Asset Allocation for the Second Half of the Year: What Do International Asset Managers Prefer?

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After analyzing the perspectives that asset managers have for the second half of the year, it’s time to ask them about the asset allocation they prefer. We start from a market context that is still anticipating central banks to cut interest rates, especially the Fed. The fact that they have lowered market and investor expectations in this regard has created quite a bit of dispersion in identifying which assets should not be missed from now until December.

According to Dan Scott, head of multi-assets at Vontobel, the second half of the year presents some positive aspects: the resilience of the US consumer, China’s fiscal stimulus, and the incipient recovery of the eurozone contribute to a moderate but steady economic expansion that is likely to continue until the end of 2024.

“However, these positive prospects are not without risks. One of our main concerns is whether interest rates will remain too high for too long, ultimately causing some disruption. In the US, an increase in delinquencies on credit cards and auto loans is already being observed. The continued increase in provisions for bad loans related to the US commercial real estate sector is also a clear indicator that cracks are gradually appearing and will require a policy response,” warns Scott.

Fixed Income

This period of waiting concerning central banks makes one of the most complex allocations to make in fixed income, where durations and maturities have become key tools for investors. In this regard, Kevin Thozet, a member of Carmignac’s Investment Committee, highlights that in public debt, maturities up to two years are favored. “Longer-term rates could yield less, given the optimistic trajectory of disinflation and the increase in public debt at a time when monetary authorities are trying to make safe cuts and reduce their balance sheets. In credit markets, premiums are not far from previous or historical lows,” says Thozet.

According to the Carmignac expert, historically, the combination of low bond yields and low credit spreads has been disadvantageous for the asset class, but the current higher-yield environment means that credit spreads act as a boost to investor returns and a cushion for volatility.

“Fixed income investors were too exuberant about rate cuts earlier this year, but now that markets are not aggressively predicting cuts, fixed income yields are more attractive,” says Vince Gonzales, portfolio manager of the Short-Term Bond Fund of America® at Capital Group. In his view, bonds remain fundamental as economic growth slows and can provide a strong counterbalance to stock market volatility.

Additionally, Gonzales adds that “given the recent tightening of corporate bond spreads, we are seeing better opportunities in higher-quality sectors with attractive yields, such as securitized credit and agency mortgage-backed securities (MBS).” According to his view, mortgage bonds with higher coupons are especially attractive. “These bonds are unlikely to be refinanced before maturity, given current mortgage rates of around 7%,” he notes.

On the other hand, Jim Cielinski, Global Head of Fixed Income at Janus Henderson, acknowledges that the fixed income market is currently very different from a few years ago: “Yields are at levels that typically pay well above inflation and offer the prospect of capital gains if rates fall. Those seeking attractive yields can start here. We see solid prospects for both healthy income and some additional capital appreciation in the next six months.”

According to his stance, they prefer European markets to US ones, as they believe the relatively weaker European economy offers more visibility of a lower rate trajectory. “With an economic backdrop of resilient but moderate growth in the US, a revival of the European economy, and less pessimism about China’s economic outlook, there is a chance that credit spreads will narrow. Among corporate sectors, we continue to prefer companies with good interest coverage ratios and strong cash flow, and we see value opportunities in some areas that have been disadvantaged, such as real estate equities,” says Cielinski.

Additionally, the expert acknowledges that credit spreads as a whole are close to their historical levels, which he believes leaves little room if corporate prospects worsen. “With this in mind, we see value in diversification, especially towards securitized debt, such as mortgage-backed securities, asset-backed securities, and collateralized loan obligations. In this case, misconceptions about these asset classes, combined with the aftermath of rate volatility, have made spreads and yields offered appear attractive. Yields in the securitized sectors are more attractive in historical terms, and they are more likely not to be affected by a more severe slowdown,” he concludes.

Don’t Forget Equities

Wellington Management argues that their position is to continue overweighting equities. “The global economy is growing steadily, and the risk of recession has faded, with strong and continuous US economic growth and an increasing momentum of global growth. Although disinflationary pressures have stalled in recent months, especially in the US, we still believe that rates have peaked in this cycle and expect a relaxation of monetary policy in the next 12 months,” explains Wellington Management’s multi-asset strategy team.

Consequently, they add, this makes them prefer the US and Japan over Europe and emerging markets. “We consider the former as our main developed market due to the macroeconomic context and our confidence in the potential of AI to continue underpinning earnings growth. We have a moderately overweight view on Japan and remain skeptical of a material improvement in China, given the real estate and consumer confidence issues,” they add.

“Conditions appear favorable for US and Japanese equities to extend their good streak. The solid growth and healthy earnings of the former, coupled with the structural drivers and corporate reforms of the latter, partly justify the increased valuations in these regions, but not entirely; thus, especially in the US, we are going beyond the hottest areas of the market to uncover opportunities. Mid-cap stocks offer solid long-term growth potential at reasonable prices and should also withstand higher rates,” adds Henk-Jan Rikkerink, global head of Solutions and Multi-Assets at Fidelity International.

