond market yields.I wanted to ask you about growth… What is your outlook for growth and how does it affect fixed income investors?

There has been an ongoing debate about whether we are going to see more of a soft landing for economic growth or more of a no-landing scenario where growth starts to reaccelerate. In Europe and the U.K., we have clearly been on a soft landing trajectory as growth has been at more recession-like levels, unemployment has started to rise and the impact of higher interest rates is starting to be seen in household demand and spending.

In the United States, however, growth has been somewhat more robust. The US has benefited from greater resilience in the labor market, but also from earlier fiscal spending, which has been percolating through the system. During the first few months of this year, it looked like there were going to be steady upside surprises in US GDP. But in fact, first quarter growth was weaker than expected and was revised down again in its most recent reading. So in the US, which looked set to deliver more upside surprises, growth is starting to moderate, which is reflected in business surveys, such as the ISM, which are starting to soften. The idea of a soft landing is starting to become more apparent in the US and, again, this is a backdrop that would be more beneficial for bond markets than a no landing scenario, which was feared earlier this year.

I wanted to ask you about growth… What is your outlook for growth and how does it affect fixed income investors?

As far as official interest rates are concerned, central banks are now considering only two paths: hold them or cut them. The European Central Bank (ECB) has already lowered rates along with the Bank of Canada, the Riksbank and the Swiss National Bank, and we believe other central banks will follow suit. With monetary policy at tightening levels, there is no need to keep rates at these elevated levels for an extended period of time. We believe that the Bank of England will be the next major central bank to cut rates and that the US Federal Reserve will follow.

From a fixed income investor’s point of view, the fact that we are talking about rate cuts rather than rate hikes is the most important factor. With growth slowing and inflation returning to target, we expect interest rates to come down at a gradual pace in the coming period. And this will help support fixed-income markets over the next 12 to 24 months.

How do these factors influence the management of Aegon Asset Management’s fixed-income portfolios?

The macroeconomic backdrop is constantly changing, and we try to cut through the noise to construct portfolios with a long-term view of where we believe there is value in fixed income markets. Strategic global bond portfolios are designed to be flexible and unconstrained and can use their flexibility to take advantage of anomalies that arise as data evolves and market value changes. Given our outlook for inflation, growth and interest rates, we believe portfolios with a more flexible approach are well positioned to benefit from changing market conditions over the next 12-24 months.

 

Four Trends Hovering Over the Market: Geopolitics and Economic Transformation, Sustainability, Technology, and Demographics

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Amundi Shares Key Insights from the 2024 Edition of its Global Forum, Amundi World Investment Forum. The event featured in-depth discussions on geopolitical issues, economic transformation, major global macroeconomic trends, and their implications for investment.

In her opening speech, Valérie Baudson, CEO of Amundi, shared her convictions about the state of the world: “The economic outlook is improving, with global GDP growth around 3% in 2024 and 2025. Meanwhile, history and geopolitics are back in focus, with energy transition and technological innovations at the center of geopolitical tensions, as they condition nations’ ability to maintain or gain power.”

The firm shared several key conclusions. The first is that major political and economic changes threaten long-standing trade and security alliances. According to the firm’s perspective, global politics affecting economies was a prominent theme among the speakers. Sanna Marin, Prime Minister of Finland (2019-2023), focused her talk on the current conflict in Europe, stating, “A major game is being played between democracies and authoritarian regimes. What is happening in Ukraine will define the future of democracy.” She urged Europe and NATO to offer “broader perspectives” and reminded that “geopolitics is not the only threat facing humanity; climate change and biodiversity loss are also critical.”

Adam S. Posen, President of the Peterson Institute for International Economics, predicted, “Markets will push interest rates up in the coming years.” Ricardo Reis, A.W. Phillips Professor of Economics at the London School of Economics, explained public debt movements by three factors: “The large current account deficits of China and the rest of Asia caused a significant capital flow into Europe and the United States, investment stagnation due to very few opportunities in the 2010s, and the perception of government bonds as very safe with little inflation risk. Today, all three factors have reversed.”

