News

Please see the below article from EPIC Investment Partners detailing their insights into GPU’s (graphic processing units), AI and the Energy Market. Received yesterday 24/07/2024.

Data centres are hardly new. Global installed capacity has been compounding at 10-20% per annum for twenty years plus. Traditionally driven by central processing units (CPUs), the advent of graphics processing units (GPUs), which excel at parallel processing, has been a game changer. GPUs can handle many smaller tasks simultaneously making them ideal for complex calculations involving large datasets. The drawback is that they consume three or four times the power of a CPU.

Google’s AI driven Gemini gives a handy analogy “imagine a chef (CPU) in a kitchen. The chef can handle complex recipes (complex tasks) but can only work on one dish (one task) at a time. On the other hand, a bakery (GPU) with multiple ovens can handle many simpler tasks (calculations) simultaneously, like baking cookies (smaller calculations)”. 

Electricity demand in developed economies such as the United States and Europe has been more or less static for the past two decades but the arrival of EVs, heat pumps and now GPU driven data centres looks to be transforming the outlook for global electricity demand. Jefferies recently published an excellent report highlighting the likely trends. Using IEA data, Jefferies estimate that European electricity demand will climb 7% over the next two years with EVs, heat pumps and data centres accounting for half the increase in demand.

Underlying these findings are Jefferies’ expectations that European data centre capacity will compound at 10-20% over the next decade. We wonder if these forecasts are too conservative.  While there remains a lot of ‘hype’ in the capital markets when it comes to AI developments, there is little doubt that AI is transformational.

With ‘net zero’ targets seemingly falling by the wayside, an unexpected boom in electricity consumption is unhelpful. To quote from a recent Bloomberg article “The world needs to be capturing about 1 gigaton of CO₂ a year by 2030 to be on track to reach net-zero emissions by 2050 and limit the global temperature rise to 1.5 degrees Celsius (2.7 degrees Fahrenheit) above mid-19th century levels, the International Energy Agency estimates. That’s 26 times what’s being removed annually now. And it’s three times what would be captured if all the projects now planned or under construction are operating by 2030”.

Please continue to check our blog content for advice, planning issues and the latest investment, market and economic updates from leading investment houses.

Alex Clare

25/07/2024

Please see below, Brewin Dolphin’s ‘Markets in a Minute’ update which offers a brief analysis of the latest movements in global markets. Received late last night – 23/07/2024

Markets had a lot to digest last week, which began with the high drama of an assassination attempt on former U.S. President Donald Trump. The details of the shooting have been well-covered elsewhere, but the impact on markets and the economy was determined by the boost it gave to former President Trump’s already soaring odds of victory.

Later in the week, Trump accepted the Republican nomination and named 39-year-old Ohio Senator J. D. Vance as his running mate. Trump’s miraculous escape, and a charismatic and articulate performance by the new potential vice president, marked a very successful week for the campaign.

The travails of President Joe Biden have also been helpful. Over the course of his week, his chances of victory were downplayed by giants of the Democratic Party including, according to the Washington Post, former President Barack Obama. The Democrats’ top-ranking senator, Chuck Schumer, was reported as having urged Biden to step down. A statement issued by his office didn’t deny the report. Furthermore, former Speaker of the House of Representatives Nancy Pelosi reportedly told House Democrats she believed he could be urged to exit the race.

To cap the week, Biden contracted Covid-19 and left the White House to self-isolate. Over the weekend he then succumbed to pressure and stepped down. What happens next is really uncharted territory.

The Democrats hadn’t formally named Biden their candidate – however, they’ve gone through the primary process, which should have made that a formality. He won almost all of the just under 3,900 delegates who would get to nominate him in a vote at the Democratic National Convention on 19-22 August.

Because Biden has stepped down, those delegates are understood to be able to transfer their votes. However, they’ll want to avoid doing so based upon personal whim. The President’s endorsement of Vice President Harris makes that process easier. Harris should also have access to Biden’s campaign funding. Indeed, funds began flooding in once news of Biden’s withdrawal became known.

