Market Update: Healthy market rumours

Stock markets keep pushing at all-time highs earlier this week, but with less enthusiasm than a few weeks ago. Then, late on Friday, a renewed Trump tariff threat against China’s rare earth export restrictions was enough to immediately send markets down 2%.

Solid growth in corporate earnings has been investors’ main source of excitement over the last six months, and that growth does not look under any immediate threat. But the same investors are looking increasingly nervous. Doubts are creeping in about whether AI companies are all they are cracked up to be and, relatedly, there are signs that the long period of low volatility could come to an end. There are few reasons to panic – but the reasons to be wholly positive are weaker than they were.

The UK needs a ‘debt restructuring’

The autumn budget is fast approaching and everyone expects tax rises. If the government has to raise taxes (and the ‘budget black hole’ warnings suggest it does), putting up base rate income taxes would do the least economic harm. To maintain Labour’s electoral pledges, though, it looks more likely the treasury will raid banks or savings.

The UK is in this situation because of a debt problem – but not the debt problem you might think. It is not so much that the state has overspent, rather that bond yields are too high relative to Britain’s low growth. Our cheap bond prices (the inverse of yields) are not attracting foreign investors to the extent they should.

Post-Brexit, global investors have considered Britain’s market unattractive. For UK stocks, this is because of weak productivity and poor financial liquidity. For bonds, it is largely because our national debt is poorly structured, with too much long-term bond issuance and not enough short-term. As we have argued before, this bond imbalance is a legacy of historical pension fund regulation.

The problem can be solved. The government could issue more short-term bonds (aided by interest rate cuts) and use the money to buy back its own long-term bonds at significantly cheaper prices than it sold them. This would be even more effective in easing government finances than the Bank of England reducing their bond sales . The media would inevitably accuse the government of ‘fiscal dominance’, but we know many UK bond managers that would welcome the move. If the treasury can properly match bond demand to bond supply, lower its long-term interest costs and improve its balance sheet in the process, what is not to like?

AI heading for near-term reversal?

Lately, there has been a cacophony of debate about a potential bubble in AI investment. This was prompted by concerns of circular ‘vendor financing’ – like Nvidia’s deal with OpenAI, which looks a lot like giving a company money to buy your own microchips. Given how genuinely profitable many of the big tech companies are, bubble talk is exaggerated. Big tech price-to-forward-earnings valuations are significantly lower than in the run up to the dotcom bubble, for example.

There are reasons to be concerned, though.