Monday Digest
Posted 7 October 2024
Why are markets so calm?
Middle Eastern tensions dominated the headlines, but markets were surprisingly muted. Oil prices and the dollar gained, but risk assets remained strong. Markets clearly think pro-growth signals, like US employment and Chinese consumer spending, are more important. We don’t think the Israel-Iran conflict will have lasting impacts on risk assets, notwithstanding the human suffering.
Since the 1973 oil shock, conflicts have only had short-term effects on oil. Of course, a full Israel-Iran war – and especially a Saudi-Iran conflict – would be a different story. But the wider context is a global oil oversupply: Libyan production has come back online and Saudi Arabia is pumping to regain market share. The conflict introduces uncertainties, but the fundamentals are still against a higher oil price.
Markets are more preoccupied with central banks. The signs last week were that the Bank of England, European Central Bank and the Bank of Japan will be looser than previously expected. This is good news for liquidity, but a note of caution: the current easing cycle is ‘old school’ liquidity creation (banks creating money) rather than ‘new school’ quantitative easing (inject money directly), so it relies on banks transmitting liquidity. The banking system is not what it was, so this transmission might not be as strong. It’s positive for risk assets nonetheless.
The US non-farm payroll surprised by adding 254,000 jobs (versus 150,000 expected) in September, while unemployment fell and corporate earnings growth rose. This seemingly confirms that the US soft patch bottomed in the summer, and the economy should strengthen from here. Even before that, the US Federal Reserve said that rate cuts would be moderate (as we predicted, contrary to market pricing). Bond yields moved up and rate cut expectations came in – though they are still on the table. Commentators talk about the ‘soft landing’ – lower rates without recession – but the US landing seemed to be so soft we didn’t feel it. If energy doesn’t shock, today’s market strength is justified.
September asset returns review
Sterling-based global stocks grew 0.3% in September – surprisingly flat considering the positive global growth signals. We had a larger-than-usual interest rate cut from the US Federal Reserve and a double boost of Chinese stimulus at the end of the month. This is partly down to sterling’s strength; returns were more positive in dollar terms.
Markets started September with a sell-off, but spent the rest of the month recovering – just like in August. Early nerves were relieved by the Fed’s 50 basis point rate cut, which was called a ‘surprise’ but was actually quite predictable after chairman Powell’s comments. Markets are pricing in several cuts from here, but we think this is a little optimistic, given US economic resilience. China’s stimulus packages were a genuine surprise – since all the signs before were that Beijing would keep things tight. That’s why Chinese stocks surged 21.5%, but this just shows how unpredictable and risky its market can be.
There was negativity around the UK Labour government’s expected tax raising, but this is probably unrelated to the FTSE 100’s 1.5% fall. UK stocks were in line with Europe and better than Japan, for example, while sterling strengthened. The move was more about the fact that UK rates are not expected to fall as steeply as elsewhere, as well as falling commodity prices. UK large-cap features many commodities companies, who did less well globally.
Falling crude oil prices were particularly stark – down 8.7%. Production is back on in Libya and Saudi Arabia will likely increase output to regain market share, meaning oil is in oversupply. Dramatic escalation in the Middle East obviously complicates this story, but at the moment the supply outlook still looks strong. That is all pretty decent for global growth going forward – particularly if the US and China start expanding in tandem.
Where do cars go next?
The automotive industry has disappointed in 2024 – highlighted by recent profit warnings from European carmakers. The biggest problem is China’s weak demand and overproduction, which resulted in an inventory overhang for electric vehicles (EVs). Tellingly, China’s recent stimulus announcements have boosted carmaker stocks.
But there are structural problems too: the EV transition has upended what was for decades a remarkably stable market. Current stock prices show big changes are expected. Tesla is worth 15 times Volkswagen’s market cap, despite currently earning a third of its revenue. Trade wars also weigh on the sector, with no one quite sure what tariffs will come next or how badly they might impact trade in cars.
Autos account for 3-5% of global GDP, employing millions across the world. The revenues of Germany’s top carmakers are worth 14% of its GDP, and that figure is 12% in Japan. The US autos sector accounts for less of its GDP and total jobs, but it is still culturally and politically important. Its workers are an influential constituency, one that Donald Trump had success in appealing to with his promises of rebuilding American industry. That’s partly why tariffs are Washington’s new orthodoxy, though ironically these tariffs have hurt carmakers globally.
There’s a solid case for a rebound in autos: central banks are cutting interest rates, China is enacting stimulus, and there is a global oil oversupply which should encourage driving through lower fuel prices. But you can challenge each point in that case. The US Federal Reserve is cutting rates because it is nervous about unemployment, Chinese policy is notoriously erratic, and middle eastern conflict could raise oil prices.
The deeper structural problems are even harder to untangle. Will governments continue pushing for EVs? Or will rivalry with China dictate industrial policy? We will know more after the US election.