Another candidate would need to begin fundraising from scratch, so it seems very likely that Harris will be the Democratic candidate. Whether the candidate is confirmed at the nominally open convention or pre-determined in a preparatory online poll should be decided this Wednesday, when Democratic National Convention organisers hold a meeting to discuss protocol.

Political analysis site 538’s polling tracker shows Trump has increased his polling lead by three percentage points. This suggests the race for the White House remains competitive. In head-to-head polling, Harris performs about the same as Biden against Trump.

Although recent events have been favourable for Trump, the objective evidence is that he’s now leading in what’s still a surprisingly tight race. The Democrats changing candidates will see them lose the advantage of incumbency but offers an opportunity to reset their campaign.

How has this impacted markets?

In terms of the market impact of these events, the increased possibility of Trump winning was accompanied by a steepening of the yield curve. He’s assumed to have plans to raise debt and generate inflation, which means longer-term interest rates should be higher. Longer-dated bonds rallied in early trading after Biden’s withdrawal, suggesting a small reversal of the Trump trade of higher longer-term borrowing costs. This comes alongside evidence from last week that the Federal Reserve (the “Fed”) would be in a better place to cut interest rates having now seen two months in which so-called “supercore” inflation (services consumer price index excluding housing costs) was negative.

Supercore inflation had been running frustratingly high throughout 2024, but May and now June have given negative readings, which will be massively reassuring to the Fed. Potentially lower short-term interest rates and potentially higher longer-term interest rates mean the yield curve has started to steepen, or at least become less inverted.

In an interview with Bloomberg released early last week, Trump made some important remarks. On the positive side, he seemed to indicate he would allow Fed Chairman Jay Powell to complete his term. Although he added the caveat, “especially if I thought he was doing the right thing.”

Trump signals clearly that he won’t allow the central bank as much independence as more conventional candidates would. That said, he isn’t indicating there should be a change in policy.

Developments in chipmaking

Markets experienced a stumble last week and Trump’s words may well have had something to do with it. After a period in which stocks have performed well (mainly driven by large-caps such as technology and communications services, with a specific focus on semiconductors), we have begun to see a reversal of some of these trends.

Firstly, small-caps began outperforming, then a sharp sell-off began in the semiconductor names. In the previously mentioned Bloomberg interview, Trump refused to commit to protecting Taiwan from potential Chinese aggression. Indeed, he accused the island state of having “stolen” America’s chips industry.

America’s support for Taiwan is important, most obviously in terms of being prepared to provide direct naval support, as Biden has promised. However, assuming Taiwan retains its territorial defences, the challenges of an amphibious assault would seem to be almost insurmountable.

If Trump’s comments did lead to conflict in Taiwan and that led to disruption to the Taiwan Semiconductor Manufacturing Company’s (TSMC) production, the implications for the sector would be harsh, with shortages downstream and a big reduction in demand upstream.

However, if Trump’s preference is reducing reliance on foreign-manufactured semiconductors, that implies a big increase in demand for semiconductor manufacturing equipment makers.

During Trump’s tenure, TSMC committed to building plants in Arizona. But its appetite may be waning as construction difficulties and a chipmaking skills shortage have slowed construction and dimmed the outlook for output. Trump may be calculating that a little jeopardy would keep TSMC focused on expanding its U.S. operations.

One such company would be ASML, which also fell as the market reacted to Trump’s comments. However, it would be wrong to suggest that Trump was the only factor weighing on the stocks. The Biden administration is reportedly considering more severe curbs on the use of U.S. technology within Chinese chip manufacturing processes. This is a threat designed to encourage companies like ASML to limit their business with China.

The news came in a week when earnings from companies within the chipmaking value chain have seemed quite robust. ASML, which makes chip manufacturing equipment, and TSMC, which uses that equipment, both reported strong orders.