Additionally, Keyu Jin, Professor of Economics at the London School of Economics, estimated that “the three fastest-growing economies in the coming years will be in Asia: China, India, and Indonesia,” and spoke about “the need for convergence” in the region: “China has room to converge with richer countries, and India also has enormous room to converge with China.”

Gordon Brown, Prime Minister of the United Kingdom (2007-2010) and Chancellor of the Exchequer (1997-2007), concluded the first day of debates with a message of hope, stating, “Even in the most difficult circumstances, even when things are very dark, we must keep hope alive. There are still signs of hope in this global economy that we must build upon, as Mandela said, ‘building for the future.’”

Sustainability, Technology, and Demography

The decarbonization of economies was a major focus. Dinesh Kumar Khara, Chairman of the State Bank of India, highlighted the “immense” potential of his country: “We are now embarking on green energy, which is being adopted significantly.”

Two case studies were presented: Chee Hao Lam, Chief Representative of the Monetary Authority of Singapore at the London Office, discussed how Singapore articulates public policy and mobilizes investors to finance the energy transition. Dr. Kevin K. Kariuki, Vice President of Power, Climate, and Green Growth at the African Development Bank Group, spoke about financing green energy infrastructure in a continent that “needs $25 billion annually to achieve universal access to modern energy by 2030.”

The firm also reflected on how the rapid acceleration of technological development has created new opportunities and pressures. Maurice Levy, Chairman Emeritus of Publicis Group, opened the second day’s debate with a focus on the rise of generative artificial intelligence. In his view, “On one hand, people think AI is probably the dream of tomorrow, which will change lives, especially for companies, their productivity, and profitability. At the same time, there is fear of job cuts and replacement, but most importantly, we need to address the implications regarding the use of deepfakes in democracy.”

Daron Acemoğlu, Professor at the MIT Institute, stated, “The key decision for CEOs will be how to use AI with workers, with human resources: whether they see workers as a cost to be cut or as an important resource that will contribute to their company’s success.” Aurélie Jean, Ph.D. and Computational Scientist, entrepreneur, and author, complemented this statement: “AI does not sufficiently protect workers. Technology owners, developers, scientists, and engineers have a responsibility to provide users with the correct information; they must protect while also fostering innovation.”

Experts remind us that financial services are at the heart of the AI revolution. “There is a huge opportunity to turn European savers into future European investors, and if AI can help with that, it will contribute to a better society,” said Dr. Kay Swinburne, Baroness of Swinburne.

Finally, the firm believes that demographic change is influencing many aspects of our lives. Mauro Guillén, Professor of Management and Vice Dean at the Wharton School, stated, “The key question is how to ride the wave of demographic transformations. India will soon have the largest consumer market in the world due to its younger population, although China will have the largest economy.” Demographics will impact investment trends, as “most of the world’s wealth, between 60% and 80% depending on the country, belongs to people over 60 years old.” Hence the need for “investment platforms to be safe, educational about risks and opportunities, and accessible” for all.

Liquidity Challenges in Private Equity: Where are the Bright Spots?

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Pixabay CC0 Public Domain

If there’s one topic that has dominated the minds of private equity investors in recent months, it’s liquidity. It is so present that you can now even buy T-shirts on Amazon emblazoned with the phrase “DPI is the new IRR”. DPI, or Distributions to Paid-in Capital, measures how much capital a fund has returned to its investors relative to what has been called. Putting DPI ahead of the industry’s widely promoted performance metric IRR (Internal Rate of Return) sends a clear message to managers: stop focusing on returns and start selling stakes to generate liquidity.

The private equity industry is currently experiencing a severe downturn in deal activity. According to S&P Global Market Intelligence, global deal volume fell by 34.7% year-on-year in 2023, reaching its lowest level in five years. Economic uncertainty, public market volatility and geopolitical tensions have made General Partners (GPs) hesitant to sell their stakes, fearing they won’t achieve their desired outcomes. IPOs, in particular, have been almost nonexistent over the past 12 months. As a result, many LPs have received significantly less capital back than in previous years.

Sustained Interest in Private Equity

Distributions from successful exits are, in general, a meaningful source of capital for investors to meet calls on previous commitments. Pension funds, insurance companies and other large investors typically rely on this liquidity stream as they often adhere to allocation guidelines that limit their exposure to alternative investments. When GPs extend their holding periods beyond the typical timeframe, these LPs not only must seek alternative liquidity sources but also face a temporary reduction in their ability to make new commitments to the asset class.

