Q2 Surprises and What Could Surprise in Q3

2. Emerging Market stocks outperformed

With China's weak economy, elevated trade risks, and the strong U.S. dollar it would seem Emerging Market (EM) stocks faced headwinds in the second quarter. Yet they modestly outperformed the S&P 500. These gains were driven by:

• Investors' strong interest in artificial intelligence stocks boosted the EM index's biggest sector (Information Technology) and stock Taiwan Semiconductor Manufacturing Company (TSMC). AI beneficiaries such as TSMC, Samsung Electronics, SK Hynix and Hon Hai Precision Industry (commonly known as Foxconn) make up 16% of the MSCI Emerging Markets Index.
• India's strong growth continued in the second quarter; India's Central Statistics Office at the end of May released an updated 2024 GDP growth estimate of 8.2%. India remains on a path to surpass Japan and Germany and become the world's third largest economy by 2027, according to IMF estimates. India's stocks make up 19.2% of the MSCI Emerging Market Index with those stocks growing 10.3% in the second quarter.
• Stabilization of China's economic growth, balanced between weak consumer demand and stronger export production, resulted in a peak gain of 18% for the MSCI China Index during the quarter. However, the market slid after May 20 following an underwhelming announcement by the Chinese government meant to prop up the property sector. Chinese stocks have been alternating between optimism about an economic recovery to disappointment over the slow pace of improvement and lack of powerful stimulus to revive consumer demand. The Third Plenum a major meeting held roughly once every five years for the purpose of mapping out the general direction of the country's long-term social and economic policies, will be held from July 15-18 and may yield some incremental reforms with potential to surprise the market, but there is no expectation for any major changes. The regular Politburo meeting, a gathering of the top Chinese party officials who oversee the party and central government, is at the end of July, with another opportunity for an announcement for additional spending or debt issuance plans, but again markets do not seem to be expecting anything big.

The outperformance by EM in the second quarter highlights the benefit of having a small strategic asset allocation to EM; trying to time when certain asset classes come in and out of favor can be difficult.

EM outperforms in Q2

Source: Charles Schwab, Bloomberg data as of 7/11/2024.

Performance is normalized, or indexed to zero, on 4/1/2024. Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly. Past performance is no guarantee of future results.

3. Election outcomes

The surprise call for an election by the French President after his party suffered big losses in the European parliamentary elections in early June led to a sell-off in French stocks and a rise in the risk premium on French debt, fueled by fears the far-right would win a majority and impose costly spending plans widening the budget deficit. According to media outlets, the far-left and the centrist coalitions coordinated with each other in three party run off races to block the far-right from winning a majority. This resulted in a surprise pickup of the largest number of seats by the far-left, although the number fell short of a majority. The outcome may mean any major legislative changes are unlikely, as the leaders of all three groups have vowed not to work together on domestic policy.

French election impact

Source: Charles Schwab, Bloomberg data as of 7/11/2024.

Past performance is no guarantee of future results.

Markets began to reverse June's losses after the first round of voting on June 30, as the margin of victory by the National Rally appeared insufficient to claim a majority in the second round. But the surprise outcome leaves some uncertainty as to what comes next, which may weigh on France's markets. French stocks trade at about 13 times earnings, below their 10-year average of 15, seemingly braced for some domestic political uncertainty. French stocks measured by the MSCI France Index were down YTD 1.4% at the end of second quarter, with the overall MSCI Europe index up 6.4% in the same period. The MSCI France index has already begun to recover post-election in the first two weeks of the third quarter.

It is noteworthy that about 85% of the sales of French companies in the MSCI France Index are not domestic, given France's global brands like LVMH and L'Oreal and Airbus among many others. While the election posed some short-term domestic risk, its mainly the global economic backdrop which over the medium-term could surprise in the third quarter with possible gains on a boost from ECB rate cuts and better growth in Europe overall.

4. Economic surprises turned negative

The quarter began with surprisingly strong global economic data that widely exceeded economists' expectations, reflected by a positive economic surprise index which measures how economic data fares relative to economists' expectations. But the data for the United States, Europe and some other major countries gradually worsened relative to expectations during the second quarter, and the quarter ended with the data generally missing forecasts and pulling the economic surprise index below zero. While surprisingly weak economic data is generally not welcomed by markets, the news might increase the likelihood of central banks rate cuts lending support to the stock market. Now that the market is pricing a high likelihood of two rate cuts for both the Fed and European Central Bank (among other central banks) later this year, further negative economic data surprises in the third quarter may be less tolerated by stock market investors.

Economic surprises turn negative

Source: Charles Schwab, Bloomberg data as of 7/10/2024.

Past performance is no guarantee of future results.

