Monday Digest
Posted 24 June 2024
Stock market highs don’t feel so high.
Even though global stocks reached another all-time, the mood feels subdued. This is partly seasonal – a US national holiday and June’s option expiry date distorted trading – but partly because growth is so uneven. US business sentiment surveys showed surprising strength yet again, while European firms’ sentiment languishes under political risk.
Even US markets are uneven. Nvidia briefly became the world’s biggest company by market cap, and has accounted for more than a third of the S&P 500’s year-to-date returns. This isn’t a classic valuation bubble, though: investors seem to have just reluctantly accepted it’s the only one that can make big money no matter what. The AI rally has been phenomenal, but it isn’t yet growing productivity or living standards outside of tech giants like Nvidia. This might explain why Americans feel so negative about their economy despite decent aggregate data. Soft patches mean the Fed can cut rates in the Autumn, but it would be a shame if all this does is add another few more billion to Nvidia’s market cap.
The Bank of England left interest rates unchanged, but strongly hinted it would cut in August. Markets aren’t fully convinced but, after headline inflation dropped to 2%, it would upset things if the BoE didn’t. The UK’s election outcome also looks like a done deal, and this policy certainty is coinciding with improved growth prospects. This stands in contrast to deep uncertainty in France, which is why sterling has gained against the euro.
Going east, Japan’s yen is still the weakest currency, though, thanks to its incredibly easy financial conditions. The Bank of Japan wants corporates to invest, but the country’s private sector seems to have forgotten how. This is a problem for China too, as the renminbi’s loose dollar peg means it has appreciated around 10% versus the yen this year. Chinese financial conditions are remarkably tight, despite the economy needing support.
A renminbi devaluation would therefore be reasonable, but is politically difficult, both domestically and among US politicians. China’s weak economy means it needs to play nice. That should be good for the global economy but, like everything else, is a mixed bag.
Markets unfazed by Labour’s lead.
Polls and betting markets suggest a Labour victory in July 4th‘s election is a done deal. Since the stereotype is that markets prefer Conservative rule, some have blamed politics for the FTSE 100’s underperformance over the last month.
That is a stretch. The FTSE 100 is dominated by large commodity multinationals and banks, so is much more influenced by global growth than domestic politics. Global growth expectations were strong earlier in the year – and the FTSE outperformed – but they are weaker now, and the FTSE is underperforming.
Investor anxieties about Labour are mainly around tax rises – but the party has ruled these out for income tax, national insurance, VAT and corporation tax, and Paul Johnson of the IFS calls the party’s planned rises “trivial”. Nothing in Labour’s communications or the market reaction leads us to doubt that.
Kier Starmer and his party have been much cagier about capital gains tax (CGT), though. A majority of voters think he will hike it, according to a Telegraph poll, and CGT does feel like the most politically viable source of extra funds. An increase could hit some private equity funds, though they would probably just move tax bases. It will probably boost demand for more tax-efficient investment structures too. After Rishi Sunak lowered the threshold for taxable gains in April, for example, our fund of funds wrapped portfolio structure saw increased demand.
All this has a pretty minimal effect on the value of investments, though. That tends to be decided by the real economy rather than the tax outlook. UK large cap will continue to be driven by global affairs, while small caps will be driven by domestic growth. On that front, Goldman Sachs see a small boost to demand from Labour’s slightly more expansive fiscal policy. But realistically there will not be much of a difference – given Labour’s plans to strengthen the Office for Budget Responsibility. Markets think there is little scope for surprises.
Commercial Real Estate: risks and potential recovery
Commercial real estate (CRE) is struggling. These troubles have thankfully not spread to the financial sector – as many thought they would after the collapse of Silicon Valley Bank last year – but risks are simmering rather than cooled entirely. $2tn worth of US CRE debt is set to mature in the next three years. $670bn of this is “potentially troubled”, according to Barry Gosin of brokerage firm Newmark. As such, banks will have “to liquidate their loans or find other ways to reduce their weight in real estate”.
Higher interest rates hit CRE with the double whammy of squeezing their leverage and dampening property values. Firms will probably have to refinance at harsher rates, as US rate cuts have been repeatedly delayed this year. $929bn will mature in 2024 alone. Banks might be forced to offload the debt at a discount, due to post-financial-crisis regulations.
That could mean opportunity for those buying the debt. In January, the billionaire founder of Zara expanded his personal stake in CRE via a “buy the dip” strategy. CRE prices are hardly recovering strongly this year, but the sector seems to be over the worst of its troubles.
The CRE market is seemingly in limbo – beyond the worst of its problems but lacking the positive momentum to truly rebound. Goldman Sachs summed this up last month as CRE debt being “volatile, dispersed, but not systemic”. Interestingly, Goldmans points out that current growth in lending to CRE is being driven by smaller banks. Falling US rates, which markets currently expect in September, would support this.
That should bring back some investment demand, helping the more resilient companies. CRE conditions are still tough but, compared to a year ago, the threat CRE stress poses to the wider financial system looks minimal.