To fully grasp investors’ growing impatience with private equity managers, it is worth looking at the current market phase we are in. Historical data shows that funds launched immediately following recessionary periods have consistently outperformed their peers. Bain & Company has compiled a comprehensive overview of the annual returns achieved by global buyout funds since 1993. For instance, after the dotcom bubble burst, the average IRR for buyout funds was 25% in 2001, 40% in 2002, and 48% in 2003. Similarly, following the global financial crisis, the IRR was 22% in 2009.

Investors Favor Lower Mid-Market Buyouts

Now, with inflation seemingly under control, the European Central Bank has recently initiated its first interest rate cut, setting the stage for an expected economic rebound. LPs also appear to be anticipating a turnaround, as interest in the asset class remains strong. A survey by Natixis of 500 institutional investors globally reveals that over a third plan to increase their private equity allocations in 2024.

However, today’s LPs are more discerning. Unlike in previous years, when money was cheap and almost all private equity segments were thriving, they are now carefully evaluating which sub-segments to include in their portfolios. Recent surveys shed light on the lessons they may have learned from recent market turmoil. Rede Partners, an advisory firm specializing in alternative investments, reports that 50% of institutional investors plan to increase their commitments to lower mid-market buyouts – funds focusing on majority stakes in small and medium-sized companies. A further 46% favor mid-market investments. Large-cap funds, by contrast, are less preferred, with only 10% planning to increase their allocations in 2024.

Stable Distributions Due to a Larger Buyer Pool

Smaller deal sizes naturally lead to a larger pool of potential buyers compared to the large-cap segment where IPOs are often one of the very few available exit channels. Lower mid-market managers typically sell their stakes to a wide range of financial or strategic investors, such as competitors; exit channels that have – for high quality assets – remained open despite the numerous macroeconomic challenges. As a result, distributions to LPs have been relatively stable in the lower mid-market.

That said, the rising appeal of the lower end of the market can also be attributed to additional structural advantages, which become particularly apparent in challenging times. By far the most important is the greater potential for value creation through operational and strategic measures. Medium-sized companies are typically more flexible than large corporations, allowing them to respond quickly to current challenges and seize short-term opportunities, particularly when working alongside an experienced private equity investor. In addition, entry prices and leverage ratios are typically lower, leading to an attractive risk-return profile.

Focus and access are key

Yet it is important to recognize the remarkable heterogeneity of the lower mid-market, characterized by a wide range of manager performance. And: Access is crucial. Managers with proven track record in navigating economic turmoil are in high demand, continuing to complete their fundraising in record time and with significant oversubscription. Given the ongoing economic complexities, we expect to see an even greater concentration on this group of exceptional managers. As a result, focus and access will become increasingly critical to investment success.

A Strengthened Trump Could Translate Into Higher Demand for Safe-Haven Assets and More Risks in the Markets

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The failed assassination attempt on Donald Trump this weekend during a rally in Pennsylvania brings a new direction to the US presidential race, improving his chances of victory. Additionally, according to experts, this event, which has dominated headlines since Saturday, could lead investors to seek safe-haven assets such as the dollar, gold, the Swiss franc, government bonds, and high-quality stocks.

In the opinion of Christian Gattiker, Chief Analyst at Julius Baer, regarding the political impact, Donald Trump’s election chances have increased dramatically. “If successful, this would mean a shift towards a more risk-taking mode in the markets, with higher expected growth in 2025 due to lower taxes and business-friendly policies,” he points out.

The experts at Renta 4 Banco share a similar assessment in their daily morning report: “The assassination attempt on Donald Trump this weekend could strengthen his chances of victory in the November presidential elections, as well as further increase political tension in the US.”

Bloomberg adds that it not only strengthens Trump’s position but also opens a new front for his opponent. “US President Joe Biden now finds himself fighting a re-election battle on two fronts: against Donald Trump and, more immediately, against some skeptics in his own party.” In this regard, Biden insisted to the press during Thursday’s press conference following the NATO meeting in Washington that “I am determined to run, but I think it’s important to allay fears.”

