Equities had a good week, with global markets rising 1.7% and 1.5% in local currency and sterling terms respectively. Emerging markets led the way with a rise of 3.7%, buoyed by gains of 4% in China, 5% in Taiwan and 6% in Korea. The US, UK and Europe saw rather more pedestrian increases of 1.2%, 0.8% and 0.6% respectively.
Bonds were little changed. Gold, however, continued its recent stellar run, rising 1.7% to $3640/oz.
The equity market gains were driven in good part by the prospect of the Fed resuming its rate cuts this week after a nine month pause. Any lingering doubts on this front were removed by last week’s crop of US data.
US inflation came in pretty much as expected in August. The core rate was unchanged at 3.1% while the headline rate increased to 2.9% from 2.7%. Although inflation is running around 3%, rather than the 2% targeted by the Fed, and probably headed higher over coming months as the tariffs continue to feed through, a weak labour market gives the Fed reason enough to cut rates. Unlike most central banks, it has an explicit dual mandate to pursue maximum employment as well as stable prices.
The US labour market looks decidedly weaker than it did a few weeks ago. Hard on the heels of the unexpectedly small gain in payrolls in August, last week brought news that the rise in employment over the past year had been revised down sharply and almost cut in half. It’s not only the UK where the labour market statistics have a little to be desired in terms of quality. Initial jobless claims also picked up unexpectedly sharply last week.
A 0.25% cut in US rates this Wednesday to 4.0-4.25% now looks highly likely – although a bumper 0.5% reduction can’t be ruled out – with rates expected to be reduced further to 3.5-3.75% by year-end. Fed easing, if not part and parcel of a recession, is normally good news for equities and underpins recent market gains.
The main proviso here is that equity valuations are high. The global price-earnings ratio is up to 19.4x, some 30% higher than the average over the last 20 years. While this does leave markets looking overdue a pause and more vulnerable to any negative shock, valuations do not look high enough to call an end to the bull market which should be supported by continued growth in corporate earnings and rate cuts.
Rather, valuations should just cap the potential gains from here, particularly in the case of the US. Whereas valuations are now close to 40% above their historical average in the US, they are only 15% higher in the rest of the world. This pattern of US underperformance has played out this year, with the US currently up 4.3% in sterling terms versus 15.4% for the rest of the world.
The technology sector led last week’s increases. It is one of the most obvious beneficiaries of lower interest rates due to its high growth potential and distant earnings being worth rather more when rates decline. Just as global equities are no longer all about the US, the tech sector is no longer all about the Magnificent Seven.
The recent strong gains in China, Taiwan and Korea have in good part been driven by their tech sectors. Even in the US, where Nvidia remains on a roll with a 6.5% gain last week, Oracle (another provider of AI-related infrastructure) surged as much as 25%. Apple, by contrast, lost 2.3% as investors were underwhelmed by Apple’s ultra-thin new iPhone.
Outside the US, the macro news was rather downbeat. China’s crop of August economic data released this morning showed retail sales, industrial production and investment growth all slowing further, reinforcing the need for the authorities to keep up their drip-feed of policy stimulus.
France, meanwhile, saw President Macron appoint yet another Prime Minister following the government losing its confidence vote. The new PM will now make another attempt to put together a new, no-doubt watered down, budget deficit reduction package acceptable to the opposition parties.
Here in the UK, there was little to distract from the sacking of Peter Mandelson. However, Starmer’s formation of a ‘budget board’ to increase cooperation between No 10 and the Treasury may reduce the risk of ill-advised measures being included in the November Budget.
This coming week, the focus for markets will be the Fed meeting on Wednesday. But for UK investors, it will also be the UK labour market and inflation data on Tuesday and Wednesday and the BOE meeting on Thursday (where rates are certain to be left unchanged). As for Trump, it will no doubt be the pomp and ceremony at Windsor Castle.
Rupert Thompson – Chief Economist