Overall Market Summary:
Strength in certain Asian markets enabled emerging market equities to outperform developed markets in June. Stocks associated with the artificial intelligence (AI) theme continued to deliver strong performances. While the European Central Bank cut interest rates, persistent inflation kept other major central banks from making similar moves.
United States:
US shares saw gains in Q2, driven primarily by the information technology and communication services sectors. Enthusiasm around artificial intelligence (AI) continued to lift related companies, supported by strong earnings and positive outlook statements. On the other hand, materials and industrials sectors showed weaker performance.
In the financial sector, several US banks announced plans to increase dividends after successfully passing the Federal Reserve's (Fed) annual stress tests.
The potential timing and extent of interest rate cuts remained a significant focus for markets during the quarter. Initial concerns about the US economy overheating led to negative market reactions to strong economic data. However, as the quarter progressed, optimism for a soft landing grew. The latest "dot plot" from Fed policymakers suggested only one rate cut this year.
Annual US inflation, measured by the personal consumption expenditures index, eased slightly to 2.6% in May from 2.7% in April. The labor market remained strong, with 272,000 jobs added in May, according to the Bureau of Labor Statistics.
Europe:
Eurozone shares declined in Q2 amid uncertainty caused by the announcement of parliamentary elections in France and diminishing expectations for significant interest rate cuts. The information technology sector gained, with semiconductor-related stocks performing well, while the consumer discretionary sector saw declines due to weakness in automotive and luxury goods stocks.
The European Central Bank (ECB) cut interest rates by 25 basis points in early June. However, the potential for further cuts may be limited by persistent inflation. Annual inflation in the euro area increased to 2.6% in May from 2.4% in April.
Forward-looking data indicated a slowdown in the eurozone's economic recovery. The flash HCOB composite purchasing managers' index dropped to 50.8 in June from 52.2 in May. Politics played a crucial role in the quarter, with European parliamentary elections seeing gains for right-wing nationalist parties, notably in France, where President Macron's call for parliamentary elections surprised markets and led to underperformance of French equities compared to the broader eurozone index.
United Kingdom:
UK equities rose in Q2, with the FTSE 100 reaching fresh all-time highs. Small and mid-sized (SMID) companies also performed well, supported by a surge in new bids and expectations of a possible turnaround for domestically-focused companies after a decade of underperformance. However, SMIDs gave back some gains towards the end of the quarter as markets adjusted expectations for imminent interest rate cuts.
The UK economy rebounded strongly in the first quarter of 2024, with GDP growth of 0.7%, following a mild recession in the second half of 2023. However, growth stagnated in April, with the unemployment rate rising to 4.4% as the economy shed 140,000 jobs. Annual consumer prices index inflation fell to 2.0% in May, hitting the Bank of England's (BoE) target for the first time since July 2021. Despite these encouraging trends, the BoE maintained base interest rates at 5.25%, amid concerns that the fall in UK inflation may only be temporary and high wage inflation continues to drive service inflation.
Japan:
The Japanese equity market generated a positive return of 1.7% in Japanese yen terms for TOPIX Total Return during the quarter. However, due to continued depreciation of the yen, the foreign currency-based return turned negative. Yen weakness was driven by the strength of the US dollar, supported by a stronger US economy and expectations of prolonged higher interest rates.
In March, the Bank of Japan (BOJ) actions led to a moderate rise in Japanese government bond (JGB) yields, supporting financial stocks. The BOJ announced a reduction in JGB purchases starting in July, although these measures were insufficient to reverse the yen's weakening trend by the end of the quarter.
Concerns over the negative impact of yen weakness on inflation persisted. Real-term wage growth remained negative, as wage increases had not yet surpassed inflation, resulting in stagnant consumer sentiment. However, a record-high number of inbound tourists contributed to increased spending, supporting consumption. The earnings season concluded with stronger-than-expected results, with Japanese companies showing sales growth, pricing power, and cost control, leading to improved corporate profitability. Many companies committed to initiatives by the Tokyo Stock Exchange, focusing on capital efficiency and share price improvement, resulting in record-high share buybacks.