So far, around 20 Democratic House members and one Democratic senator, Peter Welch of Vermont, have publicly called for Biden to withdraw from the race against 78-year-old Trump, according to Bloomberg’s count.

Regarding the market, the Chief Analyst at Julius Baer believes that “it is quite possible that safe havens such as the US dollar, gold, the Swiss franc, seemingly safe government bonds, and high-quality stocks will be sought in the short term.” However, Gattiker clarifies: “If we believe the well-informed experts on US politics, the realization that Donald Trump’s election chances, and those of the Republicans in general, have significantly improved could settle in quickly, possibly even during the Republican National Convention this week. It is quite possible that we will see an iconic image of a raised fist against a bright blue sky as a defining moment of this campaign and beyond, which could be seen as a decisive moment in the election. This, in turn, would mean a shift towards a more risk-taking mode in the markets, with higher expected growth in 2025 due to lower taxes in the US and more business-friendly policies. How quickly this turnaround can occur largely depends on how quickly and successfully the Republicans can turn this shock into political capital,” he argues.

Inflation Data for June in the US: Is It the Clear Signal the Fed Was Waiting for to Lower Rates?

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Markets and investors are confident that the US Federal Reserve (Fed) will announce a first rate cut in September. The argument supporting this conviction is the positive inflation data for June in the US: the year-over-year headline indicator showed an increase of 3%, lower than the expected 3.1% and down from 3.3% the previous month; and the core CPI surprised with a cut of one-tenth from the previous figure, reaching its lowest level since April 2021.

“On a monthly basis, the headline rate turned negative for the first time in nearly four years, with a -0.1% versus the expected 0.1% and the flat variation of the previous month. Overall, this confirms the trajectory towards the 2% target, although fluctuations may occur in the coming months,” explain analysts at Banca March.

By components, Banca March notes that both services and goods contributed less to inflation. “For services excluding energy, the variation was only 5%, the lowest rate since April 2022, contributing 3% compared to 3.11% the previous month. This was mainly due to a significant slowdown in attributed rents: 5.4% in June, the lowest growth since May 2022, compared to 5.6% previously, contributing 1.4%. As for goods prices, they declined at a rate of 1.84%, the biggest drop in 20 years, thus subtracting 0.40% from inflation. Finally, there was also a sharp slowdown in energy, growing by 0.99% compared to 3.67%, contributing only 0.08% versus 0.26%,” they detail in their daily analysis.

According to Banca March, it is undeniable that this is a good data point, reflected in market behavior. “It boosted bond prices on both sides of the Atlantic, leaving 10-year rates in the United States at their lowest levels since late March, and in Germany, the 2.5% level was breached again. Additionally, interest rate futures raise the chances of cuts in September to 90%, making it practically certain,” they add.

September: Rate Cut

In light of this macroeconomic data, combined with the outlook on the labor market and the US economy presented by Fed Chairman Jerome Powell this week during his testimony before the Senate Banking Committee, the first rate cut in the US is set for September. According to Ronald Temple, Chief Market Strategist at Lazard, at this point, a rate cut in September should be a “done deal.” “In the second quarter, the overall inflation rate in the US was 1.1%, with core inflation at 2.1%, making it increasingly evident that the upward surprises in the first quarter were anomalies. Given the growing evidence of slowing economic growth, it is time for the Federal Reserve to refocus on the dual mandate and ease monetary policy,” Temple argues.

For John Kerschner, Head of US Securitized Products and Portfolio Manager at Janus Henderson, both the headline and core CPI were weaker than expected, giving the Federal Reserve the unequivocal signal that it will start lowering rates by the end of the year. “With less than three weeks until the next Fed meeting, the market is currently pricing in that it will skip that meeting and make its first cut in September. The probability of a cut at that meeting is now close to 100%, according to the market. More importantly, the market now expects three cuts by the end of January 2025. Chairman Powell recently said that inflation risks are now more ‘balanced.’ Yesterday’s figure reinforces that view and may now tilt the balance toward concern over a sharper slowdown in the US economy,” Kerschner states.

