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Please see below, Tatton Investment Management’s ‘Monday Digest’ providing a brief analysis of the key factors currently affecting global markets and economies. Received this morning – 11/03/2024

At least currency markets noticed the budget

Markets gained again last week, with the S&P 500 hitting another all-time high. But thanks to sterling gaining 1.5% against the US dollar, our table shows negative index returns. Sterling strength may be partly about Jeremy Hunt’s budget, despite the chancellor not giving away so much in the way of fiscal handouts. 

The national insurance cut could boost growth, while the freezing of fuel duties will not. The extra ISA allowance seemed more about show; more of a sop than a solution to Britain’s obvious domestic investment problems. Even these small offerings were enough to send our currency higher, though, with foreign investors becoming more optimistic on sterling assets. The outperformance of UK small cap versus large cap was encouraging too.

Rishi Sunak is unlikely to remain Prime Minister for long, but foreign investors are predicting a relatively smooth transition to a new centrist government, and the budget bolstered those perceptions. Mortgage holders will thank him for not raising borrowing costs. So too will the Labour Party, as it means they will more likely be able to borrow to invest.

The euro also rose, thanks to the European Central Bank (ECB) leaving interest rates unchanged. The ECB will likely cut by the summer, but President Lagarde seems reluctant to be the first developed market central banker to cut. Federal Reserve chair Jay Powell was similarly mildly hawkish in his testimony to US congress, but investors think a cut is at hand. 

Data released on Friday suggests 275,000 US jobs were added in February. That is extremely strong, but the initial data is suspect, as shown by downward revisions to December and January’s initial estimates. Citi Research’s economic surprise indicator shows US economy data is now undershooting economists’ expectations. UK data is starting to beat lowered forecasts while Europe is increasingly beating economist expectations – a great benefit to European equity markets and currency. 

What stands out the most, though, is falling volatility across markets – back to or below pre-pandemic levels in most cases. This tends to go in hand with higher equity valuations, as we are seeing now. High valuations also mean that the market has priced in strong future growth. It may be difficult to get more optimistic so that may mean only mild capital gains. We are likely to see more weeks with small gains but little drama.

Tight might soon feel tighter

Balance sheet adjustments – buying or selling assets – are one of the key ways the Federal Reserve (Fed) manages liquidity in the financial system. One of the most impressive things about the Fed’s post-pandemic quantitative tightening (QT – the selling of bonds and mortgage-backed securities) is that it has gotten so little attention. The infamous ‘taper tantrum’ of 2013 caused upsets in markets – and that was just a suggestion that the Fed might not buy as many bonds as it had, not the current outright balance sheet reduction. 

Reverse repo operations are one of the key tools the Fed has used to temper the effects of QT. In these, the Fed sells securities for cash now and, at the same time, buys them back at a future settlement date – thereby reducing the current cash in the system. They were crucial in the pandemic for draining excess liquidity that the Fed’s own QE had injected, which was causing short-term “congestion”. Reverse repos have been falling significantly for a while, and this reduction has counteracted the tightening effects of QT. The Fed has been tightening with one hand and loosening with another. 

That will likely change, though. The Fed hasn’t told us of any definite plans to taper QT (it is in the ‘talking about talking about it phase’) but the rate of change in reverse repos has already fallen and will level off more the closer operations get to zero. Continuing QT in this phase will probably mean that tight may feel tighter, making markets more volatile.

The key indicator is the gap between interbank lending and the Fed’s reserve rate on repo. When they come closer together it means liquidity levels are at equilibrium. 

The Fed could offset any short-term problems by adjusting repos or QT – but we suspect this could become a politically charged topic this election year. Donald Trump might again criticize the Fed for buying up government debt, so the FOMC will want to keep a low profile. But in a sense they might be damned if they do (through allegations of political interference) and damned if they don’t (through market volatility). This poses more risks to stock and credit valuations. QT hasn’t hurt markets yet, but it still can.

Returning M&A returns?