Will the Bank of England cut interest rates?

Back in the UK, we had a succession of data to welcome in the new government.

As speculated in previously weekly round-ups, the welcome declines in the consumer price index (CPI) were most impressive in the last report ahead of the election. In June, CPI failed to drop below the 2% target, as had been the consensus forecast. Instead, headline inflation remained at 2% while core inflation accelerated slightly. This was considered bad news for the Bank of England’s Monetary Policy Committee (MPC), which might discourage it from cutting interest rates.

However, we noted the decline in median CPI, which seems a more stable estimate of underlying price pressures. It suggests that eventually, like in the U.S., underlying inflation will ease in the UK.

If, on the surface of it, CPI data might prompt the Bank of England to delay cutting rates, subsequent wage growth rates were stable enough to rekindle its appetite. Furthermore, Friday’s retail sales were weak and will provide another modicum of encouragement for the MPC, which seems eager to reduce interest rates if the move can be supported by recent data.

In totality, last week’s data should provide the ammunition it needs, although the market believes it’s a coinflip whether rates get cut or not.

Over and outage…

Lower interest rates would be encouraging for the markets. However, last week ended in a downbeat mood. Following the semiconductor sell-off, there was a global technology outage due to a flawed cybersecurity software update by CrowdStrike. This impacted Microsoft and had ongoing implications for many other users.

Most striking was the impact on air travel, which itself suffers from cascading effects when parts of the schedule are disrupted. With both airlines and airports affected, the impact was significant. However, a botched update is a less concerning cause than a malicious cyberattack and should not on its own cause lasting market angst.

Please continue to check our blog content for the latest advice and planning issues from leading investment firms.

Alex Kitteringham

24^th July 2024

Please see below today’s Daily Investment Bulletin from Brooks Macdonald, which was received this morning, 23/07/2024:

What has happened

Equity markets began to regain their footing yesterday with the Magnificent 7 (+2.33%) leading the recovery after a 4-day slump last week. The renewed vigour comes just as the corporate earnings season is set to ramp up, with industry giants Tesla and Alphabet poised to release their financial results after market close in the US today. The anticipation of these announcements has infused the market with a sense of optimism, contributing to significant gains in major indices such as the S&P 500, which rose by 1.08%, and Europe’s STOXX 600, which increased by 0.93%. Both indices experienced their best sessions since the early days of June, recouping a portion of their recent declines.

Politics driving market?

In the political arena, the aftermath Joe Biden’s withdrawal from the presidential race captured the media’s attention, though there remains some scepticism regarding any immediate, substantial changes in the election’s trajectory. Donald Trump continues to be viewed as the leading candidate, with a Republican victory still perceived a likely outcome. While Trump’s momentum has contributed to some of the recent significant shifts in the market, it is the narratives of disinflation and a potential ‘soft landing’ for the economy that appear to be more influential. Investors are keenly awaiting the release of the second-quarter GDP and June’s core PCE inflation data, which are anticipated to reinforce these themes. The bond market has already fully factored in expectations for a rate cut in September.

What does Brooks Macdonald think

There is no single catalyst behind the resurgence in momentum and growth stocks. A commonly cited explanation is that the market rotation into small caps following the CPI announcement last week may have been overly aggressive. Despite some concerns about capital expenditures in AI versus their monetization, and a projected deceleration in earnings growth for major technology firms, expectations remain high. The six largest companies within the index—Amazon, Apple, Alphabet, Meta, Microsoft, and Nvidia—are still projected to achieve an impressive y-o-y earnings per share growth of 30%, while the remaining companies in the index are expected to see a more modest growth of 5%.

Bloomberg as at 23/07/2024. TR denotes Net Total Return.

Please continue to check our blog content for advice, planning issues and the latest investment, market and economic updates from leading investment houses.

