Charlotte de Kerpoisson:

Hello and welcome to this podcast by BNP Paribas Wealth Management.  My name is Charlotte de Kerpoisson. The US-Iran framework agreement and the reopening of the Strait of Hormuz have triggered sharp falls in oil and gas prices. Crude oil prices have now returned to pre-conflict levels of around $70. To discuss this and other topics, I'm joined by Edmund Shing, Global Chief Investment Officer.

Hello, Edmund.

Edmund Shing:

Hello, Charlotte.

Charlotte de Kerpoisson:

Oil prices rose from $70 per barrel to peak at nearly $120 in May. Recently, they have collapsed back down to nearly $70. What impact could this have on growth, inflation, and stocks and bonds if this level is maintained?

Edmund Shing:

Well, that's the important phrase, Charlotte, if it's maintained.

Let's remember, this is just a framework agreement. The details are still, at the time of recording, still being negotiated. And there is a 60-day period that is in force. So it's not sure that we'll get the detailed agreement.

There are still, you know... I mean, the market has obviously been reassured. But there's still a possibility that we don't get a detailed agreement. And so that the current lull is not maintained. But let's say it is.

Let's say that the Strait of Hormuz remains open. Let's say that we get a detailed agreement in the short term. What does that mean?

Well, clearly, firstly, in terms of inflation impact, it should allow inflation to fall back. Because we've had quite a sizeable bump in inflation in the short term linked to energy prices, linked to the fact that oil and gas prices rose so sharply from the beginning of March.

Of course, as you've mentioned, the crude oil price, the Brent crude oil price is back at just over $70 a barrel. So pretty much where it was before the conflict started. If that is maintained, because the Strait of Hormuz remains open and the flow of oil and gas from the Gulf states continues both to Asia and to Europe, that should have a positive effect on bringing down inflation, because that energy inflation bump will come out of the system pretty quickly by the end of the year.

And it is also very important from a secondary point of view, because we can often get second-order inflation. The energy prices get passed into costs of goods and services over time if maintained. Now, that's less likely to happen, because the energy price shock has been temporary. So as long as it remains temporary and short-lived, we are unlikely to get long-lasting second-round effects.

Central banks can therefore calm down. So not only would inflation calm down, but central banks will feel less obliged to raise interest rates to counteract the longer-term inflationary impact of the energy shock. Therefore, on growth, if the central banks don't need to raise rates and inflation comes down, we would also expect growth to recover in the second half of this year, particularly in oil-importing regions, Asia and in Europe.

And in Europe, for instance, we would expect the consumer to come back a bit. The consumer has seen confidence plunge since March because of the energy price shock, the inflation shock, which has led them to consume less and save more. Now, clearly, if the inflation shock goes away and if final product prices for, let's say, petrol, for diesel come down, then you'd expect the consumer to regain a little bit of confidence and say, OK, that was a temporary price shock. My pricing power has not been permanently hit. And they may consume a bit more and save a bit less, which again, is better for growth. And that will predominantly be in Asia and in Europe because these are the importing regions that have been hit.

For stock markets and for bond markets, that's quite reassuring because, again, if inflation is temporary rather than long-lasting, then bond markets don't need to see rising yields to reflect the longer-lasting and higher inflation expectations. That's sort of what we see, that bond yields have been very stable of late. And finally, for stock markets, clearly, that is a pretty good backdrop because if you're saying growth can actually recover, inflation is moderating. That means nominal growth is pretty good. That's quite a good backdrop for earnings for European, US, and emerging market companies. So overall, I would say it's a pretty benign situation if the oil price situation and if the agreements are maintained.

Charlotte de Kerpoisson:

We are well into the fourth year of the current stock bull market. So, Edmund, what are the key factors that will determine whether this bull market can continue for much longer?

Edmund Shing:

Well, I think there are two. The first one is very simply the usual one, which is: will central banks kill the bull market? Because actually, when you look at the history of prior bull markets and the following bear markets where stocks fall, the trigger and the shift from a bullish market to a bearish market has been much more triggered by central banks, led by the US Federal Reserve than anything else. When they enter a rate hike cycle, i.e., they enter into a period of months or years where they continue to increase interest rates over time to throttle growth and to cool inflation, that tends to be a negative signal both for the economy, but also for the stock market. That leads to subnormal returns from the stock market over that period. So that would be the first risk.

It's not something we see. We believe, for instance, at the moment, that the ECB will not raise rates further from 2.25%, having raised rates once recently. We think that the US Fed may raise rates once, but not continue to raise rates. So it might move the Fed funds rate up to 4%, but we think they'll stop there rather than continue to go further. And that's the key. If we avoid a rate hike cycle, then I think the stock bull market can therefore be prolonged.