Mergers and acquisitions are trending up. Corporate deals are usually a sign of business confidence, so it makes sense this is happening when markets are buoyant. M&A activity fell dramatically over the last year, thanks to interest rate rises, but Morgan Stanley researchers think we will see a 50% rise this year compared to 2023. 

M&A deals need motive and financial opportunity. Activity was massive during the pandemic thanks to extraordinary liquidity, but dramatically shrank through rate rises. Rates are now expected to fall – but rate expectations don’t necessarily set current funding costs. Corporate balance sheets and credit spreads have improved, though, while rallying stock markets have helped companies get more capital. We can see this in Capital One’s all-share buyout of Discover Financial, for example. 

There is a huge amount of ‘dry powder’ – capital ready to be invested – held by businesses or private equity funds. Morgan Stanley estimates that global non-financial companies hold $5.6 trillion in cash, while private investors sit on $2.5tn. The US will probably see a lot of activity in private market deals, with less visible partial takeovers or ‘carve-outs’. Regional banks will need to consolidate too, and real estate is primed for M&A. 

Researchers also think Europe will lead the way in M&A activity after a relative drought, with consolidations among asset managers and tie ups between telecoms companies. Japan will likely rebound too, thanks to cyclical factors as well as long-term improvements in corporate governance. Globally, Morgan Stanley expects financials to see the most deals, while energy, health and technology could also stand out. 

M&A activity could catalyse a rotation from growth to value in markets, since the targets for M&A are usually always undervalued companies. Broadly it should mean more money going into stock markets, but the previous big winners will have less to gain.

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

Alex Kitteringham

11^th March 2024

Please see this week’s Markets in a Minute update from Brewin Dolphin, which was received yesterday evening:

Guy Foster, Chief Strategist, discusses recent economic growth data, while Janet Mui, Head of Market Analysis, analyses US inflation and consumer spending data.

The trend of the market reaching new highs continued at the end of February. The S&P 500 had already broken new ground but was joined by the NASDAQ, which surpassed its previous high seen at the end of 2021.

Japan has seen very strong index performance. Part of that has been aided by rapid yen depreciation. As a result, the Nikkei 225 also reached a new all-time high the week before last. But while the US markets are surpassing levels seen in 2021, the Nikkei is making a first all-time high since an extraordinary bubble in stocks and realestate at the end of the 1980s.

The Nikkei index is one of a few price-weighted indices (another being the Dow Jones in the US) where each company’s weight reflects how big its share price is rather than the relative size of the company. Japan’s more conventional TOPIX index remains well short of its late80’s high.

The FTSE 100 remains 4% off its record high, experienced early last year. Like many regions, the UK has underperformed the US recently, but the performance of indices exaggerates the extent. Overall, The UK market generates a dividend yield of 4% which is significantly driven by the energy sector.

Over the past couple of weeks, the stock market experienced fluctuations near record highs as traders awaited a barrage of economic data and remarks from Federal Reserve speakers on interest rates. The market absorbed heavy Treasury and corporate sales amidst month-end positioning, with US yields rising after government note auctions. Blue-chip companies sold a record amount of bonds in February to capitalise on investor demand amid lower borrowing costs.

The most obvious banana skin for the market overall was the US personal consumption expenditure (PCE) data. This ostensibly measures spending and feeds into gross domestic product (GDP). GDP is normally quoted in real terms, meaning it is adjusted for inflation. The Federal Reserve has typically preferred to measure consumer price changes through the PCE over the consumer prices index (CPI). PCE covers a broader range of goods and services, as well as a broader definition of consumers. The PCE process for changing the weightings of categories over time is perceived to be better, and its treatment of housing costs is more reflective of actual costs suffered by homeowners.

CPI, on the other hand, is released earlier during the month and certainly sounds more like the measures of inflation used in other regions (although some argue PCE is methodologically closer to other countries’ inflation calculations).

