Please see the below article from Tatton Investment Management detailing their thoughts on markets over the past week, received this morning:
Focus returns to stock market fundamentals
Markets were quieter last week. The lack of bad news meant investors could focus on concrete details, like stronger US growth, and looser European and UK monetary policy. The ECB cut interest rates as fully expected, and markets expect another cut in December after inflation dropped below the 2% target. UK inflation was also below 2%, bolstering market expectations of another Bank of England rate cut. Central banks are helped by disinflation from China, but new Chinese stimulus could change things. Despite UK bond yields dropping faster than others last week, the treasury is still worried yields are too high ahead of a difficult autumn budget.
UK yields are mainly high because of the US, though. US growth outperformance is back after a soft patch in the summer, exemplified by surprisingly strong retail sales data. That pushed up US yields and interest rate expectations. The Federal Reserve will still ease policy, but not as much as markets previously hoped – which has hurt smaller companies somewhat. Markets are awaiting the election outcome, which is evenly balanced. Sentiment has been helped recently by both candidates pulling back on the rhetoric markets don’t like – most notably Trump on tariffs.
Sentiment was also helped by Israel’s decision not to target Iranian oil facilities, sending oil prices lower. With oil and election anxieties easing, investors switched focus to third quarter corporate profits. Tech stocks sold off after disappointing results from ASML, the Dutch producer of chipmaking equipment, but markets soon realised this was about past over-ordering and not future demand, once TSMC’s good results came out.
Results have been mixed overall, but that’s somewhat to be expected after a soft patch for US growth. What happens next is more important, and the outlook is still good. Lastly, we note that gold is breaking new highs, at a pace not seen since 1979. The current situation feels very different to that episode, so we will talk more about it next week.
Ishiba won’t reverse Abenomics
Markets are unsure of new Japanese prime minister Shigeru Ishiba. A monetary and fiscal hawk in the past, stocks sold off when he came into office, but he since suggested a change of heart.
We are positive on Japanese growth and assets, thanks to a combination of corporate reforms and the yen’s relative cheapness. These reforms were the third arrow of late prime minister Shinzo Abe’s ‘Abenomics’ and it has hit the target. The yen’s weakness has helped, and even though it strengthened in the past month it never looked expensive against the dollar. The Bank of Japan’s promise to not raise interest rates in times of market stress has put a ceiling on the currency. That has helped exporter profits, which is feeding back into corporate structural improvement. The best example is the reduction in strategic shareholdings – where companies would often own slices of each other, creating conflicts of interest and stifling progress.
Ishiba’s victory complicates the long-term story, but doesn’t undermine it. He was critical of Abenomics in the past, calling for higher interest rates and corporate taxes, but he has reversed those stances ahead of the 27 October election. That could just be an election ploy, but it’s also plausible that being leader has just pushed him closer to Abenomics.
Even if Ishiba eventually raises taxes, the reform process probably can’t be stopped. The Tokyo Stock Exchange now think that strategic shareholdings will fall to an acceptable level in four-five years, for example, reduced from a 15-year timeline. Interest rates are set to gradually rise, but you could argue normalisation is needed to get Japan out of decades of stagnation. That was precisely Ishiba’s argument, but it must be gradual. If it’s too quick, we would probably see short-term volatility. Even then, the long-term positive case would remain.
Beijing doesn’t know how to stoke markets
Since the Chinese government announced monetary and fiscal stimulus last month, its stock market has been extremely volatile. The finance minister announced financial support for banks and local governments earlier this month, and on Friday the People’s Bank of China (PBoC) announced further interest rate and reserve requirement rate cuts. Some of these have boosted stocks, while others have disappointed market expectations. Investors were pleased on Friday that words of encouragement came from president Xi Jinping himself (he was rumoured to be hesitant about economic support) but his speech still focussed on the supply-side, when what China needs is support for consumer demand.
Markets have been underwhelmed at times, but the policy shift since September is genuine and Beijing clearly wants to stop the growth slowdown. Notably, the shift occurred right after one major coastal province warned it might miss this year’s growth target. Analysts, Alpine Macro, suggest that deflationary signals finally crossed Beijing’s “pain threshold”, and Xi’s intervention supports that narrative. We might wonder why support hasn’t been full-throated, but we suspect Chinese policymakers are waiting to see what happens with the US election. New Trump tariffs would probably require a policy rethink.
The question now isn’t so much Beijing’s willingness, but its ability. The back and forth suggests policymakers might not understand how their announcements affect markets and financial conditions. The stimulus shift came right after a disappointing PBoC conference, for example, and officials seemed to be surprised by the market reaction. Enough stimulus has already been announced to make a cyclically rebound likely, but anything beyond that requires a more stable policy framework. It’s not clear that Beijing knows how to make that framework. Stimulus will boost Chinese stocks in the short-term but, without a stable demand-side framework, those gains could be short-lived.
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Charlotte Clarke
21/10/2024