There is a clear consensus that weaker US inflation data strengthens the case for a rate cut at the September Federal Open Market Committee meeting. “Along with softer economic data, including a cooling labor market, this has increased confidence that inflation will tend to decline in the coming months. We lower our US inflation forecast to 3% in 2024 and 2.2% in 2025. We still expect the Federal Reserve to cut rates in September and December 2024,” acknowledges David Kohl, Chief Economist at Julius Baer.

According to Kohl, the decline in inflation in June follows a moderation in May and reinforces the view that the Fed will cut the federal funds rate target at its September meeting. “Weaker economic data, including a cooling labor market, also increases our confidence that inflation will decelerate further in the coming months and that the Federal Reserve will cut the target rate again at its December meeting. We lower our annual inflation forecasts for 2024 from 3.2% to 3.0% and for 2025 from 2.3% to 2.2%,” he concludes.

However, there are also dissenting voices in the industry. According to experts at Vanguard, despite the turn taken by the unexpected strength of the US economy, the events of the first half of 2024 have reinforced their view that the environment of higher interest rates is here to stay. “The current economic cycle is not normal. The global economy is still settling after unprecedented economic shocks that include a pandemic, a war in Ukraine, and rising geopolitical tensions. Structural changes, such as an aging population and rising fiscal debt, also make it difficult to decipher the economic cycle from the trend. This creates a challenging environment for central banks, markets, and investors,” says Jumana Saleheen, Chief Economist for Europe at Vanguard.

CME Group and CF Benchmarks Announce Two New Cryptocurrency Indices

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CME Group and CF Benchmarks announced plans on Thursday to launch two new cryptocurrency reference rates and real-time indices for Ripple XRP (XRP) and Internet Computer (ICP), which will be calculated and published daily by CF Benchmarks starting July 29.

These reference rates and indices are not tradable futures products.

“These new reference indices are designed to provide clear and transparent pricing data to a wide range of market participants, enabling them to more accurately value portfolios or create structured products,” said Giovanni Vicioso, Global Head of Cryptocurrency Products at CME Group.

With 24 cryptocurrencies in our suite of CME CF Reference Rates and Real-Time Indices, “we will provide pricing data across more than 93% of the investable cryptocurrency market capitalization, helping clients around the world better manage their risk,” Vicioso added.

As with all CME CF Benchmarks reference rates and real-time indices, these new reference indices will use price data from major cryptocurrency exchanges and trading platforms that are currently constituent exchanges of the CME CF Benchmark reference rate and real-time index suite, the statement said.

Each of the new reference indices will be calculated using price data from a minimum of two of the exchanges Bitstamp, Coinbase, Gemini, itBit, Kraken, and LMAX Digital.

“CF Benchmarks is proud to continue supporting the expansion and maturation of this asset class as clients begin to distribute their activity across a wider range of cryptocurrencies,” said Sui Chung, CEO of CF Benchmarks.

Each of these new reference indices will provide the price in US dollars of each digital asset, published once a day at 16:00 London time, while each respective real-time index will be published once per second, 24 hours a day, 365 days a year.

From Slogan to Numbers

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This week marks the beginning of the Q2 earnings reporting season in the U.S.

Approximately 42% of S&P 500 companies (213 in total) will report their performance by the end of the month. As usual, banks will be the first to report and are expected to detract the most from overall financial sector earnings growth (-10%), whereas excluding banks, the aggregate earnings per share (EPS) for insurance companies, capital markets, and other financial services firms would increase by ~15% (compared to the 4.3% estimated by consensus for the industry).

At first glance, the performance of banks (BAC, C, WFC, JPM) will likely be similar to the previous quarter. The yield curve remains inverted, long-term bond yields have increased by 0.17% during the period (compared to a 0.3% rise in the first three months of the year), loan growth continues to moderate, and while net interest income will also maintain a moderate growth rate, management teams might provide positive comments regarding a bottoming out of the margin. More clarity on the news reported by Reuters about comments on Basel III “Endgame” capital rules by the Fed would boost the share prices of major banks.

Broadening the perspective, according to S&P data, the consensus among analysts expects S&P 500 EPS to grow by 5.74% for the April-June quarter compared to the same quarter last year. Strategists and managers are betting on a positive EPS surprise below the average of recent quarters, placing this growth in the 7% – 8% range. The twenty companies that have pre-announced have reported ~+4% above consensus, justifying this bet.

