Key Takeaways

• The latest polls show that the Republicans chance of winning the US election stands at 62%, almost unchanged from the 65% before Biden dropped out
• It continues to be economics driving the stock market, not politics, with July’s unexpected CPI reading moving markets
• As interest rate cuts get priced in, we are seeing a rotation from larger stocks to smaller companies

Having recently written about both the French and UK elections, we thought it made sense to conclude this election trilogy with the most impactful of them all, the US. Despite, insisting he’d stay in the presidential race for months, we saw Biden step down and endorse his VP, Kamala Harris, earlier this week. This bombshell followed an assassination attempt on Trump just the week before. So how have these monumental events morphed the presidential race?

After the shooting, Trump increased his lead in the polls and the bookies gave the Republicans a 65% chance of winning. Biden dropping out proved to be beneficial for the Democrats and the Republicans chance of winning slid down to 59%. However, as memories of Harris’ failed campaign for president in 2020 resurfaced with poor interviews and a lack of vision, she has since been branded unelectable and the Republicans’ chance of winning has already climbed back up to 62%. The summary is that Biden dropping out hasn’t changed the race all that much (it’s currently suggested that only Michelle Obama could beat Trump).

All these political events though haven’t been moving the market as much as one would expect. In fact, as we wrote about with the UK election, it continues to be economics that investors are focused on rather than politics. 11^th July is clear evidence of this, as shown in the below chart. On this day, CPI, the key inflation metric, declined 0.1% in June from the previous month whilst the annual figure dropped to 3%.

One month performance of Russell 2000, S&P 500 and Nasdaq 100

Source: FE Analytics

This marginal but unexpected drop in inflation saw the probability of a September interest rate cut in the US go from very low to 96%. The Russell 2000, the US smaller companies index skyrocketed whilst the S&P 500, the US Large Cap index, and the Nasdaq 100, the US tech index, have both sold off.

Why?

In April, we published our weekly note on the small cap premium where one of the key takeaways was: “imminent rate cuts create an opportunity for small caps to outperform once again”. In May, our weekly note, titled “The US market: Running hot” discussed US Large cap stocks (particularly tech) trading at expensive valuations, well above their long-term average. The US Large cap market and the ‘Magnificent 7’ have been a safe haven for investors through the recent economic and political uncertainty, however, now that investors are more confident that interest rate cuts will happen, we’ve seen that rotation away from large cap to small cap stocks.

Bowmore Portfolios

Bowmore portfolios have a meaningful exposure to medium and small cap equity in anticipation of interest rate cuts. Due to this, the recent rotation has been beneficial to portfolios relative to our benchmark. Granahan US Focused Growth for example, our US small cap fund, enjoyed a 10.68% return in the period from 10^th July to 23^rd July, beating the Russell 2000’s 8.68%. We believe that the marginal 0.1% drop in inflation having such a vast impact on markets shows how stretched valuations are in the US, namely mega cap technology stocks and could be the beginning of the extreme concentration in the US stock market unwinding. This creates a lot of opportunity for Bowmore as areas of the global market we believe are undervalued, like smaller companies or the UK and Europe, enjoy the impending inflows and rate cuts.