deVere Group: Investment Outlook 31st Oct 2024
Andrew.J. Barros ACSI
Area Manager at deVere Spain SL | Wealth Management Consultant for the Expats and International Investors
Tom Elliott
A fortnightly look at global financial markets
31st?October 2024
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Market sentiment:?Uncertainty dominates, driven by global politics, and particularly by events in the U.S. U.S economic data is coming in stronger than expected, which reduces the scope for Fed interest rate cuts (hence higher Treasury yields), but helps company profits (hence the S&P500 at new highs). if Donald Trump wins the election on Tuesday unpredictable, and possibly inflationary, policies are likely to follow and the Fed will have a particularly difficult meeting on Wednesday when it next meets to set interest rates. Gold, the classic defensive asset, is at new all-time high, at ￡2,114.?
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Gilts wilt after U.K budget.?Yesterday’s budget, delivered by Chancellor Rachel Reeves, had the whiff of ‘tax the rich’, especially following weeks of assurances that there will be no new taxes on ‘working people’. There was disappointingly little in it that will support economic growth.
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The budget adds ￡70bn annually to public spending, to the ￡1,226bn total spending estimate for 2024-25 in April. ￡40bn comes from tax hikes, ￡30bn comes from increased borrowing. Tax hikes fall on mostly on businesses, with higher employer National Insurance contributions. The wealthy face higher capital gains tax, pensions to be subject to inheritance tax (unless left to a spouse), an end to the non-dom status, higher taxes on the private equity industry, higher air passenger duty, and VAT on private school fees. Some of these feel totemic.
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Much of the increased spending will go to the health service and schools, with other departments facing cuts in spending. Indeed, despite the increase in tax revenue government finances remain surprisingly strained – something the government is keen to blame on the last Conservative government.
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The gilt market rallied as the Chancellor spoke, the sheer size of the tax rise suggested that the amount of new borrowing will be limited. However, the publication of the full budget text after she spoke, along with the OBR’s assessment, altered the mood and there was a significant sell off in the afternoon. The 10yr gilt yield currently at 4.44%, up 23bp from just before the release of the two reports. Sterling was steady at $1.30.
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The OBR’s report on the budget suggested lower growth, a modest pick up in inflation, and higher mortgage rates will follow.?
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A Trump win becomes priced in.?With polls showing a slight lead for Trump, the likely economic consequences of his winning a second term are becoming priced in. The U.S economy does not need a fiscal boost, as last month’s surprisingly strong jobs numbers amply illustrates (254,000 new jobs created in September, against expectations of 159,000, and the unemployment rate down to 4.1%). Yesterday, third quarter GDP growth was reported to be 2.8% (annualised rate), supported by strong consumption.?
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This suggests that -from a Keynsian perspective- the time is ripe to raise taxes, in order to restore public finances and reduce the risk of an uptick in inflation. Neither Hariss nor Trump propose anything of the sort, both ignoring the deficit and the large build up of debt. The bond market may be happy to absorb an infinite supply of government debt, so long as its real value (ie, after inflation) remain stable. Default by a government that can print its own currency is impossible. But issuing large amount of debt tends to feed inflation, hence investors fear of over supply.?
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Higher inflation is considered more likely under Trump than Hariss (due to tariffs on imports, tax cuts, and higher wages as illegal immigrant labour is deported). This will, the thinking goes, lead to higher interest rates and bond yields, and so to a strong dollar. Having speculated on two quarter point interest rate cuts by the year end, a month ago, financial markets have reduced their bet to just one cut, next week.?
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What’s in a Trump win for U.S equities??U.S companies will benefit from deregulation (banks and energy companies are thought to be likely beneficiaries), and lower taxes. Fiscal deficits -whether caused by tax cuts or spending increases- tend to be mirrored in company profits, given that the money created by the required increase in borrowing has to be spent.?
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Tariffs will be a mixed blessing, depending on how much of their supply chain comes from overseas, and the degree of foreign competition in the domestic market. Retaliation from trading partners risks export sales. Higher borrowing costs, and a reacceleration of wage growth if illegal migrants start being deported, will hurt the bottom line. But overall, a Trump victory could be good for Wall Street on fundamentals.
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However, valuations are high again.?If the S&P500 can hold onto gains made this year until the year end, it will be the strongest return for the index this century. This has contributed to high valuations for U.S stocks, relative to their history, and to other major markets. Barron’s estimate that the S&P500 currently stands on a price /earnings ratio of 25 times (using trailing earnings), the highest in three years. The NASDAQ 100 is on 32 times. In addition, the concentration of a few very large companies in the S&P500 may limit aggregate earnings growth for the index. It becomes increasingly hard to consistently increase earnings when you are already a dominant player in a sector, particularly if regulators are on your back.?
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A recent report from the Goldman Sachs multi-asset team* speculated that given the high starting level for U.S stocks, the next decade could see just a 3% annual nominal return for the S&P500 (1% real). Other asset classes, such as U.S investment grade bonds (4.8% nominal), and high yield U.S bonds (7% nominal) could fare better. One could add to that list non-U.S stocks, with the FTSE 100 valued just 16 times trailing earnings and Japan’s TOPIX at 12 times.?
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All of which speaks to the need to diversify one portfolio geographically, as well as by asset class.
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Sterling…high enough against the dollar??Sterling sits at $1.30, having traded between $1.24 and $1.34 over the last six months. With both Treasury and gilt yields rising, neither currency has an advantage on that front. Long bond yields are surprisingly similar. However, stronger U.S economic growth forecasts, together with the prospect of a Trump win, appear to support the dollar against sterling. Indeed, the dollar is at its highest trade weighted value since August.
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Watch the Bank of Japan!?Japan’s central bank continued their pause on interest rate increases this morning. However, Bloomberg reports that it is itching to tighten monetary policy to combat inflation (core CPI came in at 2.4% for September, its first fall in four months but higher than expected). It has been above the BoJ’s target for two years now. One explanation for their pause is it is waiting for a new government to be formed, after recent inconclusive elections. Given the shock to Japanese, and global, financial markets in late July/ early August, when it began raising interest rates, the BoJ will want to have the support of the government.?
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The risk for global financial markets is of higher yen interest rates leading to a repayment of loans made in yen, taken out by domestic and global financial investors (the ‘yen carry trade’). This worked well, so long as yen borrowing rates were low, and the yen was weak. A change in those conditions could prompt large sales of global stocks and bonds, purchased with those loans.?
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Recommended reading: Why Nations Fail.?Congratulations to the three winners of this year’s Nobel prize in economics, Daron Acemoglu, Simon Johnson and James Robinson. Their 2001 paper ‘The Colonial Origins of Comparative Development’ preceded the 2012 book ‘Why Nations Fail’, both are considered key works in the field of institutional economics. This is a branch of economics that looks at how government behaviour and laws, and the institutions established to provide checks and balances, affect economic growth.?
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Starting with an account of the divided city of Nogales, which is half in Arizona and half in Sonora, Mexico, it asks why the northern half is so much wealthier than the south? Until 1853, it was all in Mexico, and today’s population is largely comprised of the descendants from that time. It provides a perfect illustration of their argument. The answer lies in different approaches to government and individual rights, bequeathed by the former colonial powers. The Spanish left Mexico with a political economy based on ‘extractive’ behaviour by an often-absent elite, while the British left the United States with a tradition of ‘inclusive’ legal norms, that helped share and also protected prosperity.