Charlotte Clarke

23/07/2024

Please see the below article from Evelyn Investment Partners detailing their thoughts on this morning’s UK inflation announcement for June. Received this morning 17/07/2024.

What Happened?

UK June annual headline CPI inflation came in at 2.0% (consensus: 1.9%), versus 2.0% in May. In monthly terms, CPI was 0.1% (consensus: 0.1%), compared to 0.3% in May.

Core CPI inflation (ex-energy, food, alcohol and tobacco) came in at 3.5% (consensus: 3.5%) vs 3.5% in May. In monthly terms, Core CPI was 0.2% (consensus: 0.1%), compared to 0.5% in May.

What does it mean?

Despite headline inflation remaining in line with the Bank of England’s (BoE) inflation target for a second consecutive month, June’s inflation data came in very slightly warmer than forecasters had been expected.

Within today’s data, the category for clothing and footwear was responsible for nearly half of this month’s deceleration in the annual rate, with prices falling by 1.2% for the month of June, decelerating the annual rate to just 1.6%. Similarly, the basket for food and non-alcoholic beverages continued to ease, decelerating to 1.5% on an annual basis. This has helped drive the overall basket for goods firmly into deflationary territory with prices in this segment contracting by 1.4% over the last 12 months.

Meanwhile it’s the services sectors of the economy which are still running hot, with an annual inflation rate of 5.7%. within this, restaurants/hotels posted the strongest monthly print, with prices rising 0.9% compared to the month prior. As has been seen in previous locations during her tour, there is speculation that Taylor Swift’s ‘Eras tour’ that gripped the UK during June could be responsible for driving up hotel prices during the month.

However, looking forward:

Ofgem has signalled a further £122 reduction in the energy price cap effective from July 1, this 7% reduction should help to further cool household pricing pressures later this summer and further cement headline inflation at a rate within the BoE’s target. 

Furthermore, the slowing trend in core CPI inflation remains broadly intact. Lead indicators, such as producer price inflation is also heading south. Moreover, cost-push led inflation from wages that feed into the service sector is also decelerating. In addition to weakening employment data, annual private sector wage growth slowed to 5.8% in April, down from a peak of 8.2% in June 2023.

Bottom Line

Even as headline inflation remains within target for its second consecutive month, the continued strength in services inflation will likely remain a cause for concern for committee members at the BoE, heading into their August meeting. However, it remains to be seen if this will be alarming enough to delay their first rate cut later into the year. Currently markets are only pricing in a 35% chance of a cut in August, while prior to this inflation print that number stood at around 50%.

Please continue to check our blog content for advice, planning issues and the latest investment, market and economic updates from leading investment houses.

Alex Clare

17/07/2024

Please see the below article from Brewin Dolphin detailing their discussions on the UK and US markets over the last week. Received 16/07/2024.

The major development over the weekend was the assassination attempt on former U.S. President Donald Trump. According to online prediction market PredictIt, the probability of Donald Trump winning the upcoming U.S. election has risen from 60% to about 66% since the event.

Market reactions have been relatively muted despite such a dramatic event, but there are some important observations as markets price in a higher chance of Trump being re-elected. Longer-term U.S. government bond yields have edged higher relative to shorter maturity bond yields. That is because a Trump re-election is expected to be more inflationary due to tariff threats.

Markets also believe there will be a bigger fiscal deficit and more supply of bonds because of Trump’s pledge to extend tax cuts. U.S. equities reacted favourably, but that may also be due to higher hopes for rate cuts as soon as September.

Cuts come into view

The U.S. consumer price index was the most anticipated data last week and coincided with Federal Reserve (the “Fed”) Chair, Jay Powell’s semi-annual testimony at the Senate earlier in the week. The outcome of both events helped cement the market’s view that U.S. interest rate cuts are coming soon.

