Market Matters: 13 February 2024

As we entered the Chinese Year of the Dragon, centre stage belonged to the US markets. Last week, the S&P 500 finally broke and held above the 5,000 level, and momentum remains strong. The catalyst for the move was a downward revision to December’s inflation report. Updates to the Consumer Price Index showed that the broad basket of goods and services measured increased 0.2% on the month, less than the initially reported 0.3%, the Labor Department’s Bureau of Labor Statistics said. While the change is only modest, it helped confirm that inflation was moderating as 2023 ended, giving more leeway to the Federal Reserve to start cutting interest rates later this year.

A very Happy Chinese New Year to you all as we welcome the Year of the Dragon, which I am told is a much-revered symbol representing power, strength, good luck and wisdom. Given that last year’s Rabbit saw Chinese equities lose nearly 30% of their value, it’s safe to say things can only get better, but you never know. China did stage a rally last week, more in response to technical measures designed to limit selling than any real fundamental good news, but it was a start, and if it holds, it could bring in the ‘bottom fishers’.

Outside of that news on Friday, it was a tranquil week regarding economic data. Still, we heard a speck more from various members of the central banks last week, all leaning toward the hawkish side of things, which weighed on the fixed-income markets.

We did, however, pass smoothly through another US debt auction as the US government sold $25 billion of 30-year bonds at a lower-than-anticipated yield, soothing investor nerves about the demand for longer-dated debt. It would seem that a 10-year “risk-free” yield of more than 4% is still an attractive investment for some managers, who would no doubt have bitten your hand off for that security pre-COVID!

I have largely steered clear of passing comment on the companies that have done the lion’s share of lifting the S&P higher, but we have now heard the earnings reports from six of them, so it’s probably worth devoting some airtime to this space. M7 is the new acronym that replaced the FAANGs and refers to Amazon, Microsoft, Alphabet, Meta, Tesla, Apple and Nvidia. With a combined market cap of $13 trillion+ and climbing, the combined market capitalisation of Microsoft (MSFT), Apple (AAPL), Alphabet (GOOG), (AMZN), Nvidia (NVDA) and Tesla (TSLA) is now in excess to the combined GDP of New York, Tokyo, London, Los Angeles, Paris, Seoul, Chicago, San Francisco, Osaka, Dallas, Shanghai and Stoke-on-Trent. According to Bank of America calculations (and Stoke council), the figure is quite something!

So far, with Nvidia the only one left to report on 21st Feb (Tesla missed and may be dropped from the group), most surpassed revenue and earnings expectations, and forward guidance suggests they remain on track to hit aggressive analyst expectations for the entire year.

Yes, by any metric, the valuations are generous. Still, the bullish tone of the markets suggests there is room for expensive to become very expensive, especially with all the hype surrounding AI. Every bubble needs a new narrative, and AI is the story that makes typical valuation methodology irrelevant.

Where have we heard that before? Is that dot com I hear rattling on the chains of history? Despite all the talk about the unsustainably high valuations of the Magnificent 7, the combined valuation of the big-tech sectors would have to rise a lot more to reach its peak in the ”dot com” bubble. The chart to the right of P/E valuations kindly supplied by Capital Economics, shows there is still breathing room. Remember, revenue trajectories are still on an upward path. Bubble or unusual investor insight? – only history will answer that one. But in the absence of anything obvious to derail earnings in the immediate future, I reckon this move in the juggernauts still has further to run…

The rich get richer, and the poor get poorer; at least, that’s one way of explaining the valuation and performance gulf between UK and US equities. Any UK-based fund selectors loaded up on UK equities on the predisposition of home bias will suffer; any that follow a world market cap allocation are laughing. The question is, how long can this continue? I’m afraid nobody knows the answer. I had the pleasure of a meeting with the Newton UK Income desk last week, and they are similarly perplexed, citing sector by sector, UK companies that match their US peers (BP & Shell vs Exxon & Chevron) and yet trading on half the price.

Economically, at least, the spotlight will be on UK data this week. On Tuesday, there’s an expectation for wage figures to reveal the least intense salary inflation since 2022, a development likely to be welcomed by Bank of England officials who are at least shifting focus towards reducing interest rates, in line with global counterparts. Unfortunately, attention will also be directed towards Wednesday’s inflation numbers, which might increase alongside rising energy costs.

The following day, GDP figures will shed light on the impact of the Bank of England’s monetary tightening on economic growth. Analysts predict that the UK’s economy flatlined in the last quarter, just managing to dodge a recession for the time being, we shall see.

Stepping away from US tech hype and short-term economic concerns and thinking objectively about what we might expect from UK equities from here, I find myself (unusually) relatively positive. I think we will avoid a meaningful recession; yes, we might get a technical one, but through a combination of global strength, a resilient consumer, a recovering property market and some fiscal generosity, we might begin to see UK economic growth picking up by year-end. Couple that with the fact that inflation is still on a downward trajectory and that we will see rate cuts this year. It could create, including dividends, a (potentially boring) 10% for investors, which would still benefit a multi-asset portfolio with much less downside risk, so I don’t feel it is time to ditch the UK and go Global.

If I were a betting man (full disclosure: I do have £10 on the San Francisco 49ers to win Super Bowl on Sunday night – Editor’s note: lousy luck, Tom!) I think the first central bank to cut rates will be the ECB, or at least it should be them.

Hopefully, the committee will listen to the Italians (dovish by nature). As Governing Council member Fabio Panetta put it succinctly, “Macroeconomic conditions suggest that disinflation is at an advanced stage, and progress toward the 2% target continues to be rapid“, he said on Saturday at the annual Assiom Forex event in Genoa. “The time for reversal of the monetary policy stance is fast approaching.”

In addition, Lagarde has said that ECB officials are preparing to loosen policy this year, probably from April or June; investors are hoping for the earlier of the two. The outcome will hinge on inflation, with upcoming wage figures being crucial and proving too stubborn to get the ECB to act thus far.

Even without a clear turning point in wage growth, a bit of data interrogation shows that ‘Including one-off payments’ the new gauge showed salaries rose by 5.2% in the fourth quarter, down from 5.4% in the preceding three months. It’s a start.

So, with much of Asia closed for Chinese New Year, I will leave it there and see what next week brings…

Read more

05 Feb 2024

Market Matters with 8AM

Read more

16 Jan 2024

Market Matters with 8AM

Read more