Market Update: No news is good news…

Focus returns to stock market fundamentals

Capital markets quietened down last week. Global stocks are up from a week ago, and there is a sense that anxieties are fading. Risks and uncertainties have not gone away completely, but their short-term impacts on risk assets look smaller. There was a lack of bad new news, while the old news seemed less negative. That has allowed investors to focus on more concrete details. Sharper interest rate falls are expected in the UK and Europe, while the US economic outperformance has come back strong. Meanwhile, markets are digesting a mixed set of corporate earnings results, but focussing more on what comes next. There are some important events in the next few weeks, most notably the US election and the UK budget, but the overall environment remains supportive for risk assets.

ECB cuts, as European (and UK) growth falters.
The European Central Bank (ECB) cut interest rates by one quarter of a percentage point on Thursday, as markets fully anticipated. Notably, ECB president Lagarde pronounced that “the disinflationary process is well on track” after September’s inflation came in below the 2% target. Lagarde dismissed the prospect of a Eurozone recession, but growth is clearly weak. Germany, Europe’s largest economy, is in recession and looks set to contract for another year running. Unsurprisingly, given the ECB’s signals, markets now expect another ECB cut in December.

UK inflation also came in below the 2% target for the first time since April 2021. This has bolstered market hopes, as it gives the Bank of England (BoE) greater scope to cut rates. Both the ECB and BoE are helped by goods disinflation from China. British and European core inflation rates (excluding volatile elements like food and energy) remain above target but are coming down quickly. Now that China is stimulating its economy to stop its deflation problem, central banks could get less of a helping hand. We will have to see how the ECB and BoE account for this.

Thanks to the inflation data, UK government bond yields fell faster than elsewhere lastweek. But yields are still significantly higher than a month ago. This is reportedly making the treasury very nervous as we come up to the autumn budget – as Liz Truss taught British politicians to fear bonds and budgets. However, the move up in yields from September has all been about the US: higher American growth expectations pushed up US yields and the dollar, making non-US bonds less attractive by comparison.

US growth strong, waiting on election outcome.
US growth outperformance is definitely back. We thought the world’s largest economy was losing its shine over the summer, but revised our view after we saw a turn in the weekly employment numbers. Recent data has made it clear that the Summer was a short soft patch, emphasised by Thursday’s release of surprisingly strong September retail sales growth. Treasury yields rose in response – and in contrast to bond yields here – while interest rate expectations continued their recent rise.

The Federal Reserve is still going to cut rates in the months ahead, but the path down is not nearly as steep as markets hoped it would be at the start of September. Stronger growth is good for stocks, but changing rate expectations have taken the shine off smaller companies – making for a mixed performance into the end of the week.

Markets are waiting to see what will happen in the presidential election. The next administration’s economic policy for the coming four years will potentially have a massive impact, but asset prices are still not reacting to election news. This is partly because the race is so close, but also because neither candidate is currently saying much to scare markets at the moment. Notably, Donald Trump has put less emphasis on tariffs and isolationist foreign policy in recent weeks, focussing on immigration instead.

The big stories fade, so investors focus on the factors in play. 
Relatedly, US pressure on Israel has clearly had an impact, after reports that the Israeli leadership will not target Iranian oil or nuclear facilities. That sent crude oil prices down to where they were a month ago – before Israel’s invasion of southern Lebanon. We cannot pretend the oil supply risks of a Middle Eastern war are all gone, but with that immediate concern fading, oil traders were able to focus more on the fundamentals. As we have argued for a while, those fundamentals point to a continued oversupply, and hence a ceiling on oil prices.

We saw a similar mood shift in risk markets. With oil and US election anxieties easing – or maybe just being put on hold – investors switched attention to more concrete details, like third quarter corporate earnings/profits. It felt fitting that the Dutch chip manufacturing equipment giant ASML would make a mistake in releasing its figures (they went up a day early, were deleted then quickly rereleased) considering how disappointing its profits and outlook were. The chipmaker’s stock sold off, leading  broader slump in tech stocks, but the sector later perked up after TSMC’s results. Markets realised that ASML’s weakness was not about the future of AI chip demand, but past overordering of chipmaking machines, during the post-pandemic semiconductor bottleneck.

In general, the earnings released so far have been mixed, but, there are some mitigating factors. For one, bigger tech companies (like AI behemoth Nvidia) tend to announce later, so the early releasers often have less of an impact – as we covered the week before last. More importantly, we already know that last quarter was a soft patch for US companies in particular, and that conditions are improving. We are seeing the results of that soft patch now, but what happens next is more important. And on that basis, what was already a benign outlook for investors got more positive last week.

Lastly, gold continues to push to new highs; the speed of ascent is second only to 1979. For those of us that remember that time, the current situation (a sense of risk reduction, strong global stocks, disinflationary pressures and stronger dollar) feels quite different to that period.