Global equities were in fine fettle last week, posting increases of 2.5% or so in both local currency and sterling terms. The gains were concentrated on Wednesday when markets jumped 1.5-2% on hopes of an imminent end to the war.
The news on the war that day changed almost by the hour. The US abandoned Operation Project Freedom to escort shipping through the Strait of Hormuz only a day after it had been announced. It was replaced by the US presenting Iran with a framework for ending the conflict and Trump reiterating yet again that the war would be over quickly.
But the US proposal was deemed unacceptable by Iran. It then presented its own proposal which was declared totally unacceptable by Trump on Sunday. Despite the apparent incentive for both sides to seek an off-ramp sooner rather than later, the need to be able to claim a ‘victory’ means neither side is yet willing to blink.
Unsurprisingly, oil prices have continued their roller-coaster ride. Having soared briefly to as high as $120 per barrel at the end of April, they fell below $100 last Wednesday only to move back up subsequently to $105.
How quickly the Strait of Hormuz is reopened is still far from clear, but markets certainly have their view and they differ significantly depending on the asset class. With global equities now 5% above their level at the start of the war in local currency terms and 3.5% in sterling terms, equity investors appear to be taking the view that the Strait will be reopened in some form over coming weeks.
Other markets, however, are taking a rather more cautious view. The oil market is currently assuming the Brent crude price will still be at $85-90 per barrel by year-end, well up on its pre-war level of $65-70. Bonds are also wary with 10-year UK gilt and US Treasury yields down only slightly last week and up 0.4% and 0.6% respectively since the war began.
Bonds are of course in part taking their lead from the central banks. While the Fed, ECB, BOE and BOJ all kept rates unchanged at their meetings the week before last, all look set to keep policy tighter because of the war.
Even though Trump appointee Kevin Warsh is certain to take over as Fed Chair from next week, US rates look likely to remain on hold for the rest of the year – despite Trump’s longstanding demand for large cuts. Last week’s data only reinforced this prospect with a larger than expected gain in payrolls in April for the second month running showing the US labour market holding up reasonably well.
Yet, US consumer confidence hit an all-time low in May. This is down to the affordability crisis which is afflicting much of the US population and a big reason for Trump to seek an early end to the war and reversal of the spike in gasoline prices. But as far as the economy is concerned, the wealthy continue to prop up consumer spending on the back of tax cuts and the strong stock market.
Meanwhile, the markets are assuming the ECB and BOE will both raise rates by 0.5% or so later this year. Whether or not these hikes transpire will depend on how long the disruption to energy supplies lasts. With central banks as much in the dark on this as everyone else, they are holding off on any action as long as they can.
Equities are often portrayed as being of a more optimistic bent than their fixed income siblings. There may well be some truth to this but this time at least a good part of the rebound in equities does seem justified. The reason is corporate earnings which are on a roll.
With 90% of the companies making up the US S&P 500 now reported (although Nvidia, the largest company in the index, only reports on 20 May) first quarter earnings are on course to be up a stonking 28% on a year earlier. Part of this surge is down to a revaluation of the stakes which some of the Magnificent Seven hold in private companies such as SpaceX and Anthropic. But even excluding this, earnings should still be up a strong 18% or so.
The earnings bonanza has not been limited to the US. Profits of the semiconductor chip manufacturers are soaring on the back of the surge in demand from the datacentres which the so-called hyperscalers are building like crazy. Indeed, emerging markets were up as much as 7% last week on the back of gains of 15% in Korea and 8% in Taiwan, swamping the 2% gain in the US.
It would be nice to end on this positive note, but the UK does rather need a mention. The disastrous if not unexpected local election results for Labour have left Starmer desperately trying to cling on as PM. With his speech later today deemed critical and it far from clear how any leadership challenge would play out if one is mounted, the outlook here is as murky as it is for the Strait of Hormuz.
10-year UK gilt yields have over the last couple of weeks been testing the high of 5% touched temporarily in March. Fears of rate hikes, along with the risk of a looser fiscal policy if Starmer were to be replaced, have been behind the rise. Still, despite the occasional headline suggesting as much, there is no sign of panic – gilt yields actually ended last week slightly lower and the pound was unchanged.
UK equities have also had a disappointing run of late, falling 0.9% last week, and have now unwound their burst of outperformance earlier in the year. They have suffered from a lack of tech stocks, which have led the equity rebound, and an excessive exposure to defensive sectors such as consumer staples and healthcare which have been underperforming. The relative cheapness of the UK – it is one of the few markets where the price/earnings ratio is in line with, rather than above, its long-term average – remains its main attraction.
This coming week, other than any new developments in the war, the main focus will be US inflation numbers on Tuesday – which should see the headline rate move up to 3.7% – and the meeting of Presidents Trump and Xi on Thursday/Friday. Here in the UK, politics will clearly be at the forefront, but we also have first quarter GDP figures out on Thursday.
Rupert Thompson – Economist