This week in the markets: Politics takes centre stage

The news agenda is focused on politics this week. And some of that news is having a direct impact on the markets. Most obviously that is the case in France where the first round of a two-week electoral process over the weekend delivered a victory, but an inconclusive one, for Marine Le Pen’s far right Rassemblement National.

Markets rallied on Monday morning and the euro climbed against the dollar as it looked increasingly likely that next weekend’s second round of voting will result in a win for the far right but not an outright majority. Politicians may dislike messy coalition government, with all the horse-trading and compromise it implies, but investors often prefer gridlock.

France’s blue-chip CAC 40 index was 2.7% higher at the open on Monday, clawing back some of the loss of value incurred since President Macron called a snap election in the wake of European elections last month which delivered a bloody nose to his unpopular centrist administration. The bond market also rallied slightly with the yield on the 10-year bond down to 3.24% as investors assumed that the markets will be able to keep the politicians in check in the months ahead.

The RN’s win on Sunday is still something of a political earthquake in France, the best-ever showing for a far right party in a country which has become disenchanted with a range of issues that are familiar in post-Brexit Britain - sluggish economic growth, immigration and a sense from the many that they are being ignored by the few in the Parisian elite.

Politics is very much on the agenda on either side of the Atlantic too. In the US, last week’s first Presidential debate ignited renewed anxiety about President Biden’s mental fitness for office after a sometimes incoherent performance across the floor from former President Trump. Even some strong supporters of Biden, such as the New York Times, are calling for him to stand aside to allow a younger candidate to take on Trump in November’s Presidential election. Time is running short to find an alternative candidate and the obvious option, vice-president Kamal Harris, is less popular even than the President.

Over here, it is election week with the polls pointing towards a likely big victory for the opposition Labour party, although often contests turn out to be closer than the pundits predict as disenchanted voters stick with the party they have always supported when they stand in the voting booth. All of that said, with a 20-percentage-point lead in the polls it is very likely that Sir Keir Starmer will be the Prime Minister come Friday morning and Britain will experience one of its periodic shifts from a right of centre to a left of centre government.

Again, the market impact of this is likely to be muted as Labour have gone to great lengths to suggest that they will do nothing to spook investors. Although they have remained ominously quiet on some tax issues - notably capital gains tax - in many ways there is not much to separate the two parties on economic and fiscal matters. Business is broadly relaxed about the policies laid out by former Bank of England employee Rachel Reeves, who is likely to be Chancellor of the Exchequer at the end of the week.

Our analysis of the last 60 years of UK parliaments shows little correlation between the party occupying Downing Street and the performance of the stock market. The biggest gains over the course of a parliament for the FTSE All Share index since 1964 have been evenly split between Labour and the Conservatives. The one theme that does seem to emerge is that markets do better when there is a significant majority and therefore stable government. Markets also perform better when the parliament starts with a relatively subdued market - although the FTSE 100 stands close to its all-time high, in terms of valuation it is cheap by historic standards and versus other markets around the world.

The UK and French elections come as markets conclude a positive first six months of the year. The S&P 500 index has risen by around 15% in the first half of 2024, building on its strong showing in 2023. Although this overstates the performance of the wider market - with the equal weighted benchmark up by a more modest 5% - it suggests investors remain relaxed about the outlook.

That’s unsurprising when you consider that corporate earnings are growing steadily, while inflation is headed reassuringly lower and central banks are poised to begin the process of unwinding some of the interest rate hikes of the past two and a half years.

Just in terms of the size and duration of the latest upswing in share prices since the low point of October 2022 there seems little to worry about. Cyclical bull markets over the past hundred years or so have tended to last about 30 months and to see the market rise by 90% on average. The current rally has been underway for 21 months and has pushed the market 58% higher, so on that basis alone it could have further to go.

On the earnings front, profits appear to be picking up the baton from rising valuations, which have certainly pushed to the high end of the historic range. The backward looking price-to-earnings (PE) ratio of the S&P 500 index is 24, although the equal weighted PE is a much less stretched 18 and valuations are much lower still in other markets outside the US, including our own here in the UK.

With second quarter earnings season just around the corner, the earnings growth outlook has remained remarkably unchanged which is unusual - usually forecasts are reined in as the year progresses. At the moment we are looking at 9% growth in the second quarter, about the same in the third quarter rising to 13% year on year in the last three months of the year and then 15% in the first quarter of next year.

If delivered, those earnings will keep the valuation multiple in check and it means that on the basis of expected dividends and share buybacks the forward looking 10-year market growth rate remains safely in double digits annually. That does not mean this will actually happen, just that on the basis of fundamentals the market is reasonably valued still.

Shares are also being supported by the bond market at the moment where investors have pushed the spread between the yield on corporate and government bonds to historic lows. This is the bond market equivalent of a high price-earnings ratio and indicates that investors are relaxed about the combination of relatively high yields and a low default rate in a still fairly robust economy.

The big concern for investors remains the relatively narrow leadership of the market, which has seen a handful of big tech companies, and latterly just one or two, driving a disproportionate share of the total market gains. On some measures the performance of Nvidia shares is as dramatic today as the infamous rise in RCA shares in the 1920s which ultimately led to the Wall Street crash of 1929.

The good news, though, is that investors have a healthy choice of investment options. Many stock markets around the world offer shares at a reasonable valuation. Meanwhile bonds and cash offer a positive real, inflation-adjusted income. Alternatives such as property, gold and commodities like copper are available as viable diversifiers in a balanced portfolio too.

So halfway through 2024, the glass appears half full.

Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Please be aware that past performance is not a reliable guide indicator of future returns. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.