For its part, abrdn has also increased its conviction in developed market equities, which will benefit from interest rate cuts and solid corporate fundamentals. “The Japanese equity market remains particularly interesting, as its companies are increasingly focusing on shareholder profitability thanks to a cultural shift in buybacks and corporate governance in general. The Japanese market has exposure to a variety of companies well-positioned to benefit from demand for both artificial intelligence and the green transition. We also find European and British equities interesting, given the recovery in activity, valuations, and (at least in the case of the UK) the potential return to a more stable political environment,” says Peter Branner, Chief Investments Officer at abrdn.

On the other hand, Branner believes that Chinese equity valuations seem attractive but face the country’s real estate market problems. “The Indian market should benefit from strong growth and structural reforms, but Narendra Modi’s reduced government majority may limit the scope of the country’s reform agenda, and valuations already discount a lot of good news,” adds the CIO of abrdn.

Alternatives and Currencies

Finally, Branner acknowledges that they have improved their view of the alternatives segment after two years of underweighting. “Rate cuts, limited supply, and strong rental growth mean that the valuation adjustment is largely complete. Structural factors favor the residential sector, data centers, and logistics,” he highlights.

Fidelity International Updates Its Sustainable Investment Framework and Creates Three Major Categories

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Fidelity International has revised its sustainable investment framework to adapt to changes in this field, in line with client needs and environmental, social, and governance (ESG) regulations. As the management company reminds us, sustainability is an essential element of Fidelity’s active investment approach.

The company has a robust investment analysis methodology that incorporates sustainability into its fundamental analyses and integrates its proprietary sustainability ratings with insights generated by its equity, corporate debt, macroeconomic, and quantitative analysts to obtain a comprehensive view of the companies and markets it studies.

They explain that this framework has been designed to complement the company’s overall investment approach and provide clients with greater clarity and transparency. Within this revised framework, which will be applied starting from July 30, 2024, Fidelity has created three major categories: ESG Unconstrained, ESG Tilt, and ESG Target.

Regarding these categories, they explain that ESG Unconstrained comprises products that seek to achieve financial returns and may or may not integrate ESG risks and opportunities into the investment process. “The products in this category apply the exclusions that Fidelity has adopted for the entire company,” they clarify.

In the case of the ESG Tilt category, it comprises products that seek to generate financial returns and promote environmental and social characteristics by favoring issuers with better ESG performance than the benchmark index or the product’s investment universe. Additionally, products in this category adopt the exclusions from the ESG Unconstrained group and apply others, such as tobacco production, thermal coal mining, thermal coal power generation, and certain public sector issuer exclusions.

Thirdly, in the ESG Target category are “products that seek to generate financial returns and prioritize ESG or sustainability as a key investment objective, such as investing in ESG leaders (issuers with superior ESG ratings), sustainable investments, sustainable themes (such as climate change or transition), or complying with impact investment standards. Products in this category are subject to the reinforced exclusions mentioned earlier and may apply others.”

On the occasion of this announcement, Jenn-Hui Tan, Director of Sustainability at Fidelity International, stated: “We have long been committed to sustainable investing and have continued to evolve our approach and capabilities in line with client needs and ESG regulations. Integrating sustainability into investment analysis and portfolio construction is part of our core process of identifying the drivers of long-term value creation. The objective of our revised framework is to facilitate the creation and maintenance of a consistent, transparent, and practical range of investment capabilities that cover changes in client needs and regulation. We believe this framework appropriately combines a robust approach to sustainability with a flexible approach that can accommodate different investment styles, asset classes, and client preferences.”

New Trends in Private Markets

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The growth of private markets has so far been primarily driven by the demand from institutional investors such as sovereign wealth funds, insurers, or pension funds, among others. However, various experts from M&G Investments note the expansion of the topics of conversation around private markets, as well as a greater interest in different forms of access to them, such as through impact strategies. “There are three major changes in this market that are too significant to be ignored: the size of the opportunity set, the increase in the number of geographies, and the very definition of what private assets are, which has broadened,” says Ciaran Mulligan, CIO of Investment Management and Oversight and co-director of M&G Life’s Treasury and Investment office.

Opportunities by Segments

The global financial crisis marked a turning point for private markets from a credit origination perspective, transferring much of the prominence held by banks to more agile players in the market. Emmanuel Deblanc, CIO of Private Markets at M&G Investments, states that to operate in private markets, “size and having a good name are important, because they inspire confidence in banks, which has a multiplier effect in making banks feel comfortable with underwriting assets.”

The expert also notes that the investment ecosystem has evolved, exemplified by the presence of many infrastructure funds now having their own financing teams, enabling them to attract flows beyond banking. He also observes that the role of banks has evolved, now acting more as facilitators than in the past, advising on transactions without necessarily taking positions on their balance sheets.

