“So far this year, the market reacted entirely in line with the developments of inflation and economic growth,” said Alexandre Drabowicz, CIO, Indosuez Wealth Management, during an interview with Delano.
Yet Drabowicz expects that a Trump administration would implement an import duty of 10% on all imports and probably even more for Chinese products. He thinks that Trump wants the US to become independent from China on semiconductors and pharmaceuticals, among other products, and on its supply chain. Besides, a stricter immigration policy should be expected and it will likely include the expulsion of immigrants.
Consequently, all these factors will have a negative impact on labour cost for companies that have to cope with an “ultra-low” unemployment rate of 3.9%. “This is inflationary,” said Drabowicz.
Not much effect from Trump on US interest rates
“The last mile to reach the 2% inflation objective is more difficult and consequently the market started to price fewer rate cuts… from seven to three or four today,” said Drabowicz. He expects four rate cuts from the Fed in 2024 “because real rates are too elevated and too restrictive.”
After 10-year rates reached a recent low of around 3.8% in late December 2023, Drabowicz noted that treasuries are back up at 4.2%-4.3%, an important negative development for stocks as “this rate is used as a parameter in the equity valuation models.”
Drabowicz explained that this is the result of several positive growth surprises, quarter after quarter. “Growth was expected in the US at 0% [in 2023]. It has finished the year at 2.5%.” He noted that Indosuez revised its forecast to 2.3% in 2024, up from 1.3%. Coupled with “important public deficit… it must be reflected in [higher] US rates.”
Indeed, Tanguy Kamp, head of investment management at Indosuez Wealth Management, is particularly concerned with the US deficit, which “reached $1,000bn and is higher than the military budget.” He expects the bond vigilantes to play their role which will result in higher interest rates, still.
On Trump, he thinks it is a bit too early for the market to price his policies. “Should Trump win, the financial risks will weigh on US economic adversaries such as Europe and China, as 70% of US growth is linked to US consumers,” stated Drabowicz.
Long dollar and US equities
“We like the dollar,” said Drabowicz. He sees fewer rate cut expectations and the risk haven status in the current geopolitical context as positive for the dollar. Kamp noted that rate differentials continue to play its part and should the European Central Bank become “more aggressive on rates, it will be negative for the euro and favourable for the dollar.” Following a Trump win, the trade balance should further support the dollar given the expected the lower imports and higher exports.
He added: “we are a bit long dollar and pro-risk, i.e., overweight US and emerging market equities.” More specifically, Drabowicz noted that there is a lot of momentum in technologies. “There a lot of growth and it is very profitable as for Nvidia, which has beaten 4Q24 expectations (earnings) that were perceived as too elevated.” They think that their monopolistic position helps their high margin, but admitted that it is unclear whether it is sustainable. “You can’t take a position against the sector.”
The risk of recession is no more an American but rather a European issue
Kamp noted that Nvidia’s clients-- Meta, Microsoft and Amazon--have deep pockets, making this market not comparable to what happened in the late 90s. Questioned by Delano whether Nvidia had any clients in Europe, the interviewees could not think of any company which may raise, indeed, sustainability concerns.
Economic and fiscal consequences in Europe of a Trump victory
“Military budgets below 2% of GDP will be something of the past,” said Kamp. He expects deficits and credit spreads (interest rates of weak states over the rates of strong states) to climb further. Drabowicz noted that €65bn of additional spending will be necessary to reach 2% of GDP.
Rates to go down in Europe and growth in defence
“The ECB has its meeting one week before the Fed in June,” observed Drabowicz. Consequently, contrary to his previous expectations, he thinks that the ECB may well in fact cut rates before the Fed. He believes that the ECB has more pressure to cut rates given the soft growth in the eurozone. “The risk of recession is no more an American but rather a European issue.” He added: “once the salary round is behind us, the ECB will have the leeway to cut rates.”
Drabowicz observed that international investors are turning their back on European equities as the continent is perceived as squeezed between several walls. “When things are going bad in China, it goes bad in Europe; when it gets rough with Russia/Ukraine, it is also bad for Europe; an elected Trump will hit Europe.” Kamp expects therefore the risk premium on equity to rise adding downward pressures on European equities.
Yet Drabowicz thinks some industries such as aerospace and defence will continues to perform given the higher expected expenses by the European states under 2%. In addition, he thinks that European companies having manufacturing operations in the US will be better safeguarded and will enjoy a competitive advantage.
Impact of more investments on military companies on ESG funds
Delano questioned Indosuez on the challenges for article 8 funds to invest in defence. The S of ESG used to stand for “social… maybe we should focus more on “security,” said Drabowicz. “We are not dogmatic to the extent we would exclude completely the defence or oil and gas sectors.” He believes that Indosuez’s clients prefer a pragmatic approach.
Should investors want to move the climate topic forward, Kamp suggested that they should be more active on the G of ESG and vote accordingly at the shareholders’ meetings of Shell or Total.
This article was published for the Delano Finance newsletter, the weekly source for financial news in Luxembourg. .