Market Update: Markets in brace position

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Capital markets feel more tense than at any point since the beginning of September. Global stocks sold off slightly last week, but without sharp moves. It would be wrong to say that investors are fearful. In general, the global economic outlook is still positive despite geopolitical risks. It feels more like markets bracing for some big events. Britons anxiously await the autumn budget and, after a long build-up of mixed messages, it would help to just get it over with.

Global investors are more focused on the US election. It could have huge impacts on markets and the world economy, but it remains on a knife edge. There is also a snap Japanese election this week, fears of which have weighed on the yen and hurt Japanese stocks. While markets wait for these to play out, trading volumes will probably decrease further, as more speculative investors retreat and wait out the election outcome. This means market liquidity could tighten up and we might see some more volatility as a result. But even if that feels scary, it should not detract from general long-term economic positivity.

Budget fears break for a bit of hope.
After much anticipation, Rachel Reeves confirmed a change to how debt is counted under the UK’s fiscal rules in this week’s autumn budget, which will reportedly give the government an additional £50bn (or more) of borrowing space per year. This was met with some media derision over apparently ‘moving the goalposts’ but, realistically, public debt definitions are always a little arbitrary and change quite often for a variety of reasons. UK government bond yields did rise on the news – as you would expect – but not massively, suggesting markets did not think the rule change was so bad. This is perhaps because the US government is operating under a similar definition already.

The good news is that it should mean fewer tax raising measures than many have feared in this long budget build up. There will certainly be some moves to increase tax revenue, but the treasury’s current signals are more about providing money for public investment. That is a positive for UK growth, and markets are hoping for a long-term public investment framework that goes beyond the short-term policy shifts we have become accustomed to in recent years. That might be why stocks held steady, despite the yield rises.

While UK bond yields did drift higher, we note that this was almost exactly in line with US bond markets. Basically, the spike in borrowing costs that Labour fretted over has not happened. We will know for sure this week, but this autumn budget is starting to look like the complete opposite to Liz Truss’s “mini” budget: anxiety in the build-up, but very little market impact in the event.

ECB turns accommodative amid European weakness.
Across the channel, European growth is struggling. Business sentiment surveys from France’s services sector have weakened further, while German manufacturers are stuck in a mire. Notably, corporate earnings expectations have swung down more sharply in Europe than elsewhere.

The good news is that the European Central Bank (ECB) has taken note, and is signalling further interest rate cuts. This is to be expected after inflation fell below the official 2% target, but what was significant last week were comments that the ECB might move rates from ‘neutral’ (neither supporting nor restricting activity) to outright supportive. That should mean that real (inflation-adjusted) European bond yields fall back towards zero, making risk assets more attractive by comparison and hopefully supporting growth.

European exporters are also hoping for a rebound in Chinese demand, following Beijing’s economic stimulus announcements. We have bemoaned the mixed signals from Chinese policymakers, but its stock market was again one of the best performers last week. There is a growing sense among western onlookers that Beijing’s stimulus will significantly boost Chinese and global growth – even though we still do not fully know what that stimulus will look like.

Liquidity could dry up as markets hold – potentially causing volatility.
In the US, meanwhile, the corporate earnings season is largely going as markets expected. Early company results tend to be lacklustre due to the sorts of companies reporting, but the tech big hitters are now starting to report and we hence saw more positive earnings ‘surprises’ last week. We should note that earnings surprises are always a little artificial, as companies guide down earnings expectations before release, so they can beat them. Hence, last week’s earnings reports were not really news.

Stock prices did not move much (US equities were in fact slightly down) but even that relative stasis actually made shares look a little overvalued compared to bond yields that have risen  around 0.5% recently. Election anxiety is probably the best explanation for this. We have said for a while that Donald Trump’s proposed tax cuts could be a risk for US fiscal sustainability, but until last week, markets had largely ignored this risk. Bond traders are by no means panicking, but it looks like there is some position covering (traders hedging against potential losses) which has led to bonds selling off and, inversely, yields going up. With this potentially very consequential presidential election on a knife edge, that makes sense.

However, that position covering does mean that market liquidity dried up a little last week. It feels like markets are bracing themselves for what happens next. This is not because investors expect a bad outcome, but because we simply do not know whether the world’s biggest economy is about to get tariffs and tax cuts, or a continuation of the status quo. In this brace position, smaller news items (which presidential candidate said what) will feel bigger, and relatively small market selling pressures could have bigger impacts. We could therefore see some volatility in the next couple of weeks. But if so, we should not think of this as an omen; the long-term outlook remains positive.

This week’s writers from Tatton Investment Management:
Lothar Mentel
Chief Investment Officer
Jim Kean
Chief Economist
Astrid Schilo
Chief Investment Strategist
Isaac Kean
Investment Writer

Important Information:
This material has been written by Tatton and is for information purposes only and must not be considered as financial advice. We always recommend that you seek financial advice before making any financial decisions. The value of your investments can go down as well as up and you may get back less than you originally invested.

Reproduced from the Tatton Weekly with the kind permission of our investment partners Tatton Investment Management

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