Deblanc adds that the emergence of large structural investment themes is also affecting this investment universe, specifically citing the climate transition: “It will provide key growth for this asset class, allowing access to thematic investments in energy and social infrastructure.” “Investments in energy transition open up a significant investment charge by risk and volume; we are seeing much faster growth than expected five years ago, accelerated by the geopolitical events of recent years,” adds the expert.

Regarding private credit, Deblanc states that the investment universe has expanded and matured significantly, though it remains an “inefficient, very complex market where understanding the local context is necessary.” Ciaran Mulligan adds to these observations the increase in capabilities in Europe and, to a lesser extent, in emerging markets, where professional investors like M&G are beginning to consider the possibilities presented by this universe through leveraged loans, direct lending, and corporate debt. The expert clarifies that the investment horizon is crucial for investing in this asset class, with a recommended duration of 15 to 25 years. With this in mind, operations “will take into account that debt levels will increase in the future.” Specifically for M&G, the private credit investment strategy focuses on companies with revenues between 40 and 100 million euros, considering it a segment with less activity.

Structured credit is the last segment Deblanc cites, particularly in the ABS segment. The expert recalls that this is a market with “fewer players because it is a complex asset in a closed market,” but in return, it offers the possibility of a differential with additional points of profitability. The expert observes that capital requirements have increased, a trend accelerated by the collapse of Silicon Valley Bank, opening new opportunities for investors in “a very sophisticated market segment.”

M&G Investments manages 84 billion euros in private assets, with the largest segment being real estate, with over 39 billion.

A Transition Phase

Deblanc does not see systemic risk in private markets and considers the current environment, where global GDP will move between 2% and 3% and there is no excess demand, to be benign for this investment universe. That said, he notes that the market is undergoing a transition phase, as the large gap that used to exist between buyers and sellers is narrowing. This is a trend he believes will accelerate from the fourth quarter of 2024, leading to increased dispersion among managers: “Good managers will become more visible,” he concluded.

Neal Brooks, Global Head of Product and Distribution at M&G Investments, admits that the growth of the private assets market has slowed in recent months due to the ‘higher for longer’ environment, but he expects demand to remain to the point that he anticipates the total investment universe to reach 13 trillion dollars by 2028, primarily in three areas: infrastructure, private equity, and private debt. Brooks speaks of growing appetite from clients, but also from governments and regulators, which he believes will open up markets by allowing access to a larger number of companies. This growth, according to the expert, will occur at the expense of other vehicles traditionally used to gain exposure to these markets, such as hedge funds.

Finally, Brooks highlighted the importance of the current moment in terms of developing product strategies that are accessible to a wide range of investors, noting that currently, 80% of companies with over 100 billion in revenue are not publicly traded. This is compounded by the increasing trend of public companies being delisted to become private again. M&G is advancing in developing new structures to facilitate this access, for example, through the launch of ELTIFs. “Financial education is very important; clients themselves are aware that they need it to help them allocate their capital correctly,” Brooks concluded.

Santander AM to Appoint Pablo Costella as New Head of Fixed Income in Latin America

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Santander AM, the asset management division of Banco Santander, is set to appoint Pablo Costella as the new Head of Fixed Income for Latin America as part of a broader plan to modernize operations in the region through centralization, according to information published by Bloomberg.

Costella, who previously served as the Director of Global Fixed Income at BICE Inversiones Asset Management, will replace Alfredo Mordezki, who is based in London and will leave the Spanish entity after 14 years, according to sources within the company consulted by Bloomberg.

Costella’s appointment, based in Chile, is part of a broader reorganization by Banco Santander, aiming to relocate asset management positions for Latin America within the region rather than placing them in other parts of the world. Last year, Santander AM appointed Héctor Godoy to lead the Latin American Equity division, also from Chile.

Santander AM, led by Samantha Ricciardi since February 2022, has focused on attracting new institutional clients and aims to grow in alternative investments with private debt and infrastructure funds. Santander AM manages 226 billion euros in assets under management.

The investment fund business is part of the wealth management and insurance division, headed by Javier García-Carranza, who replaced Víctor Matarranz in May.

Allfunds Appoints Paola Rengifo as Head of Global Operations and Miguel Ángel Treceño as Chief Data Officer

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Allfunds strengthens its team with two new hires to continue optimizing performance and efficiency in its global operations. According to the WealthTech B2B platform for the fund industry, Paola Rengifo joins Allfunds as Global Head of Operations and Miguel Ángel Treceño as Chief Data Officer (CDO). Both will be based in Madrid and will report to Antonio Valera, COO of Allfunds.

