Interest rates remain stable in the USA, uncertainties in Europe after the elections

Chart of the week

The chart shows the return of the S&P 500 (black shaded vertical line) compared to the return of forms with different market capitalizations.
Why this is important
In 2024, you could only beat the market (S&P 500) in the USA if you were invested in the mega caps, i.e. the companies with the largest market capitalization. The smaller the market capitalization, the poorer the return.
Apart from the mega caps, the market does seem to be heading for a recession. In such a market environment, an investor has the greatest risks with very small companies, as this is where the risk of bankruptcy is highest.

The chart shows the earnings growth delivered by the top 5 companies in the past year and expected for the coming years. For the 5 companies mentioned above, the increase in profits was over 56% for all other 495 companies in the S&P 500 only 4%. Over the next few years, the dominance of the top 5 should diminish. But the time for stocks of smaller companies will probably not come until 2025.

At present, the portfolio is better positioned in companies with a large market capitalization.

Interest rates remain stable in the USA
The markets are still in a state of rigidity and are trying to process last week's data. The interest rate cut by the European Central Bank does not seem to have had a major effect on the markets. However, the European elections appear to be unsettling investors. At the same time, the data in the USA shows that interest rate cuts are becoming less likely.

The chart shows market participants' expectations regarding the Fed's future interest rate decisions. The scenario with the highest probability is always marked in blue. The Fed's interest rate range is currently between 5.25% and 5.5%

No reduction in interest rates is expected for the Fed meeting on July 31, but a reduction is expected on September 18 and December 18.

As a reminder, 7 interest rate cuts were expected at the beginning of the year, now only 3.

The chart shows the voting behavior and assumptions of each voting member of the US Federal Reserve. For 2024, the opinions are almost identical. But for 2025 and 2026, there are big differences.

What is a very positive sign is that none of the voting members of the US Federal Reserve still expect interest rates to rise. They expect interest rates to remain the same or fall.

Over the past 3 months, people have also lost money on bonds as the market has had to adjust to this new situation. This adjustment has now taken place and investing in bonds should now be safer again.

The US Federal Reserve has two goals: Price stability (no inflation) and full employment. The chart above shows how full employment developed after the first interest rate hike (zero line). A distinction is made between cases in which the interest rate hike was followed by a recession (blue, hard landing) and cases in which no recession followed (purple, soft landing).

The chart calls for caution. The labor market behaves similarly to all cases in which a recession followed an interest rate hike. At the same time, however, it also supports the Fed's view for lower interest rates in the future.

The chart shows how much the US government has to spend on interest payments on its bonds. During the negative interest rate phase, these were very low, but the US government now has to pay over 5% for new long-term debt.

If interest rates remain this high for much longer, interest payments will explode (light blue) and have a massive impact on the US government's ability to shape the future (regardless of who becomes the new president). With three rate cuts, interest rates would move like the yellow line.

To avoid a debt crisis in the US, the US Federal Reserve has no choice but to cut interest rates soon.

Uncertainties in Europe after the elections
The European elections with the shift to the right and, above all, the announcement of new elections in France have caused great uncertainty among investors.

The chart shows how strongly the interest rates of government bonds from France (black), Spain (red) and Italy (blue) have behaved in comparison to government bonds from Germany.
The so-called spreads are always a good stress indicator.

The chart shows the weekly change in spreads between French and German government bonds. The increase was the largest in over 10 years.

With the early elections, President Macron is taking a high risk of making the country ungovernable. If the parliament changes in the same way as in the European elections, the parliament will reject all of his proposals in his remaining two years as president. It remains to be seen how the voters will decide.

It is better to wait and see before buying bonds from France, Spain and Italy.