Powell said the latest data shows that U.S. labour market conditions have cooled considerably from where they were two years ago. Indeed, we discussed the week before last how the U.S. unemployment rate has been steadily picking up and temporary help services jobs have fallen sharply. Because the labour market is no longer as tight, wage growth has slowed meaningfully. U.S. economic data indicated more of a soft patch recently, and Powell recognised that elevated inflation is not the only risk the Fed faces anymore.

The Fed’s mandate has two objectives: 2% inflation and full employment. In the past two years, the priority has been on curbing inflation. But, as inflation has made great progress, the balance of priority is now shifting toward full employment.

Powell is perceived to be leaning on rate cuts, but he’s keen not to commit to a specific timeline. The guidance is that more good data would strengthen the Fed’s confidence that inflation is moving sustainably towards 2%.

U.S. inflation eases

The Fed and the markets did not have to wait long for that evidence. Last Wednesday, both U.S. headline and core consumer price index (CPI) inflation were reported at below estimates. U.S. headline inflation surprisingly contracted by 0.1% month-on-month (MoM) in June, which was the first time the CPI was negative since we started getting the high prints back in 2021. CPI slowed more than expected on a year-on-year (YoY) basis too, with headline CPI now at 3% and core CPI at 3.3%.

The slowdown in inflation is broad-based, which is welcome. The categories most responsible for driving the downturn in core inflation were the two big shelter categories – rent and owners’ equivalent rent, which together account for over 43% of the weight in the index. Both decelerated sharply, rising just under 0.3% MoM. This is finally starting to reflect the slowdown we’ve observed in new lets inflation.

Core goods inflation is now negative for the third consecutive month. Notably, durable goods prices fell sharply by 4.1% YoY in June, which could be a symptom of weaker demand. Airfares and new or used car prices were all falling in June. The Fed’s preferred measure, so[1]called supercore CPI (core services excluding housing), contracted marginally for the second month in a row, a very different picture compared with the average +0.7% MoM pace in the first quarter of the year.

The satisfactory set of inflation data and cooling jobs data paves the way for the Fed to cut soon. Markets are now pricing in about 62 basis points of rate cuts by the end of 2024 and have fully priced in a 25-basis point cut in September. It feels like we really are finally inching towards a Fed interest rate cut, following wild fluctuations in expectations throughout the year.

The market reacts

Perhaps the most interesting aspect of the CPI release was the market reaction. Bond markets saw a marginal reduction in bond yields across maturities, while gold prices gained as real yields fell. The U.S. dollar weakened as real yields fell and interest rate differentials between the U.S. and other major economies are likely to narrow.

Lower bond yields and a dovish Fed tend to support growth stocks due to their sensitivity to interest rates, as their prospective profits are further out into the future. But mega-cap technology stocks, particularly the so-called “Magnificent Seven” (Microsoft, Apple, Alphabet, Tesla, Amazon, Meta and Nvidia), have plunged post-CPI, dragging the S&P 500 index down due to being heavyweights of the index.

Meanwhile, the S&P 500 Equal Weight Index and S&P 500 ex-Magnificent Seven posted gains. The most stunning move was the Russell 2000 (small cap) Index, which surged +3.6% on the day, the biggest outperformance versus the large-cap S&P 500 since 2020. While it’s tempting to extrapolate a one-day move, the CPI report spurred excitement on the resurrection of small cap stocks via a rotation away from valuation-rich mega-cap stocks.

Time for the lightweights to shine?

The obvious reasons for being more bullish on small caps is the rate cuts argument; smaller businesses have struggled in the higher rates environment, whereas mega-cap companies have robust cash reserves that have shielded them.

Positioning is another argument. Given the extended rally in mega-cap tech stocks due to their embrace of artificial intelligence (AI), it’s unsurprising that investors are taking profits on winners and seeking out laggards.

That said, it’s not a foregone conclusion that small caps can persistently outperform. The conditions needed for small caps to outperform are low rates and a robust economic environment (usually at the recovery phase of the business cycle). Small caps tend to lead the markets when coming out of a downturn – but the U.S. economy is not coming out of a downturn, it’s in late cycle. Also, a shallow rate cut cycle is expected, provided there’s no recession.

