Jefferies: Geopolitics biggest risk to markets, remain positive for H2

Geopolitics present the biggest risk to markets due to escalating tensions in the Middle East and the persisting conflict between Russia and Ukraine, Jefferies strategists said Thursday.

Strategists explained that these risks, combined with surging global spending on weapons, are fundamentally inflationary, especially in a G7 world where the line between monetary and fiscal policy has blurred due to central banks holding substantial portions of their own government bonds.

Despite these challenges, Jefferies maintains a positive outlook for equities and credit markets for the second half of the year.

"We remain positive for equities and credit in the second half of '24; see a range-bound market for rates while the rally in equities broadens out,” the investment bank noted. It expects the Federal Reserve and the European Central Bank to initiate rate cuts in September, although a shallow rate-cutting cycle is anticipated.

But while inflation and policy rates are expected to remain higher than usual, there is potential for more rate cuts in late 2025 or 2026 if inflation relief materializes.

"Consumers have been maintaining a relatively low savings rate for a long time, and businesses have done a better job preserving margins than we thought," Jefferies remarked.

The firm has also raised its 2024 target for the S&P 500 to 5500, projecting an earnings growth rate of 10.8%.

"S&P 500 continues to see concentrated performance, but earnings revision for Mag 7 and rest of S&P 500 has converged, and the valuation gap between the two remains high,” the note states.

Strategists said that large-cap stocks have dominated in terms of earnings and revenue growth. However, they note this trend could change by the fourth quarter, with small-cap stocks starting to catch up.

"We would prefer the rotation back to small caps NOT be ‘Three yards and a cloud of dust,’ but we will take whatever we can get given the extreme underperformance for so long vs. large caps," they wrote.

The second half of each of the last two election years has served as a catalyst for performance changes, and this time the shift could last longer, they added.