Perhaps the most critical difference between CPI and PCE in recent months is that core PCE, which excludes food and energy, has declined faster than core CPI, and thus paints a rosier picture of the consumer environment, which puts less pressure on policymakers to maintain high interest rates.

It was therefore a boon to investors to see the core PCE price index rising by just 2.8% over the twelve months to January (PCE data are released late relative to CPI). This is the slowest pace of price increases since March 2021. The data were taken positively by the market, seeming to justify hopes of lower interest rates later in the year. Afterall, real spending by consumers declined. But despite the slowdown in the annual rate of inflation, the monthly data were pretty strong, seeming more consistent with the CPI data from earlier in the month.

Gauging trends in inflation is difficult during January when a significant seasonal adjustment needs to be made. There were also a lot of one-off factors distorting consumer activity (such as weather), a strong month for dividend income, and a jump in cost-of-living adjustments for social security payments.

For now, markets expect to see interest rates declining as soon as June, but that will depend upon how policymakers interpret these data.

Federal Reserve speakers continued to influence market sentiment, with officials expressing readiness to lower rates if necessary. However, they emphasised the economy’s strength and the need for caution in policy adjustments.

Boston Federal Reserve president, Susan Collins, and New York’s John Williams, believe it will be appropriate to cut rates for the first time later this year, which is consistent with Raphael Bostic of the Atlanta Federal Reserve, who expects to cut this summer. Federal Reserve governor Michelle Bowman expects inflation to continue to decline further, with interest rates held at their current level — but said it’s too soon to begin rate cuts.

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

Andrew Lloyd DipPFS

06/03/2024

Please see today’s daily update from EPIC Investment Partners below:

Chinese Premier Li Qiang has set the country an ambitious GDP target at “around 5%” for 2024. Moreover, Li announced steps to transform the nation’s development model, coupled with defusing the risks fuelled by bankrupt property developers and indebted cities. Li Qiang acknowledged the hurdles facing the world’s second-largest economy during his inaugural work report to the national parliament. “Realising these targets is not easy,” he said to the thousands of delegates gathered at Beijing’s Great Hall of the People. “Policy support and collective efforts from all fronts are essential”, he emphasised. Li also said that China aims to create over 12 million new urban jobs and keep the urban unemployment rate “at around 5.5%”. 

In a rare move, China will also issue CNY1tn (USD139bn) of ultra-long special treasury bonds this year and lower its deficit to 3% of GDP. The bond sale marks only the fourth of its kind in the past 26 years. The most recent sale was in 2020 when the Chinese government issued a similar special treasury bond to pay for Its pandemic response measures. Alongside the treasury bonds, local governments will be allowed to sell nearly CNY4tn of new special bonds, primarily to finance infrastructure spending. 

China’s defence spending will also grow by over 7% this year, the largest increase in five years. Defence spending is expected to rise to around CNY1.7tn ($234bn) in 2024, according to the annual Finance Ministry report. In contrast, the House of Representatives approved an USD886bn defence bill for the US towards the end of last year. 

Over to Microsoft, the largest holding in our Global Equity Fund, which released its ChatGPT AI system, seen by many as the introduction of AI to the masses, just over 300 trading days ago. Since its introduction, the Nasdaq has rallied around 46%. Following the release of Netscape, the first internet web browser in December 1994, the Nasdaq also rallied 46%, in approximately 300 days.  

What happened next? +725% for the next 5 years. 

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

Charlotte Clarke

05/03/2024

Please see the below article from Tatton Investment Management providing a brief analysis of global economic news and market data. Received this morning – 04/03/2024.

Overview: Winners and losers of stabilising yields

Last week was one of positive price action in equities, although the US mega-caps did less well, while bond markets were rather stable. Indeed, stable bond markets are one of the reasons why equity markets can continue to edge up. Interest rates and yields appear close to equilibrium levels, a state of relative steadiness which enables activity to happen. There were no big mergers or acquisitions last week but it is noticeable that companies are increasingly trying to raise equity rather than loan capital. Bloomberg pointed out that companies are finding the near-term cost of equity much more bearable now that dividend yields have fallen in relation to bond yields.

