Gilt Jitters & Tech Splutters!
Author: Tom McGrath CIO, 8AM Global
Market Review
Last week was probably one of the busiest of the year in terms of economic data, fiscal policy and corporate results. From a UK perspective, the most significant news was Labour’s first budget, which was the tax and spending event we had all expected. In the US we got inflation figures, job numbers, GDP updates and a swathe of earnings results from many big names. Even without the fact that we are only days away from the presidential vote, with all the news investors had to digest, it was no surprise that markets were volatile with a bias to the downside. Bond markets and tech stocks seem to have been under the most pressure, with the UK gilt market falling the most since the Truss debacle two years ago, as money managers worry if the UK will be able to balance its books. Oil has had a rollercoaster ride of its own, first dropping sharply as it seemed Iran would not retaliate to the Israel strikes before bouncing back up, as it now looks as if it might. Gold, somewhat surprisingly, didn’t reap the benefits of all this uncertainty as higher yields quelled investor enthusiasm.
UK Budget – a Macro View
For a while, it looked as if the UK markets would be kind to Rachel Reeves’ ambitious budget, as domestic equities rose and gilt yields fell as she initially ran through her fiscal plans. But then something changed, and yields stopped falling before heading back up, way past their pre-budget levels, as investors digested the scale of the borrowing implied by Reeves. With an estimated £70 billion annual increase in public spending and an additional £100 billion allocated for capital projects, the mood music shifted to the worry that this might be an ‘inflationary budget’. And that would likely mean we will get fewer cuts from the Bank of England than hoped for.
With yields on the rise, Reeves appeared on Bloomberg, keen to calm the markets, reassuring investors that ‘we have more headroom than the previous government ‘and ‘ we have now put our public finances on a stable and a solid trajectory’. That might have just done the trick, as yields seem to have stabilised with the 10-year Gilt yield below 4.5%, but a long way up from the sub 4% levels of September. The sell-off in gilts ripped through other UK assets, the pound fell to its lowest since August, and homebuilders led a sell-off in UK equities on Thursday, but thankfully, by Friday, things seemed to have calmed down. But I would not be surprised to see another attack on Gilts from the bond vigilantes before long. The good news is that it’s still fair to say that the gilts market has not ‘blown up’ as it did after the September 2022 budget.
US Economic Updates –Jobs, Inflation, Wages & Retail Spending
I am not sure one can read too much in the latest employment report in the US, as the numbers were distorted by severe hurricanes that affected data collection rates. New jobs added were only 12,000, way below the estimated 100,000, and the unemployment rate was unchanged at 4.1%. I don’t think this inconclusive employment report will alter the Fed interest rate policy path, and we will get a 0.25% cut next week. We will have to wait a month for the revised figure to get a better read on the health of the jobs market. By then, we should know the result of the US election (that’s far from guaranteed if the results are close as we know Trump will contest), which will have a much more significant influence on future Fed policy, I imagine. Unsurprisingly, the bond markets initially liked the numbers and yields fell, but a troubling reversal occurred for the rest of the day, taking the wind out of the equity market rally. It’s probably just pre-election nerves.
We also got the September inflation data last week, as headline PCED inflation dropped to 2.1% year-over-year, which is good news. However, Core PCED inflation is still at 2.7%, and the ‘Supercore rate’ (core services excluding housing) remains stubbornly high at 3.2%. Those numbers are definitely a little higher than the Fed would want, but they are still just about trending down.
Some good news (from an economic growth perspective, although less so for inflation) was that it would appear that the consumer is in good shape and still spending, as real personal consumption expenditures rose by 0.4% month-over-month. The annual increase is at 3.1%, with total consumption at a new record, with goods spending increasing by 0.7% and services by 0.2%. This will probably continue as the average household probably has the money to keep spending, given that private salaries grew 3.8% year-over-year in Q3, with wage gains now outpacing inflation, suggesting that there has been a strong increase in productivity.
Given the fact inflation is looking a little sticky and the consumer is in good shape, I can’t help but think that the US economy probably doesn’t need any more rate cuts. It will probably get another two quarter-point cuts before year-end, but by early next year, I would not be surprised to see the Fed walking back its accommodative rhetoric. Much of the elevated price of equities is predicated on rates continuing to fall for most of next year. If that hope proves unfounded, I see some market indigestion looming – aka the risk of a minor market correction. But, of course, the whole narrative could be ripped up anyway, depending on the working policies of the next incumbent in the White House.
Big Tech Matters
Tech companies are under intense pressure to justify their massive investments in AI, which initially drove market enthusiasm following OpenAI’s ChatGPT release. Investors gave them the benefit of the doubt for most of this year, figuring heavy investment in this new technology was essential to maintain market leadership. But that ‘spend at all costs narrative’ is starting to wear thin with shareholders, who are now closely scrutinising earnings for tangible productivity gains from AI, punishing firms when results fall short. The quarterly reports that came in last week were mostly reasonable, but the bar has been set high. Microsoft and Meta saw market declines due to underwhelming AI returns, while Alphabet’s positive cloud outlook helped soften the impact. Other tech giants like Apple and Amazon reported varied results, highlighting investor impatience for quicker, measurable AI-driven growth.
If these big companies are going to continue their massive AI expenditures and not see much in the way of productivity gains in the short term, then investors are quite rightly starting to question the high premium in their valuations. This seems to be playing out across the tech sector as a whole, not just the top players.
So far, roughly 60% of the S&P 500 has reported quarterly earnings growth; the numbers have been respectable. However, Big Tech is responsible for almost all of that growth. Strip them out, and earnings for the market as a whole are broadly flat. The weight of the whole market now seems to be falling on the shoulders of these few giants, as not only are they the ones supercharging Nvidia’s earnings, but they also drive the earnings momentum for the entire S&P 500.
China
The latest economic indicators suggest that recent stimulus measures have helped stabilise the economy, with modest improvements in manufacturing and housing. October saw official and private reports on factory activity exceed expectations, and home sales posted their first rise this year—a promising signal following Beijing’s most substantial economic support measures since the pandemic.
The Caixin Manufacturing Purchasing Managers Index rose to 50.3, ending a five-month contraction and surpassing most forecasts. This recovery suggests that government efforts have bolstered confidence more than anticipated, with fiscal measures expected to further support growth.
Residential property sales also jumped significantly, up 73% from September, and sales by the top 100 real estate companies increased 7.1% year-over-year, the first such rise in 2024. This boost in the housing sector suggests that all the measures introduced—including rate cuts, eased buying restrictions, and reduced down-payment requirements in major cities—are at least having some effect.
Stock markets, having retreated from some of the September surge, are at least holding steady at more elevated levels. If economic data confirms that the rebound is gaining traction, they may well be able to move higher from here.
US Election Update – FiveThirtyEight Data
This has become a coin toss after a shift toward Harris late last week, suggesting she might have a chance in Iowa, Wisconsin, and the other Mid-Western Swing States. Despite surfing more political and betting websites than I care to mention, I really have zero extra insight, but my gut tells me Harris can still win – perhaps that’s just wishful thinking.
Rather than try to speculate on all the various market implications for what good news and bad news for asset classes depending on who wins, I am indebted to Sarasin for supplying this handy schematic, which offers their views. TCJA refers to the Trump Cuts and Jobs Act of 2018. A divided house is probably the preferred scenario for equity investors, irrespective of who wins the Presidency.
This Week…
In addition to the US election, don’t forget we hear from the Fed, with a rate cut expected. Major earnings include Novo Nordisc, Qualcomm, Toyota, Sony, and Airbnb…
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