All in all, lower inflation, rate cuts, and a soft landing are beneficial to the entire market backdrop. We may well be heading into an environment where both small and large caps can prosper. It’s not a zero-sum game, as fresh capital can be deployed as investors become increasingly confident in the outlook.

Index concentration has been raising concerns amongst some investors, so a broadening of the rally is a welcome development and would support a more sustainable long-term rally for the broad indices.

A brighter outlook

Across the Atlantic in the UK, luck is in the air since a new government took office. The outlook for the UK has brightened despite the contentious weather this summer. One notable piece of data to be cheerful of is that the UK gross domestic product (GDP) growth in May (+0.4% MoM) was double that expected by economists.

This means not only did the UK come out of a shallow recession, but activity is recovering faster than expected, with second quarter growth likely to be around 0.6% to 0.7%. This will be a boost to the new Chancellor Rachel Reeves, who wants to make kickstarting economic growth a “national mission”.

With stronger GDP data, a new government that is perceived to bring stability and a pushback on UK rate cut expectations, the pound traded at its strongest level in a year against the dollar, and in almost two years against the euro.

Investors are increasingly singing their praises for UK assets, a huge change from being one of the least popular regions since Brexit. Fundamentally, the pound remains cheap compared to its long-term average and purchasing power parity, whereas UK equities are trading at half the valuation of U.S. equities.

There is indeed room for UK equities to catch up if more international investors upgrade their allocation from negative to neutral or overweight. Our view is that some diversification into the value plays that the UK is so heavily weighted in makes sense at this stage. It can provide a relatively cheap hedge against inflation risks and growth-style equities in portfolios.

Please continue to check our blog content for advice, planning issues and the latest investment, market and economic updates from leading investment houses.

Alex Clare

17/07/2024

Please see below today’s Daily Investment Bulletin from Brooks Macdonald, which was received this morning, 16/07/2024:

What has happened

Politics dominated most of the session yesterday with markets trying to price potential Trump presidential trades. The focus in the bond market was on the changing Treasury yield curve, which saw the gap between the 2-year and 10-year Treasury yields compress to approximately 22 basis points, the smallest inversion since January. This movement was attributed to the anticipation that Trump’s proposed policies on taxes, trade tariffs, and immigration could lead to inflationary pressures and a bearish steepening trend. In the stock market, there was a noticeable shift towards companies likely to gain from Trump’s policy agenda, with the broader market finishing just shy of the previous week’s peak by less than 0.1%. Meanwhile, the Russell 2000 index, which tracks small-cap stocks, climbed 1.8%, reaching its highest point in over two and a half years.

Pricing in a Trump win?

Sectors such as banking and the oil and gas industry are perceived as likely beneficiaries in the event of a Trump victory, owing to his inclination towards deregulation and their limited vulnerability to potential tariffs. While the anticipation of Trump’s presidency buoyed many assets, it also highlighted vulnerabilities in certain areas. Notably, solar energy companies experienced declines, as the sentiment suggested they would have been more advantaged under a Democratic leadership. This was reflected in significant drops for companies like Sunrun, which fell by 8.95%, and SolarEdge Technologies, which saw a 15.36% decrease.

Powell confirms a more dovish stance

Speaking at the Economic Club of Washington, Federal Reserve Chairman Powell expressed increased confidence that inflation is on track to meet the target, based on Q2 data. However, Powell refrained from hinting at any upcoming policy decisions. He also noted a slowdown in the labour market. With the latest Fedspeak mostly in line with other recent commentary, market pricing for a July cut remains below 10%, though the odds of a September cut close to 100% and the year-end median fed funds rate of 4.80% represents 57 bp of cuts from the current midpoint.