“The appointment of Paola and Miguel Ángel further demonstrates our commitment to attracting leading talent that fosters internal collaboration and seeks synergies that benefit our clients. Allfunds aims to continue leading the transformation in the wealth management industry; with the support of our advanced technology and growing team, we are confident in our ability to remain a key partner for our clients, exceeding their expectations in a constantly evolving environment,” highlighted Antonio Valera, Chief Operating Officer of Allfunds.

As the new Global Head of Operations, Paola Rengifo will be tasked with optimizing the global operational structure through innovation, automation, and the pursuit of synergies, in close collaboration with the technology area. Rengifo has 32 years of experience in the financial sector with JP Morgan Chase & Co., with international responsibility. Throughout her career, she has specialized in the analysis and implementation of corporate strategies with a particular focus on platforms, products, and resources. She has been a member of the Technology and Innovation Advisory Board of the Santalucía Group and is currently a member of the Council for Innovation and Good Governance (CIBG) in Spain.

Miguel Ángel Treceño joins the team as Chief Data Officer (CDO). In this newly created role, he will focus on digital transformation and maximizing the use and value of data at Allfunds. Treceño has over 20 years of experience in financial services and wealth management, having worked at Credit Suisse, Santander, JP Morgan Chase & Co., and Citibank. At Citi, he led a global team responsible for the data strategy, architecture, and investment program for its Wealth Management Banking, Lending, and Custody platform from New York.

The New Popular Front Surprises in the French Legislative Elections: The Deficit Remains a Focus for the Markets

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The left-wing coalition, New Popular Front, unexpectedly won the second round of the French legislative elections, and instead of clearing up the market uncertainties triggered by President Emmanuel Macron’s call for elections, it has refocused investors’ concerns on France’s fiscal deficit and its impact on financial markets.

Mark Haefele, Chief Investment Officer at UBS Global Wealth Management, sees three potential outcomes. Firstly, a technocratic government, composed of technical experts rather than politicians. However, he considers this scenario unlikely. The second scenario points to a government formed by moderate parties (Socialist Party and Together for the Republic, the coalition of President Emmanuel Macron’s allied parties). This option also seems to have limited prospects. Haefele notes that under Article 12 of the French Constitution, the President of the Republic can only dissolve the Assembly again within a 12-month period.

A third option could be Macron appointing a prime minister from the party with the most seats in the National Assembly, which, after Sunday’s elections, is the New Popular Front (NFP). While it is customary for the president to appoint a prime minister from the majority party, there is no legal obligation to do so. A confirmation vote in parliament is not required, but in practice, the prime minister needs the support of the majority due to the parliament’s power to overthrow the government with a vote of no confidence.

This option, however, will have economic consequences. In Haefele’s opinion, “an NFP government would likely attempt to roll back recent pension and unemployment reforms, increase the minimum wage, and not pursue fiscal consolidation. We believe that the NFP’s program, if implemented as proposed, could lead to a significant deterioration of the already high budget deficit.”

The election results will undoubtedly impact the markets. Haefele assures that “an indecisive parliament is probably the best scenario for European equities,” and given that European stock indices barely changed in early trading, “it suggests that the outcome was not surprising.”

However, he considers this the best result of the second round, adding, “volatility may remain high”: political uncertainty remains elevated in France, and the elections have heightened focus on France’s precarious debt situation, with high levels of public debt and budget deficits, according to the expert. Therefore, he expects a certain political risk premium to persist compared to a month ago, and that the market rally will be limited to the very short term, “as foreign investors are likely to continue viewing Europe’s political backdrop as uncertain.”

In fixed income, UBS clarifies that due to possible political paralysis, limited visibility on political/regulatory decisions, and the potential for new negative ratings actions on French sovereign debt, “volatility in French assets will remain high.” Therefore, with limited upside potential in French bonds, the firm sees better opportunities in countries with more stable debt trajectories.

In currencies, Haefele notes that the impact on the euro is likely to be limited but also sees nuances. If the left forms a government and implements its strategy, “the euro/dollar exchange rate is likely to fall below 1.05, given the expansive fiscal implications of the party’s manifesto at a time when France is likely to face an Excessive Deficit Procedure.” If a government composed of moderate parties is formed, the euro should remain close to 1.08, in his opinion.

According to Alex Everett, Investment Manager at abrdn, the election result “has brought some relief in France” in the eyes of the markets, as Marine Le Pen’s National Rally “convincingly lost its coveted absolute majority,” but he notes that the surprising result of the left-wing coalition “leaves a complicated power struggle” in the country. “Now that a parliament without a majority seems very likely, markets can take comfort in this ‘less bad’ outcome. All things being equal, a significant increase in French debt is not expected. Compromise politics implies few changes from now on, smoothing the excesses of any party,” says Everett.

However, the expert acknowledges that “once the dust settles, the stalemate of a divided parliament will prove more damaging than initially thought.” At this point, he points to France’s budgetary problems, which have not disappeared: “The September 20 deadline to present a credible deficit reduction plan is approaching. Macron’s attempt to force unity has further fueled discord. We are skeptical about achieving significant budgetary progress and continue to underweight France compared to its European counterparts,” he asserts.

