Last week saw the disconnect between the performance of some areas of equities and other markets widen further.
Global equities ended the week broadly unchanged in both local currency and sterling terms and are now up 1-2% since the conflict started. Oil prices, by contrast, headed higher again with the Brent crude price rising as much as 15% to $105 per barrrel. UK gilts were also down 1.1% with US Treasuries off 0.2%.
The news on the war was mixed. On the positive side, Tuesday saw Trump announce an unlimited extension of the ceasefire with Iran, while Thursday saw a three week extension of the Israel-Lebanon ceasefire. These moves clearly reduced the immediate risk of the war restarting.
Less positively, the ceasefires remain fragile and there is still little sign of Iran and the US coming to any lasting deal. The immediate prospect of another set of peace talks has receded again although there is talk of a new Iranian proposal to open the Strait of Hormuz while leaving the nuclear question until a later date.
The positivity of equities does look rather overdone given the uncertainty still overhanging the war and crucially the absence of any steps to reopen the Strait of Hormuz. Indeed on Friday, a Deputy Governor of the Bank of England warned of the apparent complacency of equity markets and the potential for a downward adjustment. However, her remit is financial stability, so some caution is maybe to be expected from someone in her role.
It shouldn’t be forgotten that corporate earnings are a major factor behind the current upward momentum in some equity areas. With around one-third of companies now reported, earnings for the US S&P 500 are as ever beating expectations and on track in the first quarter to be up a large 16% on a year earlier.
Earnings growth is strongest at the moment in the US and emerging markets and these two regions were up 1-1.5% last week, whereas the UK and Europe were both down 2.5%. At the sector level, technology – particularly chip manufacturers – are leading the earnings gains and tech is the only sector other than energy to be back above its pre-war level.
US equities are now some 4% above their pre-war high and emerging markets back up to their previous peak. This is not quite as crazy as it seems as the earnings gains mean the price rises have occurred even while valuations have been falling. The price-earnings ratio is down 8% from last year’s high in the case of the US and 10% lower in emerging markets.
Clearly, if the Strait of Hormuz remains blocked over the summer, the economic hit would put this earnings growth in peril and remove this support. But this outcome still seems to be quite low risk, despite the recent lack of progress.
It remains very much in the interest of almost all the major powers involved to ensure this does not transpire. And on every occasion so far, Trump has backed down from his threats even when Iran has failed to comply with his conditions.
Bonds are taking longer to recover than equities, particularly in the case of the UK and Europe. This is because the belief remains that while the Bank of England and European Central Bank will hold off tightening policy at their meetings this week, they will both raise rates over the summer by 0.5%.
Last week’s crop of UK data did nothing to dissuade the markets of this view. Headline inflation picked up in March to 3.3% from 3.0% and although the more important core rate edged down to 3.1%, service sector inflation is still running at a worryingly high 4.5%. Wage gains are also only moderating slowly with private sector earnings growth still running at 3.2% in February even though job vacancies have hit a five-year low.
Meanwhile, hard on the heels of the recent surprisingly strong February GDP numbers, UK business confidence posted an unexpected gain in April, unwinding some of its decline in March. Retail sales were also stronger than expected in March although this was largely due to a surge in fuel sales and consumer confidence retreated further in April.
So far, the war seems to be hitting confidence hardest in the Eurozone with sentiment falling into contractionary territory in April. US confidence, by contrast, is holding up significantly better, just as one would expect given it is considerably more insulated from the war as a result of its energy self-sufficiency.
The US Fed looks very likely to leave rates unchanged at this week’s meeting and continue to indicate it is in no hurry to make any policy move. Trump nominee Kevin Warsh has got a step closer to being appointed Fed Chair. His nomination hearings in the Senate have produced no big surprises and the Department of Justice has now dropped its criminal investigation into Powell. This had threatened to delay Warsh’s appointment beyond May as some Republican senators had refused to back him while the probe was ongoing.
This coming week is a big one, both on the economics and earnings front. We have the Bank of Japan meeting on Tuesday, the Fed on Wednesday and the ECB and BOE on Thursday. We also have inflation and growth numbers out for both the US and Eurozone on Thursday. Finally, it’s a big week for the tech sector with Alphabet, Amazon, Meta and Microsoft all reporting on Wednesday and Apple on Thursday.
Rupert Thompson – Economist