What does Brooks Macdonald think

Yesterday also marked President Trump’s announcement of J.D. Vance, the Ohio Senator, as his vice-presidential candidate. At the age of 39, Vance stands as one of the youngest senators in the current assembly. Typically, a presidential hopeful selects a vice-presidential partner to attract a broader voter base or to balance out perceived shortcomings in image or policy areas. However, Trump has chosen a young loyal Make America Great Again (MAGA) supporter. Equity markets will try to price in the impact of a Trump victory and a potential return of extreme MAGA agenda. Investor could see rising volatility in specific sectors in coming months, though disinflation momentum and Fed pivot could somewhat mute the impact.

Bloomberg as at 16/07/2024. TR denotes Net Total Return.

Please continue to check our blog content for advice, planning issues and the latest investment, market and economic updates from leading investment houses.

Charlotte Clarke

16/07/2024

Please see this week’s Monday Digest from Tatton Investment Management detailing their thoughts on global markets over the last week:

Lower inflation, less profits?

Global stocks fell into the latter part of the week – thanks to a sell-off for US mega-caps. Smaller caps and other regions outperformed, in a reversal of the year’s trend so far. UK stocks did well, with markets seemingly believing Kier Starmer’s promise of quietly competent government. The clearest signs of markets’ endorsement (or at the very least its lack of opposition) of the Labour government’s plans are sterling’s appreciation versus the euro and gains for the FTSE 250. It seems that, after upheaval in Europe, investors now see the UK as relatively stable – a far cry from the ’Liz Truss moment’ less than two years ago.

US events were more impactful for global stocks. Remarkably, a surprisingly low US inflation print led to a sell-off for the ‘Magnificent Seven’ stocks on Thursday, dragging down national and world indices. This makes a Federal Reserve rate cut much more likely, which was previously considered only good news. Instead, the reaction suggests disinflation will mean lower medium-term profits.

Aggregate figures hide so much dispersion, though. US small cap stocks rallied hard, which is a little counterintuitive. Small-caps are generally seen as more sensitive to growth, while long-duration assets (like tech stocks) are supposed to benefit more from low rates.

Instead, investors clearly think an easing of the rate burden for small-caps is more important than immediate growth. Tech giants might have been punished because investors doubt how cycle-proof their earnings really are (Nvidia has to have companies to sell to, of course) or just simply diversified some of their allocations towards small and midcap.

In any case, the rebalance could be positive. It dissipates the market concentration we were worried about, and the dollar has weakened, which should benefit global growth. US specific growth implications depend on whether you think lower borrowing costs for most – or the investment spending of the mighty few – are more impactful.

Inflation targets: can central banks adjust?

The idea of central banks changing their 2% inflation targets is a hot topic this year. The question they face is: what long-term target is the optimal balance between growth and stability? 2% is orthodox but ultimately arbitrary, and there have been suggestions that the Federal Reserve or ECB have implicitly moved to a 3% target, to accommodate structural changes in the post-pandemic world economy. Resilient US growth with inflation persistently around 3% (as measured by CPI) shows that this is not necessarily a threat to price stability.

To clarify, higher background inflation doesn’t necessarily mean lower real growth or profits – as some have worried. Higher prices mean higher revenues for someone, which is why equity earnings are considered a natural inflation hedge. In the US case, 3% long-term inflation might actually mean higher real growth, as consumers have kept spending (until very recently) and corporate profits are keeping up with higher inflation. We might think this applies less to the weaker economies of Europe and the UK, but on the other hand, you could argue that less dynamic economies need higher targets to avoid stagnation (Japan maintained a 2% target despite no realistic chance of hitting it for well over a decade).

It might surprise to learn that most central banks have discretion over their inflation targets. Indeed, the Fed and ECB already showed a willingness to reinterpret their “price stability” mandate by changing to “symmetric” targets in 2020 and 2021 respectively. The Bank of England is different; its 2% target is set by law and it has to report to the treasury when it is not met. This might be why the BoE has looked more hawkish than peers in recent years. Unless the treasury tells it to change, we should expect UK policy to be more restrictive than elsewhere.

