Monday Digest
Posted 5 August 2024
Central bank week
Another nervy week for investors: a slew of interest rate decisions, weak US employment data and disappointing Q2 earnings reports from US tech firms (including nasty results from Intel, which laid off 15,000 employees. On the central bank front, the Bank of England (BoE) cut, the Federal Reserve (Fed) stuck and the Bank of Japan (BoJ) hiked. Bond prices moved up, negatively correlated with equities – suggesting weaker growth estimates.
The BoE delivered its first rate cut in years, but by a wafer-thin margin 5-4 margin. Governor Andrew Bailey downplayed the prospect of more rate cuts, warning that some members of the committee think the inflation shock will have lasting inflationary effects – a view Bailey is sympathetic to. The BoE will at least take comfort in the clear fiscal restraint shown by the Labour government – through talk of plugging the £22bn “black hole” with tax rises, for example.
If the BoE’s move was a hawkish cut, the Fed’s was a dovish stasis. The central bank held rates steady, but chair Jerome Powell strongly suggested a cut was coming in September. Inflation is apparently no longer the Fed’s primary concern, with focus now shifting to growing unemployment. US unemployment has moved to a tipping point – past which job losses could spiral – and the Fed is clearly mindful.
The BoJ, meanwhile, raised rates, pushing the yen below ¥150 on the dollar for the first time since March. Domestic investors weren’t pleased, and Japanese stocks fell sharply on Friday. The yen’s strength last month was strongly related to the US market rotation from large to small caps, through the drying up of cheap yen financing for hedge funds with large tech stock positions. With the BoJ tightening and the Fed loosening, this source of funding is harder to come by.
The Fed will need to pull off a ‘soft landing’ for stocks to benefit from here. That seems likely, but we hope the bank didn’t miss its best chance to cut. Lower rates will help, but US valuations are high and earnings are weakening. This will likely lead to turbulence – which is normal, but scary. As ever, it’s about time in the market, not timing the market.
July asset returns review
July saw political drama and huge rotation from large to small-caps – yet, overall, global stock prices were exactly as they were a month ago in sterling terms. The reversal of fortunes, away from the “Magnificent 7” US tech stocks that have dominated for so long and toward smaller companies, began with weaker-than-expected US inflation and was bolstered by Donald Trump’s perceived boost in electoral chances after his attempted assassination. President Biden’s decision to bow out of the race evened the odds somewhat, thereby lowering tax cut chances and stalling the US small cap rally.
The Mag7, however, couldn’t regain momentum. We think this is in part because of de-risking from hedge fund types, whose bullishness on the mega-caps was chipped by July’s events, greatly increasing volatility. This was also related to the Japanese yen, whose strength last month (prompted by monetary tightening after months of the currency sliding) removed a source of funding for the leveraged Mag7 trade. Japanese stocks benefitted; the Nikkei 225 ended July as the best performing large cap index in sterling terms.
When including small caps, however, the UK’s FTSE 250 won out, jumping more than 6%. This is a vote of confidence in the domestic UK economy, after stronger growth, business confidence and a rate cut from the Bank of England. Markets also clearly approve of the new Labour government too, particularly its warmer relationship with the EU.
China was once again the weakest region, still suffering from its economic malaise. Weak Chinese demand was another reason commodity prices fell in July. Overall, the month was a shakeout for many investors, but we think the rotation away from dominant mega-caps is a good thing. Overall portfolio returns are still decent, and growth prospects are much broader based.
Cybersecurity securities less secure than you’d think
The global IT outage has put focus on the cybersecurity sector – not just because of CrowdStrike’s stock losses, but because it made clear how vulnerable our society could be to an intentional attack. Cybersecurity start-up Wiz rejected a $23bn buyout offer from Google last week – a show of confidence in a sector which is set to more than double by 2031. Much of the future demand will come from government contracts (protecting against state attacks) or legally-mandated private spending (to protect individuals’ information).
Increased cybersecurity spending could well be a drag on the rest of the economy – taking money from other areas without adding productivity. Moreover, cybersecurity becoming entwined with national security could lead to a regional fragmentation of global IT systems. This could prove a barrier for the international trade of services (though maybe not goods).
Many would assume that increased cybersecurity demand would at least be a benefit for firms that specialise in the area. But stock markets in recent years have not reflected this; cybersecurity stocks have largely stagnated since 2021, despite the AI boom and its boost to larger, general tech firms. Notably, the main cybersecurity stock to keep up with big tech has been CrowdStrike – which has lost nearly half its value since the global outage and faces an expensive lawsuit (led by Delta airlines).
As a general point, this shows that thematic investing, a popular strategy which focuses on societal trends, is never as simple as just predicting the broad strokes. The world needs cybersecurity now more than ever, but there is a massive gap between appreciating this point and making money out of it. To make the case for cybersecurity stocks, you need an understanding of sector-specific dynamics, not just an understanding of technology themes. Cybersecurity stocks might not be as secure as you would think.