The most positive development in recent weeks has been the sharp decline in oil prices, with front-month Brent trading near $70/b as we go to press, a 40% drop over two months. This comes as a welcome boost for voters, with the US driving season getting underway.
As discussed in our previous report (The Aftermath of the Hormuz Crisis), this creates broadening opportunities in equities. Lower energy costs provide a tailwind for energy-intensive sectors such as industrials and materials, and, to a lesser extent, consumer discretionary, where travel and leisure stocks remain our top pick.
From a cross-asset perspective, the new energy landscape is expanding the opportunity set in fixed income. Central banks remain inclined to tighten and are deliberately staying behind the curve after the 2022 inflation shock, when they failed to contain price pressures. They now need to reassert their credibility, and the current environment makes that task easier.
By the end of the summer, we expect central banks to gain sufficient confidence that headline inflation is converging rapidly towards their 2% targets, while the relatively short-lived energy shock should limit meaningful second-round effects on core inflation.
In the near term, focus turns to euro area CPI for June, released this week. Inflation is expected at 3.0% year-over-year (down from 3.2% in May), with core inflation is seen unchanged at 2.6%. Any downside surprise would likely exert further downward pressure on euro area rates.
Credit strategy: a focus on insurers. European insurers remain fundamentally solid. However, the debate is shifting from headline capital strength to pricing momentum, market sensitivities, shareholder distributions, and the evolution of asset risk. The carry is attractive, but tight spreads make the investment case increasingly selective.
Tier2: Neutral to selective. Insurance Tier2 now screens better than Bank Tier2 on a quality-adjusted basis. However, spreads have retraced close to their tights and the Tier2/Senior spread multiple remains compressed. We favour higher-quality issuers and bonds with adequate reset economics.
RT1: Carry. RT1s have recovered sharply and still offer long spread duration. However, current spreads call for selective bond selection rather than broad segment exposure. See our top picks inside.
Equities: tech fatigue or business as usual? Little has changed in the Tech narrative. Last week’s quarterly results from Micron Technology (for the three months ending in May) offered no disappointment. Net income increased fifteenfold year-on-year (+1,400%), while revenues rose 4.5x (+345%). Gross margins expanded sharply, from 38% to 85%, and the share price has surged by around 900% over the same period. The numbers are extraordinary, but it would be unrealistic to extrapolate such growth rates far into the future. Yet, does this imply that the market is irrational? Notably, the top three constituents of the MSCI USA Value index are now Alphabet, Meta Platforms and Micron Technology, an intriguing development, where what looks like growth increasingly qualifies as value.
Tech remains a volatile segment that has delivered substantial performance; trees do not grow to the sky indefinitely. Periodic pullbacks are therefore both natural and healthy, reflecting market efficiency, although some may argue that excess volatility signals inefficiency. When earnings and margins expand at such an exceptional pace, it is unsurprising that markets continuously reassess the net present value of future cash flows.
Diversification remains essential, as assets that rise sharply tend to become more volatile. This does not mark the end of the Tech story in our view. However, Q3 could prove softer, as investors reassess risks before gaining renewed confidence.