What has struck us in recent weeks is that consumer and business behaviours appear to be sensitive to quite small changes in rates. Small businesses are negatively sensitive and step up efforts to cut costs and reduce debt on any sign of a rise. Particularly in the UK, households are positively impacted by lower mortgage rates which drive a swift rise in housing activity. Currently, US rates are just about bearable for both camps. However, this also implies that the Federal Reserve (Fed) is unlikely to cut interest rates meaningfully. February data suggested US inflation was stabilising just below the 3% level –consistent with a slight Fed easing in the summer or autumn. This Thursday, the European Central Bank (ECB) conducts the first of March’s central bank meetings. We think both the Bank of England (BoE) and the ECB ought to be on the verge of rate cuts. Growth is not collapsing, but neither is it rising. By focusing on labour pricing power alone, they miss the point that it is businesses that are paying that price. It is neither being funded out of money creation nor reflected in rising prices. Unfortunately, for yet another month, we will analyse words, not actions.

February 2024 asset returns review

Despite a mid-month lull, February turned out to be yet another strong month for investors, with global stocks delivering a very healthy 4.4% in sterling terms. The US was once again one of the strongest performers, with the S&P 500 jumping 5.2% in sterling terms. February’s broad-based rally was a good sign, allaying previous concerns that too much capital was focused on the US mega-tech sector. Speculation over an artificial intelligence (AI) asset bubble grew before and after Nvidia’s stellar earnings report, with revenue up 265% and profit up over 750% for the year. Euphoria seemed to peak last week though, and trading since has been much more muted. There was also a pick-up in US mergers and acquisitions, a sign of changes in market composition, which helped bring confidence to markets. One clear sign of this is the weaker dollar, suggesting solid global growth expectations. This was also reflected in bond yields, which weakened at the start of the month but subsequently recovered to recent highs.

European stocks gained a respectable 2.9% through February in sterling terms. So far, 2024 has been a steady incline for Europe, but as we have written before, the continent stands to benefit from stronger global growth. If the ECB is able to cut rates soon (and before the Fed) and Chinese demand comes through strong, it will be a potent recipe for growth. The FTSE 100 ended February with a 0.7% gain, ensuring a slight decline in year-to-date returns at -0.6%. Smaller British companies in particular – being more closely tied to the dynamics of the domestic economy – are having a hard time, with UK small-cap equities down 1.2% last month. The disparity between the UK and other markets – particularly the US – leaves UK equities with relatively attractive valuations, at least.

Chinese equities gained an impressive 9.3% in sterling terms, making it the best-performing region for the month. Weak demand and goods prices out of China have been a decisive factor behind lower commodity prices. Accordingly, there was an upswing in oil prices last week, and the commodity index we track gained 1.3% in sterling terms through February. Growing positivity in the global economy is a welcome sign, as is the fact that returns are no longer solely focused on AI. The worry, as usual, is that this could mean returning inflation pressures and a delay in central bank easing. There is no sign of that yet, but we will keep a close eye.

Nigeria shows why reform is always difficult

When Nigeria’s President Bola Tinubu came to power last May, Western investors cheered his embrace of market-friendly policies. These included removing the currency peg with the US dollar, dealing with the consequences of a botched attempt to move Nigeria’s cash-based economy into electronic banking, and scrapping Nigeria’s nationwide fuel subsidies. The latter reform was specifically recommended by the International Monetary Fund (IMF) and Tinubu won plaudits from the World Bank. But Nigeria’s economy has only worsened since; inflation is at nearly 30% and the naira has lost more than 70% since the peg’s removal.

