deVere Group: Investment Outlook 30th September 2024
Andrew.J. Barros ACSI
Area Manager at deVere Spain SL | Wealth Management Consultant for the Expats and International Investors
Investment Outlook
Tom Elliott
A fortnightly look at global financial markets
30th September 2024
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Market sentiment:?Improving. The S&P 500 and the Stoxx Europe 600 indices made new highs last week, and the CSI 300 China index had its best week since 2008, up 15.7%, as confidence in risk assets continued to improve. The rally has been driven by the surprise 50bp cut in U.S interest rates, announced by the Fed on the 18th, and by last week’s large financial stimulus package from the People’s Bank of China (PBOC).?
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The Barclays Global Aggregate bond index rose a little last week. With both global equities and bonds up, the Bloomberg Global 60/40 index closed on Friday at a new high.?
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Sterling is at a two and a half year high of $1.34. The Bank of England has adopted a cautious approach to interest rate cuts in the face of stubborn services inflation, while economic growth is forecast to be stable, if not buoyant. Two weeks ago the OECD forecast that the U.K will have one of the strongest growth rates amongst the G7 nations this year, at 1.1% (only being beaten by the U.S, at 2.6%).?
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Gold has reached new highs, touching $2,685 an ounce, helped by declining global interest rates and geopolitical worries. There is also steady buying by emerging economies, as a deliberate policy to diversify their currency reserves away from the U.S dollar.?
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The VIX index of anticipated volatility on the S+P 500 (‘the fear gauge’) stands at 17, about average over the last year.
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Investors should remain diversified by region and asset class. Financial history shows that diversification is the key to maximising long-term risk-adjusted returns. With U.S stocks looking quite expensive relative to their history, and to other regions, investors should be mindful of the need to rebalance portfolios to ensure exposure to regions that offer better value.
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The Fed cut.?The Fed’s surprise 50bp interest rate cut on the 18th?was well received by global investors. Careful wording by Fed chair, Jay Powell, helped avoid give the impression that the size of the cut was because of fear of recession. Last week a surprisingly low CPE inflation number for August (down to +2.2% y/y), reinforced investors’ hope that the Fed has further room for rate cuts this year. It appears that the Fed is successfully squeezing out inflation, while maintaining growth…in fact, just as Jay Powell says it is!??
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At what point is a soft landing for the U.S economy fully priced in by the U.S stock market??The forward price/ earnings (p/e) ratio on the S&P 500 is at 23.35 times next year’s earnings, the highest it has been since March 2022, and 1.5 times standard deviation away from its 25 year long term average*. This would suggest that an attractive combination of falling interest rates and economic growth is fully priced into the S&P 500. There is little room for disappointment, and any further rally in prices that extends the p/e ratio merely accentuates the risk of a pull back.?
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The Chinese stimulus package.?A massive stimulus package was announced last week by the People’s Bank of China (PBOC). This included a $113bn (800bn yuan) stock market stabilisation fund, as well as cuts in several key interest rates, and reductions in reserve requirements for banks that will allow them to lend more. There will be direct cash payments to some of the poorest households, to boost demand.?
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This not only boosted Chinese stocks last week, but helped lift global stock markets. European stocks benefited, given that many of the continent’s largest companies are big exporters to China, as did global industrial materials (eg, Rio Tinto, the world’s lowest cost large iron ore miner, rose 6% last week).?
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China’s economic malaise includes weak household spending and record high youth unemployment, which have contributed to falling property prices. The core of the problem is the excessive leverage used in infrastructure and property building over the last decade. Higher interest rates, and weaker than expected demand, have led to businesses and households paying off debt, building up savings, and spending less.?
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In so far as higher stock prices tend to bolster confidence in the economy, and looser monetary policy will ease the cost of servicing debt and encourage new lending, the package will help address the problem.?
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U.S Treasury yield curve continued the dis-inversion?that began earlier in September, with the 10yr yield creeping higher while the 2yr remained flat. The normalisation of the relationship between the cost of borrowing, and the length of time that money is borrowed for, is for many evidence that the bond market no longer expects a recession.?
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Others take a more pessimistic view, pointing out that on previous occasions over the last thirty year when the yield curve has dis-inverted (eg, spring 1990, winter 2000/2001, second half of 2007, and late 2019), recessions have followed. Much has been written on this.
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I favour the argument that, aside from the recession of 1990, the next three were triggered by events that that bond market traders had little inkling of…so the relationship is coincidental. Indeed, had the bond market had an inkling of the collapse of the U.S housing market in 2007/08 and the fall of Lehman Brothers, Michael Lewis would have had no story to tell in his book ‘The Big Short’. And how could the bond market have predicted the Covid pandemic and the global economic downturn that followed??
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Rather, we should take the dis-inversion at face value, and accept it a signal that investors are again willing to pay more to borrow for longer. This is the traditional time/value relationship of money that modern economics and finance are built on.?
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U.K budget and gilts.?The 30th?October budget looms ever-nearer. Either taxes rise, public spending is cut, or the government will announce more borrowing and so (probably) brake its commitment to bring down total debt to GDP within five years. Most commentators expect higher taxes (pensions look vulnerable) and limits on public spending growth, meaning cuts in real terms. But how can the government’s growth agenda be delivered in such an environment? The debt rule, which the Institute of Fiscal Studies (IFS) declared impossible the moment that the previous Conservative government announced it this spring, looks like being fudged, or abandoned.
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At last week’s Labour Party conference, Chancellor Angela Reeves hinted at a change in the definition of public borrowing, that may be used to permit more borrowing within the rules. The OECD has added its voice to those urging the new Labour government to borrow more to invest, and for the Treasury to re-write its ‘short-termist’ fiscal rules that inhibit it doing so. The gilt market appears un-perturbed. Perhaps because it knows that the only way for a government to service an increasing amount of debt, on a long term sustainable way, is through growing the economy and increasing tax revenues. To do this, investment is needed.?
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What would provoke a Liz Truss moment??What would lead to a sell-off in gilts, and to higher yields? Perhaps if the government announced more borrowing for current spending (or for tax cuts, as the Liz Truss government did), rather than for investment.?
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Announcing an increase in borrowing to fund investment, while calling for higher taxes and cuts in real spending on public services, will provoke a backlash from the trade union backers of the Labour Party. They are demanding more spending on public sector pay, and more public sector jobs. Just as Conservative Party backers demanded the tax cuts in 2022. Both groups prefer the immediate sugar rush of such policies, that benefit themselves, to waiting many years for the fruits of higher investment to benefit the population at large.?
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The decisions announced on 30th?October will go a long way in demonstrating whether the Keir Starmer government is a throw back to the 1970’s Labour governments, or whether it is committed to a long-term program of economic growth that benefits all. If the later, it appears that the gilt market will support it.