Monday digest
Posted 4 March 2024
Overview: Winners and losers of stabilising yields
Last week was one of positive price action in equities, although the US mega-caps did less well, while bond markets were rather stable. Indeed, stable bond markets are one of the reasons why equity markets can continue to edge up. Interest rates and yields appear close to equilibrium levels, a state of relative steadiness which enables activity to happen. There were no big mergers or acquisitions last week but it is noticeable that companies are increasingly trying to raise equity rather than loan capital. Bloomberg pointed out that companies are finding the near-term cost of equity much more bearable now that dividend yields have fallen in relation to bond yields.
What has struck us in recent weeks is that consumer and business behaviours appear to be sensitive to quite small changes in rates. Small businesses are negatively sensitive and step up efforts to cut costs and reduce debt on any sign of a rise. Particularly in the UK, households are positively impacted by lower mortgage rates which drive a swift rise in housing activity. Currently, US rates are just about bearable for both camps. However, this also implies that the Federal Reserve (Fed) is unlikely to cut interest rates meaningfully. February data suggested US inflation was stabilising just below the 3% level -consistent with a slight Fed easing in the summer or autumn. This Thursday, the European Central Bank (ECB) conducts the first of March’s central bank meetings. We think both the Bank of England (BoE) and the ECB ought to be on the verge of rate cuts. Growth is not collapsing, but neither is it rising. By focusing on labour pricing power alone, they miss the point that it is businesses that are paying that price. It is neither being funded out of money creation nor reflected in rising prices. Unfortunately, for yet another month, we will analyse words, not actions.
February 2024 asset returns review
Despite a mid-month lull, February turned out to be yet another strong month for investors, with global stocks delivering a very healthy 4.4% in sterling terms. The US was once again one of the strongest performers, with the S&P 500 jumping 5.2% in sterling terms. February’s broad-based rally was a good sign, allaying previous concerns that too much capital was focused on the US mega-tech sector. Speculation over an artificial intelligence (AI) asset bubble grew before and after Nvidia’s stellar earnings report, with revenue up 265% and profit up over 750% for the year. Euphoria seemed to peak last week though, and trading since has been much more muted. There was also a pick-up in US mergers and acquisitions, a sign of changes in market composition, which helped bring confidence to markets. One clear sign of this is the weaker dollar, suggesting solid global growth expectations. This was also reflected in bond yields, which weakened at the start of the month but subsequently recovered to recent highs.
European stocks gained a respectable 2.9% through February in sterling terms. So far, 2024 has been a steady incline for Europe, but as we have written before, the continent stands to benefit from stronger global growth. If the ECB is able to cut rates soon (and before the Fed) and Chinese demand comes through strong, it will be a potent recipe for growth. The FTSE 100 ended February with a 0.7% gain, ensuring a slight decline in year-to-date returns at -0.6%. Smaller British companies in particular – being more closely tied to the dynamics of the domestic economy – are having a hard time, with UK small-cap equities down 1.2% last month. The disparity between the UK and other markets – particularly the US – leaves UK equities with relatively attractive valuations, at least.
Chinese equities gained an impressive 9.3% in sterling terms, making it the best-performing region for the month. Weak demand and goods prices out of China have been a decisive factor behind lower commodity prices. Accordingly, there was an upswing in oil prices last week, and the commodity index we track gained 1.3% in sterling terms through February. Growing positivity in the global economy is a welcome sign, as is the fact that returns are no longer solely focused on AI. The worry, as usual, is that this could mean returning inflation pressures and a delay in central bank easing. There is no sign of that yet, but we will keep a close eye.
Nigeria shows why reform is always difficult
When Nigeria’s President Bola Tinubu came to power last May, Western investors cheered his embrace of market-friendly policies. These included removing the currency peg with the US dollar, dealing with the consequences of a botched attempt to move Nigeria’s cash-based economy into electronic banking, and scrapping Nigeria’s nationwide fuel subsidies. The latter reform was specifically recommended by the International Monetary Fund (IMF) and Tinubu won plaudits from the World Bank. But Nigeria’s economy has only worsened since; inflation is at nearly 30% and the naira has lost more than 70% since the peg’s removal.
To cushion rapid inflation and a tanking currency, the Central Bank of Nigeria (led by Dr Olayemi Cardoso) raised interest rates last week by an outsized 4% to 22.75%, when a 2.5% lift was expected. The move leaves Nigerian rates at their highest recorded level, but it may still not be enough. The country’s highest inflation rate this millennium is now being driven by currency collapse – itself an effect of dramatic capital outflows. There seems to be a run on Nigerian assets from both foreign and domestic investors, and it is unclear what would stop the flow. The experience of other countries has been that it requires rates to be far enough above inflation to tempt investors to risk earning the ‘carry’ (yield).
Part of the problem is some very unfortunate timing. When global energy prices skyrocketed two years ago, commodity-producing nations like Nigeria benefitted greatly. But what followed, the sharpest monetary policy squeeze in a generation, combined with dramatically lower commodity prices, had the opposite effect. In the last year, when inflation has been steadily declining in Western developed countries, Nigeria and other EM nations have been under increased pressure. Nigeria’s government is thereby focusing on what it can do alone, thereby reducing its economic dependency on the big economies of the US and China.
Last year, the government allowed the regulated banks to resume trading in cryptocurrencies, given that many Nigerians are involved in this market, with some commentators even suggesting that flows from Nigeria were a factor in the recent resurgence of Bitcoin. However, the Nigerian authorities have become worried that the crypto market is part of the Naira’s current instability and so banned the use of the unregulated exchanges. Gaining control of its sliding currency is a necessary first step in stabilising the economy, always a very difficult one to take, and one which modern markets make even more difficult.