Peter Goves, Head of Developed Markets Sovereign Debt Analysis at MFS Investment Management, is clear about the French legislative election results: “Divided politics, less political visibility, and more mid-term uncertainties.” In the short term, “a ‘rainbow coalition’ or a ‘caretaker government’ are feasible. Certainly, it’s not the most politically acceptable outcome, but it’s also not the least favorable for the market,” he asserts, maintaining his short-term range of 70-90 basis points for the spreads between French and German bonds. Behind these market doubts are “relations with the EU, which may be far from benign, especially in an EDP context,” and he advises selling on the upticks in spreads.

For his part, Kaspar Koechli, Economist at Julius Baer, also observes that the absence of an absolute majority from the far right or far left in the National Assembly “keeps fears about the implementation of spending-driven fiscal policy changes limited and practically unchanged since the first round.” However, he is aware that the fixed income market may remain somewhat uneasy about a potential left-wing government, “which might lean more towards spending and question fiscal consolidation efforts in its next budget project for 2025, necessary for the resumption of the EU Stability and Growth Pact.”

With ongoing political uncertainty and an unclear timeline for forming a new government, “we are likely to see a breakdown of the recent tightening of spreads that occurred after the first round last Sunday, following the shock of the announcement of early elections that caused a spread rally,” according to Koechli. Moreover, he notes that while the euro has remained range-bound, “it is awaiting more clarity and is likely vulnerable to news from the French fiscal front.”

“In the long term, the events of recent weeks are problematic from an EU perspective. A strong EU needs a strong France almost as much as a strong Germany. With an increasingly unclear political situation in both countries, the EU project will need a new push. As a desk, the general opinion was to reduce exposure to French assets when President Macron announced his early elections, reflecting increased uncertainty. With the French elections nearing their end, the consensus is more inclined towards identifying investment opportunities. However, our bias towards globally relevant companies rather than those more focused on the domestic sphere will remain a feature of our thinking,” adds Jamie Ross, Portfolio Manager at Janus Henderson.

For now, the market reaction has been mixed, given the prevailing uncertainty. “The 10-year OAT-Bund spread is slightly narrower at 65 basis points. French and European equities opened the week positive (around +0.5% late morning); and the euro opened slightly lower but has already recovered those losses (EUR/USD at 1.0840),” highlights Vincent Chaigneau, Head of Research at Generali AM, part of the Generali Investments ecosystem.

Cryptocurrency ETFs and ETPs Listed Globally Accumulated $44.5 Billion in Inflows by May

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The universe of passive cryptocurrency vehicles continues to show its strength. According to data recorded by the analysis and consulting firm ETFGI, cryptocurrency ETFs and ETPs listed globally accumulated $2.23 billion in net inflows in May. This means that inflows into this type of vehicle amounted to $44.5 billion in the first five months of the year, which is much higher than the $135.57 million in outflows recorded in the same period last year.

“The S&P 500 Index increased by 4.96% in May and has risen by 11.30% so far in 2024. Developed markets, excluding the U.S. index, increased by 3.62% in May and have risen by 6.09% so far in 2024. Norway (10.84%) and Portugal (8.72%) saw the largest increases among developed markets in May. The emerging markets index increased by 1.17% during May and has risen by 4.97% so far in 2024. Egypt (11.82%) and the Czech Republic (9.44%) saw the largest increases among emerging markets in May,” says Deborah Fuhr, managing partner, founder, and owner of ETFGI.

According to the firm, the global cryptocurrency ETF and ETP industry had 208 products, with 551 listings, assets of $82.27 billion, from 47 providers listed on 20 exchanges in 16 countries. After net inflows of $2.23 billion and market movements during the month, assets invested in cryptocurrency ETFs/ETPs listed globally increased by 16.7%, from $70.47 billion at the end of April 2024 to $82.27 billion at the end of May 2024.

Additionally, it highlights that inflows into sustainable vehicles can be attributed to the top 20 ETFs/ETPs by new net assets, which collectively accumulated $3.11 billion during May. Specifically, the iShares Bitcoin Trust (IBIT US) accumulated $1.17 billion, the largest individual net inflow.

Four Macro Scenarios for the Short and Medium Term, From the Most Positive to the Most Negative

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Despite central banks’ efforts to lower market expectations, they’ve caused so much volatility that dispersion is noticeable not only across different asset classes but also in macro predictions themselves. One of the most optimistic firms is Deutsche Bank Spain, which anticipates a new phase of global growth, with a gradual reduction in inflation figures and developed central banks cutting rates, a positive scenario for financial markets. Rosa Duce, their Chief Investment Officer, stated that “the global economy is entering a new bullish cycle.”

