Monday Digest
Posted 28 October 2024
Markets in brace position
Markets are bracing for some big upcoming events: the UK autumn budget, and a knife-edge US presidential election. Trading volumes could fall as a result, causing volatility, but that shouldn’t detract from the positive long-term outlook.
The Chancellor, Rachel Reeves, confirmed a change to how UK debt is counted, allowing the government £50bn in extra borrowing. Some derided this as a ‘moving of the goal post’ tactic, but public debt definitions are always a bit arbitrary and change often. Bond markets didn’t seem to mind – perhaps because the US government has a similar rule. The good news is that this should mean fewer tax rises and more money for long-term investment. This budget is starting to look like the opposite of Liz Truss’s “mini” budget: anxiety in the build-up, but very little market impact in the event.
Meanwhile, European growth is struggling. Thankfully, the ECB has taken note, and last week moved into outright supportive mode – after previously promising to keep interest rates “neutral”. That will help risk assets and, hopefully, the economy. European exporters will be hoping for a rebound in Chinese demand too, following Beijing’s stimulus announcements. We still don’t know what shape the stimulus will take, but China’s stock market was one of the best performers last week.
The US corporate earnings season is going about as expected. There were some positive earnings ‘surprises’ from big tech companies, but these are always a bit artificial (companies guide down expectations to beat them). Bond yields rose, however, making stocks look slightly more expensive in valuation terms. It seems like bond traders are taking note of the threat that Trump’s proposed tax cuts pose to US fiscal sustainability. They aren’t panicking, but just covering their positions to brace for some potential risks.
Market liquidity dried up a little as a result. That will likely make small moves feel bigger, potentially causing volatility. If so, long-term investors should remain focussed on a broadly positive economic outlook.
Can the goldrush continue?
Gold prices keep breaking to new highs. Since gold is the classic ‘safe haven’ asset, some think this portends global risks – but that’s at odds with the benign economic outlook. Strangely, gold is surging while inflation is falling, when you would expect it to be the other way around. Investor risk appetite is generally strong, so there doesn’t seem to be a ‘fear factor’ in gold’s rally.
We often compare gold prices to real (inflation-adjusted) US bond yields, because they represent the available risk-free economic return, and gold is considered a stable store of value. People buy gold when the economy struggles, and risk assets when growth is strong. That’s why gold and real yields are historically correlated – but that relationship has completely broken down of late.
One reason is that emerging market central banks have bought considerable amounts of gold in recent years. Russia being frozen out of the dollar-denominated financial system prompted other developing nations to diversify their dollar holdings, out of fear it could happen to them. Chinese buyers are another key source of gold demand. Through China’s economic malaise, citizens have been buying gold as a means to keep money wealth away from a government they are wary of.
The final factor is simple upward price momentum – which has become prominent in the age of trend investing, but can swing down as quickly as it does up. The Chinese government is now stimulating its economy, so Chinese buyers could well drop off, and central bank purchases will inevitably wane too.
Gold often gets headlines, but investors should be wary of it as a long-term investment. It is far from a ‘safe haven’ in terms of returns, which is why we prefer to invest clients’ money in more predictable assets like stocks and bonds.
Argentina on the narrow path to progress
Argentine president Javier Milei is a self-described “anarcho-capitalist” who promised a radical economic experiment when coming into office 11 months ago. His first task was quelling a hyperinflation spike that peaked at 25.5% month on month in December, and he has since dropped that to 3.5%, the lowest monthly gain since 2021. His main method has been to “take a chainsaw to the state”, slashing public spending (including, incredibly, closing down and reforming the tax collection agency). But, the chainsaw has cut economic growth too: the IMF forecasts Argentina’s economy to shrink 3.5% this year. Remarkably, confidence in Milei’s administration is faring no worse than previous presidents at this stage.
That might be because Milei has been more pragmatic than his campaign rhetoric suggested. He planned to remove the Argentine peso and get the whole economy using US dollars, but the central bank seems to have accepted a dual currency system. That is wise: Argentines use US dollars in everyday life, but full dollarisation would be impossible without a hard-fought funding agreement with Washington. The central bank has instead soothed inflation by projecting monetary discipline and regaining control of the money supply. The gap between Argentina’s official dollar exchange rate and the black market rate has come down to 20%, from 60% in January.
The light at the end of the tunnel is that the government is expected to run a primary budget surplus this year. Spending cuts have been sharp, with the aim of building domestic savings and balancing capital flows – which seems about to pay off. From that point, the government can stop compressing fiscal policy and unlock Argentina’s undeniable growth potential. We shouldn’t overstate the progress; Milei’s policies are still unproven, but the government is on a narrow path to success. That in itself is a surprise.