Monday Digest
Posted 8 July 2024
New government, same economy
The election results were emphatic but full of contradictions. Labour achieved one of the largest majorities ever with the lowest winning vote share, and it did so by promising change while emphasising continuity. The contradiction most relevant to investors is that capital markets were unmoved by this political earthquake.
Even though UK stocks rallied on Friday morning, this probably had more to do with global factors than domestic politics – just like last month’s sell-off. Markets are nonchalant because Kier Starmer continues to emphasise fiscal discipline. This is more about Liz Truss’ legacy than his own preferences: the former prime minister’s disastrous ‘mini budget’ reaffirmed the position of capital markets as the most unforgiving opposition of all. That means fiscal growth upside from the new government is limited, but growth indicators are already trending up and could well benefit from Labour’s stability.
That is a far cry from the US. Debt-to-GDP has risen dramatically in the last decade under successive administrations, and this is likely to continue regardless of who wins the November election. But Morgan Stanley research suggests that fiscal policy will be looser under Trump – so Biden’s recent debate failure has increased fears about debt instability. The US usually avoids bond market punishment thanks to its global economic dominance, but that could be tested if its fiscal stance worsens further. Even Jay Powell seems to be worried about the US eventually at risk of facing a ‘Liz Truss moment’.
US stocks continue to outperform all the same. Lately this has been a ‘bad news is good news’ story, with weaker economic data firming up expectations of a Federal Reserve rate cut. There are problems with this mindset. Stock market returns are so concentrated on a handful of mega-tech companies, but background macro conditions seem to have worsened for the group. And while slower growth might mean quicker rate cuts, it could also mean weaker profits. Markets seem to expect a ‘goldilocks environment’, but that could just be hubris. We will have to watch valuations, relative to the unfolding economic progress, closely.
June 2024 asset returns review
Global stocks returned a healthy 3% in sterling terms through June, but returns were highly concentrated on the dominant US mega-tech sector. Interestingly, emerging markets (EMs) also outperformed, jumping 4.7%, despite a 1.6% fall in Chinese stocks – the biggest component of EM indices. This continues the theme of dispersion between China and wider EMs. The latter rallied 6.8% because of rebounds in India and South Africa. Both had previously slumped due to surprising election results, but we said at the time that such political upsets are often overdone and can be good buying opportunities. So it proved.
European stocks saw a political sell-off too, dropping 1.7%, after President Macron’s surprise election call. We wait to see if the French far-right can win an outright majority in second-round voting. The 1.1% drop in UK stocks, on the other hand, isn’t political. The large multinationals that dominate the FTSE 100 are just particularly sensitive to global commodity demand – which has been weak for commodities other than oil. Markets were neither surprised by Labour’s landslide nor fearful of its moderate policies.
The US outperformed again, gaining a further 4.3%. This came despite weakening economic data through June. Investors clearly see slowing growth merely as proof that the Federal Reserve will cut interest rates in September. Bond yields moved gradually lower, but spiked into the end of the month. Reasons for the spike aren’t certain – but we suspect it could be down to struggling Japanese banks offloading their foreign bond holdings.
US strength was yet again really strength of a handful of mega-tech stocks. It shows how skewed returns are that Nvidia alone accounts for 35% of the S&P 500’s year-to-date returns. Monitoring this concentration and the risks it brings is the key challenge for investors in the second half of 2024.
Are Americans wrong about their economy?
US consumers are much less confident about the economy than aggregate economic data should suggest. The US continues to outperform in growth and capital market terms, but 55% of Americans think their economy is in recession, and 49% think the S&P 500 is down year-to-date, according to a Harris poll for the Guardian.
Consumer confidence has never recovered to pre-pandemic levels, despite strong growth and low unemployment during that time. This is a big problem for Joe Biden, and it has been suggested that highly partisan US news sources could be to blame. Backing this up is the fact that economic confidence differs dramatically by party affiliation – but political bias isn’t the whole story.
Some economists have suggested that traditional economic measures miss key factors, like the psychological impact of inflation and high interest rates. The clearest example is that average real (inflation-adjusted) hourly earnings are still below where they were in mid-2020. These were boosted during the pandemic thanks to emergency stimulus, but that did little for confidence because consumers couldn’t spend it on what they wanted at the time.
Wealth inequality, which grew during the post-pandemic recovery, is a crucial component too. Low aggregate unemployment hides the fact that the worst off are struggling much harder. Booming stock market returns are concentrated on just a handful of mega-tech companies, an uncanny reflection of America’s unevenly spread opportunities.
The US economy is set to gradually slow and restart at the aggregate level, but aggregate figures hide so much of what makes the economy important to people. The sentiment gap might have more of a concrete impact – both economically and politically – as growth comes down.