To cushion rapid inflation and a tanking currency, the Central Bank of Nigeria (led by Dr Olayemi Cardoso) raised interest rates last week by an outsized 4% to 22.75%, when a 2.5% lift was expected. The move leaves Nigerian rates at their highest recorded level, but it may still not be enough. The country’s highest inflation rate this millennium is now being driven by currency collapse – itself an effect of dramatic capital outflows. There seems to be a run on Nigerian assets from both foreign and domestic investors, and it is unclear what would stop the flow. The experience of other countries has been that it requires rates to be far enough above inflation to tempt investors to risk earning the ‘carry’ (yield).

Part of the problem is some very unfortunate timing. When global energy prices skyrocketed two years ago, commodity-producing nations like Nigeria benefitted greatly. But what followed, the sharpest monetary policy squeeze in a generation, combined with dramatically lower commodity prices, had the opposite effect. In the last year, when inflation has been steadily declining in Western developed countries, Nigeria and other EM nations have been under increased pressure. Nigeria’s government is thereby focusing on what it can do alone, thereby reducing its economic dependency on the big economies of the US and China.

Last year, the government allowed the regulated banks to resume trading in cryptocurrencies, given that many Nigerians are involved in this market, with some commentators even suggesting that flows from Nigeria were a factor in the recent resurgence of Bitcoin. However, the Nigerian authorities have become worried that the crypto market is part of the Naira’s current instability and so banned the use of the unregulated exchanges. Gaining control of its sliding currency is a necessary first step in stabilising the economy, always a very difficult one to take, and one which modern markets make even more difficult.

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

04/03/2024

Please see today’s daily update from EPIC Investment Partners below:

Bank of Japan Board Member, Hajime Takata, has signalled there is a growing case to end Japan’s negative interest rate policy, with the BoJ’s goal of achieving 2% inflation “finally in sight”. “With monetary easing continuing, I believe we have reached a point where attainment of the 2% price stability target is finally in sight, despite uncertainty over the Japanese economy”, Takata said, adding “It is necessary to consider shifting gears from extremely powerful monetary easing, and how we should respond nimbly and flexibly toward an exit. 

Takata’s remarks, who is seen as a neutral on the nine-member board, will fuel speculation that the Bank of Japan may be preparing for its first rate rise in 17 years. However, Takata did not provide specific timing for any such increase, meaning the next BoJ meeting in March will be even more closely watched. 

 After Takata’s remarks, the yield on the policy-sensitive 2-year notes rose 1.5bps to 0.175%, the highest level since the War Horse film was released. 

We also heard from a number of Fed members overnight, all of which continued to tow the party line, leaning towards hawkish patience.   

Collins said that January’s CPI was an example of uneven inflation progress and that she wants to see more evidence of inflation stability. However, she did say that it’s unlikely the inflation decline can be sustained without slower growth. Bostic said that he expects inflation to continue its trajectory to 2%, although he is comfortable being patient on policy.  

Lastly, Williams said that he expects this afternoon’s PCE inflation number, the Fed’s favoured inflation indicator, to be around 2-2.25% in 2024 and at 2% by 2025. He said that the Fed could think about cutting rates later this year and that three rate cuts in 2024 is a “reasonable starting point”.     

Happy 29th February. 

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

Charlotte Clarke

29/02/2024

Please see this week’s Markets in a Minute update from Brewin Dolphin, which was received late yesterday afternoon:

Guy Foster, Chief Strategist, discusses earnings results from the Magnificent Seven and how these microeconomic factors are affecting the markets.

One topic dominated markets last week: Nvidia’s earnings announcement. It was one of the most anticipated and celebrated events in the market this year.

The shares, which were cyclically depressed at the start of 2023, went to triple in value by the end of the year and have risen another 50% since then. In the week before announcing its profits, Nvidia’s shares slid by nearly 9% as some investors feared that others were expecting too much. Memories of the technology stock market bubble of a quarter of a century ago loom large.

But Nvidia is far from the profitless companies offering jam tomorrow in the late 1990s. Nvidia’s results revealed revenues rising 22% over the preceding quarter, and 200% from the same period last year, with profits up 8x.

