MARKET UPDATE 10/06/2024
Market sentiment: Investors are circumspect. Following May’s global stock market rally, investors have become cautious over the last two weeks. Confidence was helped last week by interest rate cuts from the Canadian central banks and the ECB, but uncertainty over the date of the Fed’s first interest rate cut continues to spread volatility into global bond and stock markets. This has not, however, halted the rise, and rise, of perhaps the world’s most talked about company: Nvidia. Last week it overtook Apple’s $3tr market capitalisation, to become the world’s second most valuable company. Its rise helped drive the NASDAQ and S&P 500 to new highs last Wednesday. The FTSE 100 and the Euro Stoxx 50 indices have been broadly flat so far this month.
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As of the close of Friday, markets were giving a 57% chance of a September cut, compared to an 81% chance prior to that day’s surprisingly strong May payroll data. Labour markets remain tight in all the major economies, leading to strong pay growth and service sector inflation. This accounts for the reluctance of the Fed and the Bank of England to commence their own interest rate cuts.
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Investors nervous of sticky inflation, and fearing ‘higher for longer’ interest rates, should consider portfolio exposure to real assets, such as commodities and real estate. In bond markets, short-dated bonds offer better risk/return profiles than long-dated, if inflation and interest rates continue to fall slower than had been anticipated. Stock markets have historically offered relief against inflation, given that many companies are able to pass on rising input costs in the form of higher selling prices, so long as wage growth persists.
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However, investors should maintain a broad exposure to all asset classes and regions, including small cap stocks and emerging markets. A managed multi-asset fund follows such a strategy, which financial history shows offers the best long-term risk adjusted returns.
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The Fed and Bank of England to remain on hold. Both the U.S and U.K central banks’ monetary policy committee meet soon. Neither are expected to cut interest rates given the ongoing strength of their labour markets, contributing to 4.8% pay growth in the U.S, and 6% in the U.K. In the U.S, all eyes will be on the Fed’s ‘dot chart’ which will be published alongside its interest rate decision on Wednesday. It shows interest rate expectations amongst the monetary policy committee, and if diverging from market expectations, can move market prices. The Bank of England meets next Thursday, as does the Swiss National Bank, which was the first major central bank to cut rates in March. ?
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The Democrat and the Conservative party would both like their central banks to deliver interest rate cuts ahead of forthcoming elections, to offer voters proof that their policies are working. Some perspective is needed here. An increase in U.S government spending, and tariffs on imports, was begun under Trump and continued under Biden. This has helped stoke not only growth, but also inflation. Thereby keeping interest rates high.
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In the case of the U.K, the claim may have more merit. Cuts in real wages for public sector employees, weak investment spending, together with a rise in taxes, will have helped reduce inflation. However, the result is an aggregate increase in GDP per head of just 1.7% since the end of 2019, according to the OECD*, with only Germany performing worse amongst the G7.
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The European far-right gains support. The strength of the far-right parties in Sunday’s elections for the European Parliament add to investors’ geopolitical risk. The most obvious example is in France, where the surprising strength of the National Rally vote (previously the Front National) has led President Macron to call a snap general election. It is possible, though many suspect unlikely, that he may have to work with a new prime minister as a result: the National Rally’s leader, Marion Le Pen. The far right did well across the E.U, with one or two notable exceptions such as Slovakia.
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At the European level, the far right may unite to steer Brussels into taking a harder line on immigration and to relax some environmental and social legislation. However, they differ on many points, the main one being their openness to Russian influence, which in turn determines their position on Ukraine. On economic policy, they tend to favour protectionist policies and redistribution from ‘woke’ urban elites to rural workers, and to those with declining industries.
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Nigel Farage to split the opposition in Westminster? In the U.K, the decision by Reform leader Nigel Farage to stand as a member of parliament for Clacton has led to a further rise in the party’s approval rating, and is eating away at the Conservative Party vote. The result may be, ironically, an easier life for the Labour Party. When it wins the 4th July general election, with what is likely to be a large majority, the opposition will be split into shards.
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The election campaign is full of tax and spending promises, that should be taken with a grain of salt. Neither of the two main parties are being honest with voters over a ￡30bn black hole in public spending, identified last week by the IMF. Higher taxes and/or cuts in public spending will be needed to avert the gap, given the government’s stated goal of also bringing down the overall debt burden in five years’ time. This is a goal shared by the Labour Party, in nits bid to be seen as fiscally responsible.
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Labour and the LTA on pensions. Rachel Reeves, the Labour Paty’s shadow chancellor, is today reported by the Financial Times to have ditched plans to re-introduce the lifetime allowance limit (LTA) on tax-free pensions. It reflects a fear within Labour of being attacked as being hostile to the elderly and the middle class. The previous limit was ￡1.073m. The ￡800m a year this might have raised for the government was not, apparently, included in Labour’s fiscal plans and so dropping the LTA won’t necessitate tax hikes elsewhere.
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The reintroduction of the LTA may re-appear as a policy idea under a Labour government, given that it has a signalling value to the left that goes beyond its significance to public finances. The Labour Party’s policy of ending the charitable status of private schools, is perhaps of a similar mould.
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A Bloomberg poll** published this morning shows that traders believe a Labour government will be best for growth and for U.K financial assets in general, but also most likely to raise taxes. While a Labour government will be good for the pound, 61% of respondents believe it will take more than five years for the currency to regain the $1.50 level it held before Brexit.
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Indian election. The surprise result of the recent Indian general election, announced early last week, triggered an immediate 6% fall on the benchmark Nifty 50 index of leading Indian stocks. This was followed by a recovery rally, and the index currently sits at a new high (as of 10th June). We can expect further volatility, while prime minister Modi negotiates with the NDA coalition parties. However, we should not loose sight of the fact that Modi will remain prime minister, and his program of massive infrastructure spending (on roads and rail in particular), is likely to continue and will help drive economic growth. ?
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Commentators put the worse-than-expected result for Modi’s BJP on voter concerns, over unemployment and inflation. To an outside observer this may seem unfair, given the remarkable current growth rate of the economy, with GDP up 7.7% year-on-year in the first quarter.
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India or China stocks? One reason for investor caution, however, is the current high valuation of Indian stocks. Value investors may want to look elsewhere. The Nifty 50 had risen by 25% in the last year, and its forward price earnings ratio of 22 times is at the top of its five-year range. This compares with the Shanghai Composite index, in China, which is down 5.5% over the last year, and which is valued at 13.5 times forward earnings.
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