Asia (excluding Japan):
Asia ex Japan equities achieved solid gains in Q2, with Taiwan, India, and Singapore leading the MSCI AC Asia ex Japan Index. Conversely, Indonesia, the Philippines, and Thailand were the worst-performing markets.
Chinese shares achieved strong gains, as low valuations encouraged Asia-focused investors to return to the market despite concerns about India's high valuations and Japan's continued currency weakness. Investor optimism for AI-related stocks drove gains in Taiwan, making it the best-performing index market for the quarter and year-to-date. Indian shares also saw robust growth, with benchmark indices reaching record highs, driven by gains in media and banking stocks. South Korean stocks recorded a modest decline amid growing caution over the global economy and US interest rate cuts timing.
Emerging Markets:
Emerging market (EM) equities outperformed developed markets in Q2. Softer US macroeconomic data eased concerns about the timing of US interest rate cuts, and a rebound in China supported EM returns.
Turkey was the best performer in Q2, buoyed by optimism about orthodox economic policies. Taiwan posted double-digit returns in US dollar terms, driven by investor enthusiasm for technology stocks, particularly AI-related names. South Africa also performed well, following positive election outcomes that saw a coalition "Government of National Unity" formed. In India, political developments supported equity market returns, with Prime Minister Modi's Bharatiya Janata Party (BJP)-led alliance retaining its parliamentary majority.
Eastern European markets, including Hungary, Czech Republic, and Poland, performed well. China's recovery in April and May helped it outperform broader EM indices, supported by optimism about housing sector support and reform rhetoric from President Xi.
Underperforming markets included Korea and energy-related markets such as Kuwait, UAE, Colombia, and Saudi Arabia. Brazil and Mexico posted significant losses in US dollar terms, with central banks signaling caution on future interest rate cuts. Flooding in Brazil raised concerns about economic growth, fiscal spending, and inflation. In Mexico, the election of Claudia Sheinbaum as president and her Morena party's supermajority raised concerns about potential institutional weakening.
Global Bonds:
Global bond markets had a challenging start to Q2 due to renewed US inflation concerns, leading investors to reassess the timing of interest rate cuts. Later, softer labor market conditions and encouraging inflation news created a more favorable environment. Political risks caused localized weakness in some emerging markets, while snap parliamentary elections in France and anticipated UK elections added to the volatility.
Investment grade (IG) corporate bonds in the US and Europe delivered positive absolute and relative returns over government bonds, driven by higher income from widened credit spreads. High yield (HY) markets also performed well, outperforming government bonds and IG corporates. Securitized bonds, including covered bonds and mortgage-backed securities, generated modest total returns.
Global government bond markets diverged, with US Treasury yields peaking in April before trending lower. In the eurozone, French spreads widened versus Germany due to the announcement of a snap parliamentary election. Central banks remained in focus, with the US Federal Open Market Committee (FOMC) signaling a relatively hawkish stance, maintaining rates on hold but reducing the expected number of cuts for the rest of 2024. The ECB cut rates by 25bps in June, with a relatively hawkish accompanying statement. The BoE's decision to keep interest rates unchanged was deemed "finely balanced."
Emerging markets faced difficulties due to the postponement of the Fed's easing cycle, pushing yields higher. Unexpected election outcomes in South Africa, Mexico, and India added to investor unease.
In currencies, the US dollar weakened against its G-10 peers, except for the Japanese yen, which underperformed due to wide interest rate differentials.
Convertible bonds could not benefit from equity market tailwinds, with the FTSE Global Focus convertibles index, hedged in USD, finishing Q2 with a loss of -0.5%. Despite robust primary market issuance, convertible bonds lacked exposure to major equity performance drivers. The Q2 volume of new issues surpassed $27 billion, exceeding first-quarter issuance.