As with all stocks, the controversy surrounds what will happen in the future. The pipeline for artificial intelligence-related sales remains very attractive, but unlike the technology bubble, those expectations are grounded in exceptional growth happening right now.

We believe semiconductors are in a cyclical upswing that forms part of a secular uptrend. Individual companies can be volatile, but the supply chain comprises a number of different types of company serving different parts of the value chain, whose long-term trajectory should be positive, even while different factors move them in the shorter term.

Last week felt like Nvidia was singlehandedly pulling the market around, but what else was going on?

Back in the real world…

The purchasing managers indices (PMIs) offered an early snapshot of economic activity in February, painting a mixed picture.

In keeping with other data released so far this year, the US continues to look economically firm. The manufacturing and services sectors both seemed to expand at an accelerating pace. It makes sense to be a little wary of extrapolating the current trend too far. With unemployment so low there is limited room to expand employment, driving increased household income and spending. However, there still seems to be at least some scope because initial jobless claims for the last week declined. This leaves them very low, at levels consistent with a strong economy, although things can change fast.

Outside the US, PMIs were more mixed. European manufacturing remains in a slump and while France showed signs of early stages of recovery, Germany seemed to regress. Outside of these core economies, the peripheral eurozone members performed better – we just won’t know how much better until the end of the month as they don’t release provisional reports like the core countries.

Inflation benign?

Perhaps worryingly, selling price pressures rose during the month. We can take some comfort from the fact that price data from PMIs don’t correlate very well with consumer price indices. However, they suggest that for the services sector at least, the tight labour market is making it difficult to hold wages down. If other data backed these up, it could be difficult to cut interest rates as fast as the market has been hoping.

Interestingly, the price pressures are quite limited to services while disinflation seems to continue within manufactured goods. This is where we would expect to see the impact of higher freight rates emanating from the Red Sea (or, more accurately, from the Cape of Good Hope, around which Red Sea freight has been diverted). The Red Sea is an important transit route for Middle Eastern oil and Southeast Asian goods en route to Europe.

Freight rates are clearly continuing to rise but in Europe’s biggest economies, impact is outweighed by weak demand. This partly reflects the fact that freight is often transported on long-term contracts, which are less vulnerable to movements in spot freight rates.

China stimulus

China and Europe have a substantial bilateral trade balance, but both are currently labouring some.

In China, decades of overinvestment in property, which had become the principal vehicle for the wealthy, has resulted in chronic oversupply. Bursting that bubble became a priority for Xi Jinping’s Chinese Communist Party, but doing so has resulted in a persistent negative wealth effect (declines in the value of property make Chinese consumers feel poorer).

In an attempt to revive fortunes, China cut the loan prime rate for terms of greater than five years. This is essentially the rate which underpins mortgages and therefore serves as a stimulus for Chinese property. This morning’s data from China’s National Bureau of Statistics showed how important that could be, as property prices have continued to decline over the last month.

The slight green shoot of recovery that might be showing is the breadth of price declines may have narrowed. In December, 62 out of 70 cities saw prices for new properties decline, whereas in January that was just 56. Prices of existing properties fell in all 70 cities in December, whereas two saw an increase in January.

There is clearly a long way to go before this becomes a positive trend, and the risk remains that policy will not be able to turn around a sector so distorted by successive stimulus rounds and captive savings over decades. But at least policy is becoming more forceful in its attempt to support the sector.

Tax cuts

Finally, some good news came from UK public finances.

After strong tax receipts, it seems the government will borrow less than had been anticipated by the Office for Budgetary Responsibility. This means we can anticipate the unveiling of tax cuts potentially up to £10bn in the forthcoming budget. This is an enormous number that is difficult to put into context. It would be around half the tax cuts that took place at the beginning of this year after the autumn statement.

Recognising how much ten billion pounds is might also help to appreciate the scale of the market’s response to Nvidia’s earnings announcement. The company’s market value rose by more than 20 times that much on the day ($277bn, which is a record daily change in value for a single company)!

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

Andrew Lloyd DipPFS

28/02/2024