The numbers are heavily skewed towards the contribution of the technology and communication services sectors. Earnings for Microsoft, Amazon, Apple, Meta, Nvidia, and Alphabet are expected to grow by 32%, while non-tech industries will only grow by ~2%. This starting point increases uncertainty regarding the outcome of the quarterly performance announcements because, on one hand, the EPS growth of these tech companies is slowing down (from 68% in Q4 2023 to 56% in Q1 this year). On the other hand, margins are unlikely to improve much further.

The consensus projects operating margins of 12.5% for the S&P (an increase of 5.3% from last year, still below the 2021 peak of 13.54%), with a 30.87% contribution from technology and communication services.

Therefore, it is important to pay attention to the comments from the management teams of hyperscalers regarding their plans to deploy around $200 billion in capital investments, with a significant portion associated with generative AI developments announced last quarter.

Everything has its limits, and while generative AI remains a priority for tech companies from an investment perspective, monetary commitments of this magnitude could negatively impact return on invested capital (ROIC) if not adequately monetized, and this is not simple or quick to achieve.

Nvidia’s cadence in launching new products helps build an AI offering more efficiently in the medium term, although in the short term, the price to pay starts to concern investors.

Blackwell, Nvidia’s new GPU chip, which will be marketed around 2025 and installed in the AI server GB200 NVL72, provides up to 30 times more performance than a rack configured using the same number (74) of Hopper GPUs (H100, the model preceding Blackwell) for large language model inference, while reducing energy consumption per computing unit (FLOP). The new system is also four times faster in training AI models than the previous version. However, these impressive improvements are not cheap. The price of two 16 GPU H100 systems is $400,000, and according to some analysts, the GB200 NVL72 could cost $3.8 million.

Nvidia is undoubtedly the clear winner in the AI leadership race, as demonstrated by its numbers. Analysts estimate more than $200 billion in revenues for the data center business by 2025, which generated $48 billion in 2023, translating to a compound annual growth rate of 63%. However, according to a Morgan Stanley survey of Chief Information Officers, AI investment momentum is slowing, and passing on such significant price increases to customers, despite efficiency improvements, may become more challenging.

Experts in the field expect continued spending on increasingly costly and complex large language models (LLM) development, which could cost between $10 billion and $100 billion by 2027, according to the CEO of Anthropic in this interview. And investors have no reason to doubt.

If Microsoft, Alphabet, Meta, or Amazon suggest slowing their investments or taking a more patient approach, these same investors might start to waver.

As explained earlier, the good performance and maintenance of guidance by tech companies are necessary for analysts to maintain their aggressive earnings growth targets, averaging 12.85% per quarter for the next five quarters. This is possible but increasingly challenging if, as mentioned last week, the recovery in industrial activity begins to cool.

Arguments in favor of a first rate cut in the U.S. in September are mounting after Thursday’s CPI and Jerome Powell’s comments: the Fed chair stated in his testimony this week that inflation “is not the only risk we face.” However, while the compression in public debt yields benefits the valuation of growth companies like software or semis, managers seem too focused on the return of disinflation but not enough on the slowing growth – which is becoming increasingly evident – and the volatility that the presidential campaign will bring starting in September.

Biden’s intervention at the NATO meeting was much more solid than his debate with Trump, and his intention is to run for re-election, although there are increasing domestic (both political and non-political) and international pressures for him to step down.

The aggregate polling provided by RealClearPolitics gives Donald Trump a 47.2% voting intention compared to 44.2% for Joe Biden. Although isolated polls like ABC News (46-46) or Reuters/Ipsos (40-40) show a more uncertain situation, Trump still has the electoral college count on his side, even if he loses the popular vote. Of the 10 states that could tip the balance – with results within 5 points – he would emerge victorious in 7 of them.

Jensen Huang, CEO of Nvidia, said at his developer conference in California that, despite the rising cost of their GPUs, “the more you buy, the more you save.”

The math is correct, but investor sentiment’s volatility and a less dynamic economic activity could suddenly shift investors’ focus from the slogan to the numbers.