Duce recently explained at a press conference that her firm anticipates a 0.7% growth for the eurozone in 2024, which could rise to 1.1% in 2025 thanks to the boost from Germany. This recovery would be driven by real wage growth and an increase in external demand as the global economy revives, as well as the planned disbursements from the NextGen funds. Consequently, they expect the ECB to cut interest rates three more times by June 2025.

Spain is expected to surprise positively with its growth, projected at 2% for this year and 1.2% for the next, with room for upward revision, given that the country is benefiting from the boost in tourism, consumption, and greater strength in the labor market.

For the U.S., the firm expects an expansion by the end of 2024 and 2025, primarily driven by consumption, although the expert noted the need to delve deeper into the macro data. For example, observing the reduction in market participants or the increase in demand for a second job to supplement wages. “If these components were excluded, the U.S. unemployment rate would be around 7.5%,” Duce stated.

The expert mentioned that the U.S. “hides weaknesses” that could influence the Federal Reserve’s monetary policy (they anticipate a rate cut in 2024 and two more in 2025) but sees the country embarking on a new positive cycle of productivity driven by artificial intelligence, leading Deutsche Bank Spain experts to expect more growth in the medium term.

Alejandro Vidal, Head Investment Manager at Deutsche Bank Spain, explains that European corporate debt with an investment grade is currently at the heart of their strategy, although he recommends a barbell approach: adding positions in mega caps (they like the Magnificent Seven but also find opportunities in other market areas) and small caps, long in Asian equities, and positioning in IG corporate debt, especially financial.

UBP also shows an optimistic stance. Olivier Debat, product specialist, explains that his firm is working with a thesis of growth reacceleration, minimizing the possibility of a soft landing. They also anticipate more wage increases in the U.S. and Europe, with their consequent impact on inflation, which will remain more persistent than anticipated. However, they do not foresee major changes in monetary policy for the moment: “We do not see room for the ECB to continue cutting interest rates. The June cut was a technical reduction,” adds Debat.

Given this macro scenario, UBP declares itself positive on credit and cautious on sovereign debt. “We do not see a catalyst to adjust duration,” Debat comments, referring to the fact that, as the curve remains inverted, short segments continue to offer attractive remuneration and the possibility of investing in quality debt, assuming less risk.

The expert notes that currently, various segments within fixed income offer returns more typical of equities, so the firm also recommends a barbell approach, combining IG corporate debt with allocations to the riskier part of fixed income (high yield, AT1 bonds, CLOs) to obtain higher returns and diversification.

“After a decade in which the main source of return in fixed income came from the movement of spreads, now the focus is on the coupon that bonds can pay. This makes credit very attractive,” concludes Debat.

A New QE?

From M&G Investments, manager Richard Woolnough proposes an alternative scenario. The expert foresees that inflation and GDP will converge towards the neutral rate, a scenario that does not present “a great entry point for investing in bonds.”

Woolnough states that the world is heading towards a slowdown: “The economy is already overheated, but it has been shown that inflation can be reduced without causing a recession. The current question is whether banks will rush to recognize the risk of recession and lower interest rates prematurely, or if they will remain hawkish, maintaining the ‘higher for longer’ environment.” “The longer central banks maintain their hawkish stance, the greater the risk of a hard landing,” Woolnough concludes.

The manager has long been drawing attention to the levels of liquidity present in the system, given that major central banks have been systematically draining it. Looking ahead to the coming months, he presents an unusual thesis: “Central banks need to maintain an adequate amount of money in the system to encourage GDP growth. If they want to return to normal, they will have no choice but to start printing money again (QE).”

Bearish Signals

The most pessimistic stance is held by Henry Neville, manager of Man Group. Based on market behavior from 1800 to 2024, the manager states that the current environment of rising equities and falling bonds has only occurred historically 11% of the time, and he considers it a possible indicator of the proximity of a bear market. Neville highlights that valuations are very high and earnings forecasts are narrowing, asserting that “the bearish potential is significant in stocks.”

“We are in a relatively uncomfortable place, where small market movements can cause larger impacts than in the past, and where duration no longer offers the same protection as before, even with inflation falling,” the expert declares, adding that corrections the markets may experience in the future “could be more damaging than those in the past.”

In the long term, the manager’s forecast points to a bear market for equities versus commodities, reflecting the cost of the significant transitions the world is heading towards (energy transition, multipolar world, increasing debt…). In his opinion, the global economy is heading towards a period of secular stagflation, where yields will tend to rise in fixed income. “The level of uncertainty could increase in the next decade and, if this happens, risk premiums should be higher than they are today. The current premium offered by U.S. debt is too low,” Neville states, concluding: “This would implicitly harm equities and explicitly harm fixed income.”