Trump trumps Truss?

Opinion polls and betting markets suggest a second Donald Trump presidency is now likely. How that will affect markets depends on whether the Republicans can also win a ‘clean sweep’ – the White House and both houses of congress. Current odds suggest the party will win control of the Senate, but lose their majority in the House of Representatives. That would limit what Trump can do, but the House race is very tight.

If Republicans did get a clean sweep, Trump’s agenda of tax cuts and tariffs will become reality once more. Markets reacted very well to his 2017 tax cuts, but they may not be so happy about an expansion of the fiscal deficit this time around. Trump has no qualms borrowing to fund tax cuts, but current debt metrics are worse than in 2017 (debt-to-GDP at 122% and a 6.3% deficit last year), in part because of his policies.

Potential trade wars – particularly with the EU – will make any debt problems worse. The US historically has escaped bond market punishment due to its status as world’s largest economy and owner of the global reserve currency. But fragmented global trade and deteriorating fiscal policy make it less likely capital will flow to the US. The dollar is already expensive on historical and purchasing power parity bases.

Without international flows, the treasury will need to borrow from domestic investors – which takes capital out of the stock market. If yields (particularly longer-term) go up, the extreme result would be a ‘Liz Truss moment’ and a reckoning for US policymakers that thought their bonds immune to global pressures. That isn’t our base case, but the risk is growing. That growing risk itself might lead to short-term sell-offs, but the bigger problem for the US is a long-term deterioration of its global market status.

Please continue to check our blog content for advice, planning issues and the latest investment, market and economic updates from leading investment houses.

Andrew Lloyd DipPFS

15/07/2024

Please see below, The Daily Update from EPIC Investment Partners. Received late this morning – 12/07/2024

Over the last few weeks, we’ve been having a bit of fun applying our NFA model (which measures a country’s net assets held abroad less liabilities owed to foreigners) to predict the EURO 2024 matches. With England facing Spain in the final on Sunday, it’s time for a look back at our model’s performance – and our prediction for the winner. 

Early results were promising, with 10 out of 12 countries automatically qualifying for the round of 16 boasting NFA scores of 3 stars or better. Only Portugal and Spain seemed to defy the odds. We even managed a 63% success rate in the round of 16! But alas, the semi-finals proved our undoing, with a 100% failure rate. 

You might think we are disappointed, but we’re actually thrilled. Why? Because 4-star England defied our model’s prediction and triumphed over 6-star Netherlands!  

Although predicting the EUROs is just a light-hearted distraction, there is a serious side to NFA analysis. Last week we highlighted the similar debt levels of the UK and France (with debt-to-GDP ratios of 104% and 111% respectively) but noted that France’s NFA position has markedly deteriorated in recent years. France only just scrapes in as a 3-star rated country, with net foreign liabilities of 48.8% of GDP. Deteriorating NFA positions are often associated with credit downgrades (and vice versa), so it is worth noting that both Moody’s and S&P have flagged that France could be downgraded following the recent elections. S&P already downgraded France’s rating at the end of May due to the country’s deficit figures, and further downgrades may occur if growth is slower than previously predicted.  

Back to the Football. Regardless of Sunday’s outcome, we cannot quite compete with the legendary Paul the Octopus. His keepers at Germany’s Sea Life Centre presented him with two boxes representing each team, and his food choice determined his prediction. With an astonishing 85.7% accuracy, Paul’s legacy is unmatched. Sadly, Paul passed away at the tender age of two, so we can’t ask for his expert opinion for the final. 

We will have to rely on our NFA model instead. Now, here’s the worry: our model predicts an England victory in the final against Spain. So, fingers crossed our NFA gets it right this time!

Please continue to check our blog content for the latest advice and planning issues from leading investment firms.

Alex Kitteringham

12^th July 2024