Monday Digest

Posted 8 January 2024

Overview: After the party, the hangover

After the Christmas party, January perhaps started with a bit of a hangover. After an exceptional last two months of 2023, both equity and bond prices fell back last week as trading volumes normalised. UK and US yields were up quite sharply on the week, at 3.80% and 4.05%, respectively. Equities also responded in their usual way of falling back some 1%-2% through the course of the week, with some notable underperformance from tech-related stocks.

Professional investors, like us, seem to have looked at the lower yields on bonds and larger cap equities and decided to take the near-term profit. In part, this may well be because they are making space in portfolios for potential new investment positions. Companies are seeing the lower cost of capital as an opportunity to finally replenish funds with new bond issues, and equity issues in the form of initial public offerings (IPOs) and convertible bonds offering the appealing combination of bond-like downside protection with equity upside.

Such behaviour is born of optimism rather than pessimism. Companies want to raise capital because their business can generate a better return than the cost of that capital (even at these relatively higher rates than in the past few years) and investors believe in the new opportunities. It also suggests that capital markets are more in balance now than they were in December, when optimism rose but corporate treasurers wanted to wait until the new year.

The real news of the week was that the narrative of global policy rates being cut sometime in the second quarter took a hit. European inflation data was in line with – but not below – expectations while US December employment data was the same as November’s very surprising low of 3.7%. Indeed, the evidence suggests employment tightened at the end of the year, something that should bolster consumption but will do nothing to reduce robust wage growth. Low inflation data may help for this month, and possibly next, but rate cuts in March and April look as far-fetched as we thought they did at the tail end of last year.

US election: will a Trump candidacy shake markets?

When America votes, the world watches. Ever since Donald Trump announced his first presidential campaign in 2015, melodrama has given global audiences another reason to tune in. And with criminal charges piling up against the former president – but not even scratching his campaign for his party’s candidacy – the 2024 election is sure to be Trump’s most dramatic yet.

Strangely, though, that established truth does not usually extend to investors. Looking back, the 2020 election had little impact on the US stock market either before, during or after the fact. This was despite an extremely politically volatile campaign that ended in accusations of fraud and an attempted insurrection. Trump’s shock victory in 2016 initially knocked US equities, as investors feared the destabilising effects of a divisive political novice in the White House, but this downturn was recovered within days and markets later surged in what was wryly called the ‘Trump rally’.

The big question as we head into this election year is: can markets ignore US politics again? Judging by market reactions – or lack thereof – to Trump’s myriad legal troubles in 2023, it seems possible they can, but it is hard to analyse because of a lack of clarity about implications regarding market expectations. Many think that Trump gaining the Republican Party candidacy, and thereby featuring on national presidential ballots, is inevitable, but while Trump has a dominant lead over Republican rivals, his legal battles – in particular cases relating to his attempts to overturn the 2020 election result – could still sink his campaign.

That said, there is a growing feeling that, if Trump makes it onto the ballot, he will likely win in November. This is supported by his polling lead against President Biden, both nationally and in key swing states. Again, there are many unknowns here – including whether Biden himself will feature on the ballot, and whether economic improvements might rescue his dire popularity ratings before polling day. But a second term for Trump is certainly enough of a likelihood that investors and American citizens have to seriously consider it. For many Americans, the thought is extremely unpalatable, to put it mildly. There is a large group of liberal-leaning highly educated urban-dwelling citizens who think a second Trump presidency – combined with a radically conservative Supreme Court – could destroy the liberal democratic institutions that keep the republic running. That demographic tends to skew wealthier than rural less educated counterparts and, as such, makes up a much larger proportion of US domestic investors.

We have written much recently about the prolonged outperformance of the US, and whether it can continue now that its assets have become much more expensive compared to Europe and EMs. A change of market fortunes, as we argued before, needs a catalyst. Half the US fearing the death of democracy could be such an event.

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