The Ripple Effect of the Debate Between Biden and Trump

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The average age of CEOs of the companies on the Fortune 500 list is 58 years, with only three of them exceeding the age of 80: Warren Buffet, 93, and Robert Greenberg of Skechers, and Albert Nahmad of Watsco, both 83 years old.

Cognitive abilities decline to varying degrees as we age and affect our performance differently depending on the type of professional responsibilities we face. Additionally, from age 80 onward, the probability of death begins to increase exponentially, and the current president of the U.S., if victorious in November, would end his second term at 86 years old.

Therefore, it is surprising that the Democratic Party waited until last week’s debate to seriously consider Joe Biden’s suitability as a presidential candidate, something that could have been addressed almost a year ago when an  AP poll, widely covered by the media, showed that Americans believed Biden was too old to consider a second term as president.

Certainly, Donald Trump is also nearly an octogenarian (78). But at these ages, 3-4 years can make a difference, as evidenced by Biden’s decline since his inauguration in 2020, something reflected by 77% of respondents in a CNN poll, who overwhelmingly declared Trump the winner of the debate.

The ripple effect of the first Biden-Trump debate has yet to fully manifest in the polls, but an Ipsos analysis reveals that voters’ confidence in Biden’s ability to lead the country has further declined. The conclusion is echoed in a New York Times poll, which now gives Trump a 6-point lead (up from 3 points before the debate), and a Wall Street Journal poll showing the same gap, indicating that 76% of Democratic participants do not see Biden fit for another 4 years.

A Wall Street Journal article on Friday also began to reveal growing doubts among Democrats about Biden’s suitability as the party’s presidential candidate, who could be replaced by Kamala Harris (the most likely option) or Gavin Newsom, to prevent Trump from leveraging the debate result as an electoral weapon.

Initially, as the betting markets show (see graph below: PredictIt with a 59% probability of Trump winning after the debate, almost assuming Kamala Harris will replace Joe Biden on the ticket), this would be a damage-control move, as it would consolidate the votes of indecisive Democrats regarding Biden’s situation. But it would still be a patch. Either alternative would start with a disadvantage due to late entry into the campaign: the Democratic convention, the last opportunity to replace Biden, will be held in Chicago from August 19-22, with the election on November 7. On the other hand, Kamala Harris’ popularity, although higher than the current president’s, remains mediocre.

The markets’ reaction, in general terms, also indicates an increase in the Republican candidate’s electoral chances. After the recent rises, public debt prices adjusted downward for the long term (bear steepening) due to the perceived fiscal profligacy associated with the Republicans’ agenda; some Latin American currencies corrected in response to the threat of renewed trade sanctions and/or tariffs, and the stock market continued to rise.

Although the U.S. Treasury bond may suffer in the short term from a consolidation of Donald Trump’s leadership, Japan’s example (which in just over 20 years has seen its debt-to-GDP ratio rise from 100% to 225%) reduces the likelihood of the worst-case scenario. The U.S., like Japan, keeps a significant portion of its public debt at home (approximately 74.9% is held by domestic investors such as families, businesses, and federal agencies like Social Security and Medicare), with just over 23% held by foreign institutions, including central banks and financial corporations in international business centers like the UK, Switzerland, Luxembourg, or the Cayman Islands.

As long as the dollar remains the reference currency for international trade and investment, and despite the trend towards central bank diversification, it seems unlikely that the U.S. will face significant refinancing problems in the medium term.

It is also important to consider that, ceteris paribus, as highlighted by the latest report from the Congressional Budget Office (CBO), the trajectory of the U.S. budget deficit, estimated to remain close to 7% of GDP in 2034 with a debt-to-GDP ratio of 122%, should be a concern for both Democrats and Republicans alike, regardless of their base’s preferences, which do not lean towards austerity. The CBO estimates that Social Security will exhaust its resources by 2033, forcing whoever is in the White House then to cut benefits by approximately 20%-30% or significantly raise taxes.

Therefore, it is reasonable to think that if the Republican party wins the November elections, it will seek discretionary spending adjustments to at least partially offset a potential extension of the Tax Cuts and Jobs Act (TCJA, 2017), which expires in 2025. The risk to public debt valuation through an increase in the term premium remains distant, though it is certainly something to monitor.

Forecasts suggest that the cost of U.S. federal debt interest as a percentage of revenue will increase in the coming years. Based on the rise in debt levels and the 2022-2023 rate hike campaign, interest payments are expected to consume around 20.3% of revenue by 2025, surpassing the previous peak of 18.4% set in 1991.

In 2023, the U.S. government spent $658 billion on net interest payments, or 2.4% of GDP. Projections indicate this figure will continue to grow, potentially reaching 3.9% of GDP by 2034. This significant increase will pressure the federal budget, complicating the financing of other essential programs and services that are citizens’ rights (Medicaid, Medicare, Social Security, unemployment benefits).

The growing cost of public debt service is expected to exceed spending on key federal programs like Medicaid and defense in the next decade. By 2033, interest payments could account for 14% of total federal outlays, doubling the percentage spent in 2022.