The second element, which is a very big question, is about AI. Is it a bubble or is it simply strong growth that can be maintained like a megatrend? If you believe it's a bubble, then of course, following a bubble, you can get a bust and that also could bring the stock bull market to an end like it did in 2000. However, if it's a megatrend and that growth rate can go on for longer, then that in itself can maintain the upwards trend of earnings, of profitability, and therefore the stock bull market can go on for longer.

So those are the two aspects: central bank interest rates and AI, is it a bubble or is it more of a sustainable megatrend?

Global stocks have gained nearly 10% year-to-date. So is it all about big tech and AI?

It has been a lot about AI, but even within the AI theme, the winners have shifted. For instance, if you look at the Magnificent Seven group of stocks who have been some of the biggest spenders in AI, companies such as Alphabet, Google, Meta, Amazon, Microsoft, others such as Oracle, they have actually underperformed. Since November, the Magnificent Seven as a group have actually fallen by about 6% at a time when the US S&P 500 index has gone up 9%. So 15% underperformance is quite significant for such a big chunk of the index. So it's not everything in AI that's continuing to work well.

On the other hand, you've seen memory chip makers have gone to the moon. So, you know, companies such as SK Hynix and Samsung in South Korea, Micron and Sandisk in the US, have performed incredibly well. So there are parts of the AI theme that have performed actually accelerated performance. So the Magnificent 7 on the one hand, underperformance, software stocks as well have underperformed. On the flip side, memory chip stocks have done extremely well. So it's a bit of a mixed bag, I would say, in terms of performance around the AI theme.

But there are other segments of the global stock market that have also performed very well. Value, non-tech value areas such as European banks have done well. US small caps and even emerging markets outside of Korea and the tech-heavy Korea and Taiwan have actually held up pretty well. Japan, which is partly tech but also heavily industrial, has performed very well. So these are some areas that I think we can continue to concentrate on.

If you want to construct a portfolio which has some tech, but also some non-tech, I think there are plenty of areas in the non-tech or the less focused tech areas that you can look at today. In a long-running bull market, stock market leadership changes from time to time.

Charlotte de Kerpoisson:

Edmund, do you think that such a shift is currently underway?

Edmund Shing:

Well, yes, because as I said, the Magnificent Seven are underperforming. The mantle has been picked up by former underperformers such as US small caps. We see healthcare, which is more of a defensive growth sector, coming back well after underperforming for quite a while. As I've said, you continue to see strength in a number of value areas such as European banks and even in Japan. And so I do think there has been a rotation, certainly in the US, towards more small-cap and industrial exposure away from particularly the Magnificent Seven. There is also, I think, some rotation still within the rest of the world as well.

Again, a little bit less emphasis on tech, a little bit more emphasis on other more value areas that have performed very well. I mean, if you look within emerging markets, some of the best-performing countries have actually been countries with a very low exposure to tech, such as Poland. And that's an area we like today.

Finally, what are your top investment convictions for the summer months?

Firstly, I've mentioned European banks. This is still a cheap sector with strong earnings momentum, backed by actually a pretty solid economic backdrop. You're seeing rising demand for bank loans, both from households and from companies, which is typically a positive sign. And it still offers a dividend yield of 5%, so a very nice income level.

Secondly, I've mentioned value. So countries offering a lot of value, such as Poland, a little bit like the banks, high-dividend yield, low valuation, strong economic backdrop. And I think it's a country which is... it's in the emerging market universe. But as it's quite a small weight, it tends to be overlooked in favour of predominantly Asian countries, such as, of course at the moment, South Korea and Taiwan. And I think actually Poland is definitely worth a look today.

Thirdly, if you want to continue to have exposure within US stocks, I would say US small-cap stocks are definitely a way to go, up 22% year-to-date versus +9% for the large-cap S&P 500 index. So it's catching up pretty quickly to the large caps. And I think there is more to come there.

Final point for those who want something in commodities. Don't forget gold. Gold was at $5,400. It's now back at $4,100. We maintain a $5,500 target in 12 months. So that gives you plenty of potential upside. So I think gold is always a nice thing to add at this point.

Charlotte de Kerpoisson:

Thank you Edmund.

And thank you to our audience for following this podcast.  Please like share and subscribe to our weekly podcasts.

We recently published our mid-year investment themes.  For more information about these and for all our investment strategy research, please visit our website. 

Goodbye.