Bull market trundles onwards!
Author: Tom McGrath CIO, 8AM Global
Market Review
Western equity markets trundled higher, with a slight outperformance from the UK and small-cap generally. China spluttered but got a significant bounce at the end of the week as there was a further fiscal commitment from the authorities. Oil tumbled as it would appear that Israel is unlikely to target Iranian Oil and nuclear sites. The yield on UK 10-year debt moved below that of US debt for the first time in a while, as UK inflation unexpectedly dropped below 2%. Gold continued its meteoric run, setting new highs, possibly as a result of the continued trouble in the ME after Israel killed the Hamas leader. Or, perhaps, it is just that there are more buyers than sellers, as China and other global central banks continue to use the precious metal as a store of wealth. So, for the moment, we have avoided any troublesome October shocks, but I have a hunch that volatility could increase in the US Presidential election’s run-up.
US Market & Economic Updates
US equities continued their upward momentum this week, with the S&P 500 gaining nearly 1%, marking its sixth consecutive increase, the longest such streak since December. Meanwhile, yields on ten-year Treasury bonds remained relatively stable after a four-week rise driven by a pullback from expectations of significant interest rate cuts.
The critical driver of optimism remains the broader economy, as data released this week indicated that consumer spending and the labour market remain resilient. In addition, bank executives offered almost universally positive outlooks, as corporate earnings largely exceeded expectations. On Thursday, the Atlanta Fed’s GDPNow tracker revised its forecast upward once again, now predicting third-quarter GDP growth of 3.4%.
These data points reinforce my belief that the Federal Reserve was probably overly cautious when it cut the federal funds rate by 50 basis points in September. If a central bank cuts more than is warranted, as economic growth and corporate earnings remain solid, it is not surprising that risk assets are moving higher and fixed income is selling off.
Can the rally in the U.S. equity market continue? Despite the challenge of extending a rally that has seen the S&P 500 rise more than 60% since its low two years ago, there’s still reason for optimism. While the index trades at 24 times annual earnings, a high valuation by historical standards, recent market declines due to labour market concerns have consistently reversed thanks to strong buying from retail and institutional investors.
Though pinpointing the exact stage of the U.S. economic cycle is difficult, the feared recession that triggered the selloff two years ago never arrived. I firmly believe the economy still has room to grow, and when coupled with productivity growth, that should drive earnings considerably higher over the foreseeable 18 months. Is it enough to justify the current valuation? We shall see. But if people are around with money and a willingness to invest, I think so. Despite scaled-back expectations of aggressive Federal Reserve cuts, bullish flows persist, with Bloomberg estimating $3.2 billion flowed into risk-on ETFs this week, the fastest pace since August. Sentiment indicators are undoubtedly in Bullish territory, but not enough to trigger any alarm bells, and there is a real comfort when you see the record amount of cash sitting in the money market funds.
UK Inflation
UK inflation fell sharply in September (CPI dropped to 1.7% in September, down from 2.2% in August), mainly due to lower fuel prices and favourable base effects. However, before we get too carried away, inflation is expected to rise again in October and towards year-end, as energy prices increase and base effects fade. It’s nice to see the Oil price drift back down below $70 a barrel, and if it stays low, that will help.
With pay growth cooling slightly, this data supports the likelihood of the Bank of England cutting interest rates by 25 basis points in November. From there, the pace of further rate cuts will depend on continued positive trends in pay and inflation, as well as the upcoming Budget on October 30. It was nice to see UK equities finally enjoy a good week, and my hunch is that if we can get past a budget that isn’t too austere, we may see UK equities play catch-up with US markets in the run-up to the end of the year.
Europe Cuts Rates
This week, the European Central Bank (ECB) lowered its key interest rates by 25 basis points for the third time this year. This was expected, and we got confirmation that more cuts could follow in upcoming meetings. President Christine Lagarde emphasised the ECB’s focus on data rather than committing to a set rate path, but the economic outlook very much suggests that this will result in further easing.
Recent economic data, including weak PMIs and a downward revision of inflation to 1.7% in September, pushed the ECB to act. The much-anticipated consumer-led recovery has yet to materialise, with households saving more despite wage growth outpacing inflation. Germany and France are on the verge of recession, and risks to growth remain on the downside.
It is tough to know what will convince Europeans to start spending more; part of their reluctance would seem to be down to cultural differences between the free-spending Americans and, to some extent, the Brits. A survey showed an increase in demand for housing loans, anticipating easier policy, so there are signs that lower rates will get them buying again, but businesses remain cautious as loan demand remains weak. The ECB’s focus is undoubtedly shifting from inflation to growth risks, though inflationary pressures remain high enough to stop them from going for aggressive cuts above 0.25%. Slow and steady on the rate cut front, I expect, as growth and inflation forecasts are likely revised down in December.
And the winner of the US election will be…Equities!
Sorry, it’s too close for me to make a call on who the next President will be, but I think the asset class that will do the best, irrespective of the actual winner, will be equities! Trump or Harris, even the betting markets and polls suggest it will be close. I have always favoured the FiveThirtyEight website Who Is Favored To Win The 2024 Presidential Election? | FiveThirtyEight as the best place to get unbiased statistical analysis of the likely result. Since FiveThirtyEight began tracking the presidential race between Kamala Harris and Donald Trump, Trump has edged ahead in the odds for the first time. As of October 18, the model gives Trump a 52% probability of securing the Electoral College, leaving Harris with a 48% chance. I will instantly counter that by flagging that the FT has Harris with a slight advantage, although that is with 93 of the 538 seats available, designated as a ‘tossup’!
The FiveThirtyEight shift in sentiment comes after a steady stream of polls indicating a closer race in critical battleground states. Trump now holds a slight advantage in Pennsylvania, flipping Harris’s previous lead. Similar trends are seen in Michigan and Wisconsin, where her edge has nearly disappeared. Arizona and Georgia have shifted to favour Republicans. A 52-48 split is nearly even, meaning the outcome is still highly unpredictable. A few positive polls for Harris could easily change the dynamics. I have a slight hope that younger black voters, who are less likely to engage with pollsters, might actually show up on election day for Harris, but perhaps that’s just wishful thinking.
Whilst the election remains a toss-up, the potential economic effects are becoming more apparent as each side unveils a little more detail on likely policy changes. If Donald Trump is elected, the upside potential for GDP growth will be higher, mainly because of his proposed tax cuts. But that would also mean inflation risks would be slightly higher. On the other hand, if Kamala Harris wins, the outlook for GDP growth will drop a bit, mainly due to the increasing likelihood of a divided government, which would limit the scope for major fiscal changes. Still, she also looks likely to be spending more than previously thought on projects such as Medicare.
In either scenario, the election significantly risks the economic outlook more than anticipated. Regardless of who wins, they will go into spending mode, increasing federal debt. This could upset the Federal Reserve’s plan to reduce interest rates steadily next year. Equities could survive this news after a few indigestion problems, but less so the US Bond market. So, I think I would have to vote on equities, most likely to emerge as the election winners, with bonds trailing quite some way behind next year.
US Earnings this Week
As we go into the busy period for Q3 US earnings over the next few weeks, so far the numbers are looking good;
Earnings Scorecard: For Q3 2024 (with 14% of S&P 500 companies reporting actual results), 79% of S&P 500 companies have reported a positive EPS surprise and 64% of S&P 500 companies has reported a positive revenue surprise.
This week there is a long list of companies reporting including ; Procter & Gamble, American Express, Baker Hughes, General Motors, Lockheed Martin, Coca-Cola, Intel, Tesla, IBM, Meta (Facebook).
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