Tuesday Digest
Posted 27 August 2024
Late summer heatwave
Global stocks have turned things around from the early August sell-off. Up until the end of last week, the gains of the recovery were strong and remarkably stable. Last week’s main capital markets event was Federal Reserve chair Jerome Powell’s speech at the annual Jackson Hole central bankers conference. He basically confirmed a steep path down in US interest rates to start in September, and markets approved. This is good news, but investor optimism is a little unnerving; markets seem to be running a little hot.
For the S&P 500, the two-week period following the sell-off was in the top percentile of any two-week periods of the last 50 years. Daily gains were remarkably smooth – to an extent you rarely see. But many of the previous concerns are still here (slower growth and stretched US valuations) so we shouldn’t be surprised if another bout of volatility comes soon.
The dollar has weakened, seemingly because of slower US growth and the Fed’s expected cuts. But the US economy is still expansionary, according to the most reliable business sentiment surveys. Company earnings forecasts are going up too. Investors bristled at Kamala Harris’ interventionist economic proposals last week, but the election is unlikely to hurt strong corporate earnings too much regardless of who wins.
Markets are currently under a spell of ‘goldilocks’ mentality: they are happy with slower growth if it means lower rates. But this could be self-defeating. If valuations and corporate credit are supported enough by the goldilocks narrative, growth will be stronger after all, meaning less of a need for rate cuts. That is exactly the debate we have seen in recent weeks. Powell’s messaging was dovish, but if he keeps talking down US economic strength it could unnerve markets for the opposite reason. We could see another bout of short-term volatility. This isn’t a big problem for long-term investors, but we shouldn’t be lulled into a false sense of security.
Who’s afraid of UK wage rises?
The Bank of England cut interest rates earlier this month, and bond markets expect them to continue cutting over the next couple of years. But the monetary policy committee’s (MPC) more hawkish members keep warning about wage inflation. Opposition politicians have suggested that the government’s recent public sector pay rises are an example of this.
Put simply, though, we don’t think these public sector pay deals will materially affect inflation. BoE governor Bailey suggested as much earlier this month, and bond markets wouldn’t bet on more rate cuts if inflation was about to spike. Services inflation, which is more sensitive to wages, keeps falling and was below economists’ expectations in July. The drop in headline inflation will feed through to wages too, since many pay packets are indexed to CPI.
Hawkish MPC members argue that the recent inflation spike has structurally increased workers’ pricing power – and hence inflation pressures are higher – but these claims are hard to evaluate when cyclical effects are still being felt. Survey data from service providers suggest wage pressures are close to the long-term average, and growth seems to be as much to do with productivity gains as price pressures. If we were about to see a wage-price spiral from higher pay demands, all these indicators would be showing the opposite.
The UK rate cut path is not as steep as elsewhere for both cyclical (growth is improving) and structural (the BoE has a more restrictive legal framework) reasons. But bond markets have a benign inflation outlook, predicting another rate cut in the Autumn. Current public sector pay deals are more about ‘catch up’ after years of real-terms cuts – and those agreements tend to be short-run. The MPC has its hawks, but the majority opinion will be driven by the data, which points to a steady fall in rates. Nothing in recent wage data suggests otherwise.
The monopolistic seven?
Google is an illegal monopoly, according to a US federal judge. The Justice Department is reportedly considering breaking up the tech giant in response. That would be a huge blow not just to parent company Alphabet, but the entire ‘Magnificent Seven’ big tech stocks. The Mag7 dominated for most of this year, but investors have become concerned about their high valuations, leading to recent underperformance. Antitrust cases against tech giants would certainly give investors more to worry about – a sign that US politicians are cracking down on their market power. What happens depends on the upcoming election, but neither major party seems fond of silicon valley.
This isn’t a problem for the entire Mag7. Nvidia and Tesla can’t really be described as predatory monopolies, for example. But internet companies like Alphabet, Amazon and Meta are in many ways prime targets of antitrust litigation: they dominate new tech spaces, and actively limit competition by buying up competitors or investing to “make the ecosystem exceptionally resistant to change” (in the words of a former Google executive). Newer entrants can’t realistically compete without policy intervention – which makes it more likely it will come.
For a long time, US politicians were reluctant to pursue big tech; cases against Google and its ilk were mostly in Europe. This is probably because the US benefits from its national champions acting like monopolies abroad: capital flows back to the US, bolstering stock markets and tax revenues. That has changed under President Biden, and Washington now sees fewer benefits in giving its tech giants free reign.
It isn’t clear that the global dominance of US tech has helped American companies or citizens more broadly, for example, and most voters prefer government intervention to level the playing field. Antitrust pressure will not go away anytime soon.