Although the deterioration is undeniable, according to the World Bank database, the differences remain notable when comparing the U.S. situation to the debt crises that preceded those in New Zealand in the 1980s, Canada in the early 1990s, Greece, or Sweden.

Besides keeping inflation under control and preserving full employment, the Fed has a “third mandate” to ensure financial stability. In a context like the one depicted in the CBO report, this involves avoiding excessive tension on the cost of money.

In this regard, Jerome Powell’s statements in Sintra (where he explained that inflation seems to be “back on a disinflationary path”) and the minutes of the last Fed meeting (which expressed concern about growth and employment prospects) highlight the possibility of positive surprises regarding monetary policy direction. The core PCE is already below the target set for December 2024 (2.6% vs. 2.8%), and unemployment aligns with the forecast by U.S. central bankers (4%).

The updated JOLTs survey, which came out slightly better but adjusted May’s data downward, shows that unemployment claims have entered a clear upward trend, suggesting difficulties in reemployment after job loss. The weakness in the June ISM Services, surprisingly entering contraction territory (48.8 vs. consensus expectations of 52.7, with the new orders sub-index plummeting to 47.3 from 54.1 in May) or – as we explained last week – the stagnation in the nascent recovery in industrial activity pointed to by the ISM Manufacturing (48.5 vs. 49.1 expected, showing weakness in subcomponents of employment, export orders, and production) are symptoms of a slowing economy.

Fed members expressed concern in this regard, suggesting that the payroll series may be presenting an overly optimistic view of the labor market situation. They also noted that moderate/low-income households are facing increasing strain in coping with rising living costs, no longer benefiting from the savings accumulated during the pandemic.

The economy, as the data and Fed comments show, is slowing down. Investors remain in “bad news is good news” mode, and as we explained last week, the consensus is for a soft landing. Technically, the S&P is overbought, sentiment is optimistic, and the stock market is not cheap.

Soon we will hear management teams report their second-quarter performance, and expectations are high with 9% EPS growth, the largest since 2021.

Sentiment is now the main support for this market, which is why it is worth monitoring what “hot money” does. In this regard, bitcoin’s price is reacting to the dollar’s strength (and what it implies), breaking relevant support levels that could result in a much steeper decline. What relevance does this have for the stock market? Bitcoin, as shown in the graph, is a “steroid bet” on the movement in the equity market risk premium, and this week’s declines do not bode well for stockholders.

 

The European Union Already Has Common Regulations for the Prevention of Money Laundering and the Financing of Terrorism

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The new European Union regulatory package against money laundering and the financing of terrorism was published on June 19, following its approval by the European Council. The intention, according to the legislators, is to homogenize the current regulations on the prevention of money laundering and the financing of terrorism (PMLFT) across the Union.

Thus, as explained by experts from finReg360, the rules of the game for entities subject to this regulation are now equalized, with the aim of eliminating differences in the applicable regime among Member States and ensuring homogeneous supervision throughout the Union. “The published package contains relevant modifications and new rules of conduct, with which entities must familiarize themselves in order to comply with the new regulations within the adaptation schedule,” they note.

According to their analysts, the package includes various regulations. For example, the regulation that creates the new Authority for Combating Money Laundering and the Financing of Terrorism (AML Authority or AMLA), with regulatory powers, will directly supervise financial entities with the highest level of money laundering and terrorism financing risk and will hold indirect supervision over the rest, and will be able to impose sanctions and penalties.

Additionally, the regulation that consolidates and unifies the PMLFT rules, now known as the “single regulation”. This regulation revises the categories of obligated entities, introducing some new ones such as crowdfunding service providers, intermediaries of these services, and football agents and clubs, among others.

As explained by finReg360, the directive on mechanisms for combating money laundering and the financing of terrorism, which amends Directive (EU) 2019/1937 and repeals Directive (EU) 2015/849. The new directive is known as the “Sixth Directive“.

“The directive on the access of competent authorities to centralized bank account registers and the technical measures aimed at facilitating the use of transaction registers. Also part of the new regulatory framework is the regulation that consolidates the regulation on fund transfers, which seeks to make crypto-asset transfers more transparent and traceable (this text was already approved in May 2023 and is known as the Travel Rule),” they add.

Entry into Force and Application

Published in the Official Journal of the European Union, the new regulations come into force on July 9, 2024. The new European authority, which will be based in Frankfurt, will start operating in mid-2025. As recalled by finReg360, the single regulation will be applicable from July 10, 2027, except for agents and football clubs, to whom it will apply from July 10, 2029.

On the other hand, Member States must transpose the Sixth Directive by July 10, 2027, except for: Article 74, which must be transposed by July 10, 2025; Articles 11, 12, 13, and 15, by July 10, 2026; and Article 18, by July 10, 2029.