October proved to be a roller coaster month for risk assets and portfolios overall as liquidity and positive sentiment raised valuations higher, but ebbing lower at month’s end. Valuations in some sectors now appear decidedly stretched. Can the perennial year-end rally add some further upside to close the year on a high? We will investigate this and more in the update which follows.
Following a pre-election pledge to abide by the Fiscal Rules, we are not shocked to see Chancellor Mrs Reeves tearing up the commitment allowing the UK Government to raise a further £50+ billion of debt. What surprises us is the lack of market and commentator response, especially following former Prime Minister, Mrs Truss’, debacle of only 2 years earlier. Much of the British establishment in the Treasury and Bank of England subscribe to Keynesian philosophy where the state borrows, taxes and spends to create growth. Where growth is not delivered, the process is repeated. This is fine in theory but can lead to debt crises as we have seen in the UK in the 1970s. So much of the UK Government agenda is based upon growth, which leads us to wonder whether higher costs for business and tighter regulation will deliver the growth relied upon. The Office for Budget Responsibility forecasts show modest growth in 2025, abating in 2026. Impacts to gilt yields were notable on Budget Day, ending the day around 4.4% for 10-year debt. A significant wall of new Gilt issuance will follow and likely push yields higher. Sterling is also under our observation. UK equities represent decent value and have done so for a long while. Selectively, and when used for an appropriate role in portfolios, we continue to find appeal.
Elsewhere, the US economy continued its positive performance with GDP on track to deliver +3.4% growth. Credit spreads are at a low point for the cycle, indicating a robust economy and overall corporate health, but also meaning portfolio managers must closely observe any changes and the rate of change. Inflation headlines point to some stickiness around the 2.4% mark but removing Owners’ Equivalent Rent (a purely theoretical figure not paid by anyone) from the CPI make up, we see the inflation figure plunge below the 2% target. Employment and jobs data had weakened alarmingly in preceding months, provoking the Federal Reserve to cut rates by 0.5%. During October, employment data proved to be less alarming, and this coupled with decent economic growth caused the trimming back of rate cut expectations. The impact of potentially fewer rate cuts in America also drove Treasury yields higher. Consequently, equity valuations are more difficult to justify when bond yields rise. We anticipate a further interest rate cut in America during November. Likewise, unemployment remains at 4.1% with some underlying weakness which will make easing policy easier to justify for the Federal Reserve.
The looming US election result appears to be on a knife edge. Markets view a Mrs Harris win as “more of the same” and a continuation of what Democrats would phrase ‘Bidenomics’. However, the hangover from punishing inflation and a weaker jobs market provoked by surging immigration weighs heavy on Democrats. By contrast, former President Trump’s policies of tax cuts, severe tariffs on certain imports and reductions in immigration are considered inflationary. We await the outcome of the election with great interest. As we approach the election date markets ebb and flow dependent on latest polls and event risk probabilities naturally rise.
Ample liquidity especially in America is one important underpin for risk assets. The flow of liquidity remains a feature as we head into the final fling of the year. A notable rise in short-dated bill issuance and other key supporting measures helps us remain in broadly positive mindset for the year end. The US dollar strengthened notably in October on geopolitical fears, helping portfolios insulate against risk. We should also note the ongoing strength in silver and gold also helped by geopolitical tensions and central bank buying to protect reserves from the impact of key global currency debasement. Quarter 3 corporate earnings results will be a critical support feature if indeed a Santa Claus rally is to be delivered. Of course we keep this under close surveillance.
Source: Bloomberg
The yield on the 10-year US Treasury is now higher than the earnings yield of the S&P 500, shown in the chart, meaning equity risk premium has turned negative.
As we suggested here last month, China’s stimulus programme needs to be comprehensive for markets to be persuaded of the merits of a recovery. The People’s Bank of China committed RMB 200 billion, or $28bn, of stimulus to promote growth and underpin falling equity values. The policy so far has been only partially successful, with markets demanding a far larger response. We have covered China’s difficulties before in some detail but suffice to say investor’s end of term report is clear - the People’s Bank of China “must try harder”.
Japan has delivered strongly for investors with renewed vigour in corporate performance clearly visible. A structurally weaker yen and higher wage growth leading to rising inflation was welcome at modest levels, but the trend has become problematic with the Bank of Japan now seeking to control the currency and restrain inflation. China’s ultra-low-cost export drive will also help restrain excess in Japan. For now, equity values appear to have peaked and the potential for further Bank of Japan intervention is a real possibility.
Meanwhile in Europe we have witnessed a further rate cut and inflation falling to just above 1% for the Eurozone. Germany and France, the engine rooms of the Eurozone, continue to suffer economically, skirting perilously close to recession with manufacturing industries in decline notably in the automotive sector where Volkswagen plan to close factories for the very first time. A resumption of some sort of quantitative easing should not be ruled out. The chart shows German inflation.
Source: Bloomberg
Alpha Beta portfolios have enjoyed a decent year so far. We set asset allocation to benefit from our ample liquidity thesis which has delivered well. Our proprietary momentum indicator suggests the party may have a little further to run but we are now thinking carefully about the timing for locking in gains, taking some profits and lowering risk at the margins. Likewise in Japan where positive momentum has faded, as discussed above.
We will notify you of changes made of course, but for now we are assessing the correct timing for our next move.
We look forward to updating you in December and meantime we thank you, as ever, for your ongoing support.
Written by the Alpha Beta Partners Investment Team.
All sources Bloomberg unless otherwise stated.