More and more loose ends

Posted 22 November 2024

We are getting to that time of year when investment houses like us write their annual market outlooks. That is easier to do if the loose threads wrap themselves up before Christmas, but right now the opposite is happening. Uncertainty is growing, and it is creating a wide range of plausible medium-term scenarios. Some of them are very bullish for markets and the world economy, while others are more worrying.

Analysts and commentators seem genuinely divided on how the biggest current themes – Trump, Chinese stimulus and geopolitical risk – will play out. That uncertainty is now impacting asset prices, which bounced around without clear direction this week. The best thing long-term investors can do in this environment is humbly stick to the plan. We should not underestimate the risks – but neither should we underestimate the potential rewards.

Cracks appearing in the Trump trade?
US stocks have outperformed the rest of the world since Donald Trump’s election win. The rationale is that Trump helps American companies with his tax cuts, and hurts non-US companies with his tariffs. But that outperformance was not as pronounced this week – even after business sentiment surveys showed a weaker-than-expected outlook in the UK, Europe and Japan. The Trump trade has lost some momentum, probably in part due to the president-elect’s radical and therefore somewhat inexperienced cabinet hires.

Investors hoped that Trump II would choose cabinet members able to consistently execute a broadly business-friendly agenda. Instead, some might say that the administration is shaping up like a medieval court – the various powers vying for influence and policies changing on a whim. That was investors’ main frustration with Trump’s first term and it makes future policy inherently unpredictable.

Incoming “government efficiency” executors Elon Musk and Vivek Ramaswamy laid out some of their thoughts regarding spending cut plans in a Wall Street Journal opinion this week. We have noted in previous columns that slashing government expenditures before pro-growth policies take effect would almost certainly hurt near-term US growth. Even if markets like the long-term supply-side implications, lower short-term growth would mean lower short-term earnings – and hence more stretched valuations. Only time will tell if Trump II is prepared to risk this sequencing.

Investors were even tepid towards microchip behemoth Nvidia, whose third quarter revenues were ‘just’ 94% higher than a year before. The leading AI chipmaker beat lofty expectations once more, but revenue growth has slowed in each of the last four quarters (from an eye-watering 265% in Q4 2023). Nvidia’s performance is still remarkable, but its reputation as a perpetual growth machine is starting to wane. That is significant, because markets usually see the tech company as a safe haven stock – the vanguard of a supposedly recession-proof AI boom.

UK inflation surprises but still heading down.
UK inflation increased sharply last month. Both headline and core inflation (removing volatile food and energy) were above expectations, which increased inflation concerns and initially pushed up bond yields.

Still, yields came back down after encouraging words from Bank of England deputy Dave Ramsden, who said UK inflation was “bumpy” but indisputably heading down. He even warned that sharper rate cuts might be needed if wages cool too quickly. Markets took this as a dovish signal (preferring lower interest rates) from the BoE.

We suspect the government’s autumn budget played a role in the BoE’s dovish turn. The post-budget noise was about debt changes and fiscal deterioration, but now the complaints are about national insurance increases and how they might hurt businesses and jobs. Ironically, job suppression could be a blessing for the BoE, who have been concerned about a tight employment market since the pandemic. Weaker wage prospects will allow the BoE to cut rates more aggressively than the US, and that growing expectation is now pulling down UK yields.

Yields fell even further on Friday after October retail sales and the UK’s purchasing managers’ indices (PMIs) both came in significantly weaker than expected. That suggests a tough road ahead for businesses, causing yields and the value of sterling to fall. But the yield and currency effects actually pushed up UK stocks in sterling terms – as they make Britain cheaper for overseas investors.

Diversification protects against the unknown.
The currency effect was also felt for European stocks, which gained on Friday after PMIs pointed to severe contraction. Markets were already dour about Trump’s tariff effect on European businesses, and now businesses themselves seem to agree.

On balance, US purchasing managers are quite happy, at least in the service sectors. The US services PMI unexpectedly moved higher to 57 although the manufacturing PMI rose only slightly to 48.8 and remained below the 50 neutral level.

What Trump’s victory gives to the US, it takes from elsewhere. It is possible, however, that European and UK company purchasing managers are overly pessimistic, and that the medium-term outlook will not be as bad as it currently looks. Everyone felt a sense of dread this week that Russia might broaden its war on Ukraine, but another way of interpreting these events is that both sides are preparing for the end – showing strength or gaining territory ahead of negotiations. That would help ease burdensome energy prices in Europe. Similarly, markets fear the impact of Trump tariffs on Europe – but his proposed 10-20% blanket levies might just be a negotiating tactic.

If the Chinese government succeeds in stimulating its consumer demand, that would help European businesses immensely too. Thankfully, the latest growth data are already improving. Western investors often worry that Chinese assets are “un-investable” because of government hostility and erraticism towards business, but Beijing has recently made overtures to foreign capital. The key question now seems not to be about China’s openness, but about whether the US will shut them out of the global financial and economic systems.

That brings us back to the biggest unknown – what Trump will do and what effect that will have. Are tax cuts pro-growth or will they force bond yields painfully higher? Will tariffs reinforce US exceptionalism or hurt global growth and spur other nations to work together? Your market outlook varies drastically depending on how you answer these questions, but unfortunately no one can confidently answer them.

Does this uncertainty mean we should “get out of risk assets and wait for more information”?

That too could be risky. In our view, the wide range of outcomes includes some really positive ones. Not being invested for those could mean missing out on significant returns – and rallies often happen when you least expect them.

In this particularly uncertain environment, diversification – the spreading of risks and rewards – is essential. We should take the noises right now seriously, but stay level headed and not jump to conclusions. That is what we try to do at Tatton in our investment management, and it is more important now than ever.