5. No rate cuts by Fed even as ECB and other did start to cut

The European Central Bank, and the central banks of Sweden, Switzerland, and Canada cut rates in the second quarter—but not the Fed. At the start of the second quarter, the interest rate futures market had priced in a greater than 50% chance of a rate cut by the Fed in June and a 95% likelihood of cut by the July meeting. No rate cut took place in Q2 and those July odds now stand at less than 10%. The surprise shift in expectations was in part due to the stronger than expected U.S. economic data for much of the quarter (economic surprise index above zero) along with still relatively easy financial conditions. As noted above, early in the third quarter, markets are now pricing in two rate cuts from the Fed and ECB—but those expectations are subject to a high degree of uncertainty surrounding developments that could influence monetary policy, leaving plenty of room for surprises.

Odds of June rate cut diverged in the run up to the central bank meetings

Source: Charles Schwab, Bloomberg data as of 7/11/2024.

Past performance is no guarantee of future results.

Surprises

Market surprises tied to market concentration, China, elections, economic data, and central bank actions may also be potential drivers of volatility in the markets in Q3. Investors might consider adding a portfolio review and assessing potential exposures to their list of summer plans.

Michelle Gibley, CFA^®, Director of International Research, and Heather O'Leary, Senior Global Investment Research Analyst, contributed to this report.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision. All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed. Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Please note that this content was created as of the specific date indicated and reflects the author's views as of that date. It will be kept solely for historical purposes, and the author's opinions may change, without notice, in reaction to shifting economic, business, and other conditions.

All corporate names and market data shown above are for illustrative purposes only and are not a recommendation, offer to sell, or a solicitation of an offer to buy any security. Supporting documentation for any claims or statistical information is available upon request.

Past performance is no guarantee of future results and the opinions presented cannot be viewed as an indicator of future performance.

Investing involves risk, including loss of principal.

International investments involve additional risks, which include differences in financial accounting standards, currency fluctuations, geopolitical risk, foreign taxes and regulations, and the potential for illiquid markets.

Investing in emerging markets may accentuate this risk.

Performance may be affected by risks associated with non-diversification, including investments in specific countries or sectors. Additional risks may also include, but are not limited to, investments in foreign securities, especially emerging markets, real estate investment trusts (REITs), fixed income, municipal securities including state specific municipal securities, small capitalization securities and commodities. Each individual investor should consider these risks carefully before investing in a particular security or strategy.

Diversification and asset allocation strategies do not ensure a profit and do not protect against losses in declining markets.

Currency trading is speculative, volatile and not suitable for all investors

Futures and futures options trading involves substantial risk and is not suitable for all investors. Please read the Risk Disclosure Statement for Futures and Options prior to trading futures products.

The policy analysis provided by the Charles Schwab & Co., Inc., does not constitute and should not be interpreted as an endorsement of any political party.

Indexes are unmanaged, do not incur management fees, costs, and expenses and cannot be invested in directly. For more information on indexes, please see schwab.com/indexdefinitions

BLOOMBERG^® is a trademark and service mark of Bloomberg Finance L.P. and its affiliates (collectively "Bloomberg"). Bloomberg or Bloomberg's licensors own all proprietary rights in the Bloomberg Indices. Neither Bloomberg nor Bloomberg's licensors approves or endorses this material, or guarantees the accuracy or completeness of any information herein, or makes any warranty, express or implied, as to the results to be obtained therefrom and, to the maximum extent allowed by law, neither shall have any liability or responsibility for injury or damages arising in connection therewith.

The S&P 500 Equal Weight Index is the equal weighted version of the S&P 500, containing the same constituents as the headline index, but with each security allocated the same fixed .2% weighting during the quarterly rebalance.

The MSCI All-Country World (ACWI) Equal Weighted Index is the equal weighted version of the MSCI ACWI, containing the same constituents as the headline index, but with each security weighted equally during the quarterly rebalance.

The MSCI China Index captures large and mid-cap representation across China A shares, H shares, B shares, Red chips, P chips and foreign listings (e.g. ADRs) covering about 85% of this China equity universe.

The MSCI France Index is designed to measure the performance of the large and mid-cap segments of the French market covering about 85% of the equity universe in France.
The MSCI Europe Index captures large and mid-cap representation across 15 Developed Markets countries in Europe, covering approximately 85% of the free float-adjusted market capitalization across the European Developed Markets equity universe.

The Global Economic Surprise Index measures data surprises relative to market expectations for global economic data, with a positive reading indicating stronger than expected data releases, and a negative reading denoting data releases being worse than expected.

0724-DSRX

---

A message from Advisor Perspectives and VettaFi: Join us on July 25 for the Q3 Fixed Income Symposium, where advisors will gain insights into essential fixed income strategies and market trends to navigate 2024's challenges.

© Charles Schwab

More Municipal Bonds Topics >