US small companies rebound and the Bank of England makes its first rate cut

US smaller companies were oversold going into July, further discounting their relative valuations, so their recent strong performance was not unexpected. The shifting narrative around rate cuts expected by Fed, following a period of falling inflation, has bolstered smaller companies and led to a sell-off in tech companies. We view the recent tech sell-off as a healthy correction rather than something more ominous. Nevertheless, we expect tech companies to continue outpacing other sectors in earnings growth and they will be supported by ongoing AI innovation.

Double digit earnings growth

Earnings season in the US has been positive so far, with year-on-year earnings growth increasing by double digits, driven by mega-cap tech companies, such as Apple, Amazon, and Microsoft. Even excluding these tech giants, earnings have grown by high single digits and above expectations. However, we have seen some notable differences in companies that have reported thus far. Consumer-facing businesses, for example, have generally reported weaker results, highlighting softer consumer spending. The weakness in consumer spending has been particularly pronounced for European luxury companies, which have reported that the slowdown in earnings was primarily impacted by weak spending by Chinese consumers.

Economic outlook

On the economic front, US GDP increased by 2.8% in Q2, beating forecasts and showing an improvement from Q1. The US economy continues to be resilient and supports our thesis that this business cycle will extend for longer than many anticipate. We saw less good news in Europe, as manufacturing remained in contraction in July. This raises questions about the longevity of the European growth recovery. However, we anticipate that strong real wage growth and interest rate cuts will support growth as we go through the year.

Progress on inflation

Lastly, we have seen inflation in both the UK and US making good progress towards the 2% target, bringing a more dovish tone from the Federal Reserve (Fed) and the Bank of England (BoE). The BoE has taken the lead, by implementing its first rate cut. The Monetary Policy Committee voted to lower the bank's key rate to 5%. However, like the European Central Bank, the BoE maintains a data-dependent approach, and our expectation is that the upcoming rate-cutting cycle for both will be less aggressive than previous ones. The Fed, in its July meeting, signalled the possibility of a rate cut in September, acknowledging significant progress on inflation. This was the clearest indication yet of a potential policy rate reduction. Barring any dramatic developments, markets now anticipate a rate cut at the September meeting. Following the Fed's announcement, the S&P 500 and Nasdaq recorded their best day since February.