Market optimism abounds
Some days one can, if watching markets, only stand back and marvel. Yesterday, Tuesday, was just such a day at the close of which the Dow Jones had risen by 742.78 pts or 1.85%. That’s a big move in anybody’s book although compared to the move higher in the Russell 2000, the index tracking US small caps, that was nothing as it put on 3.50% in a single day.
For once, it was the Nasdaq, the home of Big Tech that looked feeble, rising by only 0.2% and the S&P500, which is where most equity investors look to gauge the real temperature of the market, “only” gained 0.64%. The casual observer might be confused by the way in which the indices tracking the biggest and the smallest stocks seemed to be on fire while the rest did nowhere near as well. But the professionals find this easy to explain. It’s called rotation.
For too long now, the debate has been focussed on whether too much money has been blindly pouring into Big Tech, and especially into the Magnificent Seven, while paying only scant heed to the rest of the market. Sooner or later, that was going to have to change and yesterday seems to have been the day when capital flows pivoted away from momentum and towards value. Firstly, there were Fed Chairman Jay Powell’s comments – as good as unequivocal as far as risk asset markets were concerned – that conditions to cut rates from the cyclical high of 5.25 have been met. Additionally, the surge in support for Donald Trump, after surviving an assassination attempt pretty much unscathed, also supported the view that, within six months, the business environment will once again become paramount in White House thinking.
In that vein, it might be noted that Elon Musk has confirmed that he will take the head offices of X and of SpaceX out of California and move them to Texas. He had long threatened to do that if Governor Gavin Newsom insisted on pushing through a law banning schools from notifying parents of their children’s gender transition choices. Musk, a social as well as a political conservative, called that the last straw in the dismantlement of the family and will now make good on his word. Musk has already moved Tesla from California to Texas as he perceives the business environment in the Golden State to be anything other than golden and to have been ruthlessly sacrificed to social experimentation. Politicians the world over – with a spotlight on the UK and France – should take note. This is no longer the 20th century but the 21st and packing up and moving is relatively easy if entrepreneurs and major taxpayers begin to feel that they are being targeted by governments sporting big holes in their budgets to fill as easy meat.
No more than a decade ago, all the rhetoric was about the international community coming together to suppress tax havens, especially ones created in island nations the world over. The Republic of Ireland, although not occupying an entire island, was one of them where notional per capita GDP stands in no proportion to the actual economic output. If governments, however, tighten the screw too far, businesses and people will move to more benign environments which need not as such be classed as tax havens. I digress.
The long rally in tech stocks in general, and in AI-related ones in particular, has been driven by focus on rising revenues and earnings growth. The prospect of an imminent easing in US monetary policy will, however, benefit the expense side of the P&L as older and more traditional businesses as well as the smaller companies tend to have more highly leveraged balance sheets. Earnings will grow not necessarily by higher revenues but by lower interest expense. It’s not a quiz and, by inference, yesterday was a day on which an unusually large number of investors chose to act in the same way and at the same time. The rotation is away from momentum and into value. That’s how it works. Many algorithmic models are driven by the observation that certain stocks or certain sectors are moving beyond their statistically normal range which in turn triggers trading instructions. Yesterday was such a day and, once the market has moved outside of its normal band of option-implied volatility, the computers go nuts.
Optimism abounds. And then gold goes and makes anew all-time high, now trading in the US$ 2,470s, and within spitting distance of US$ 2,500.00. That makes sense if one buys into the theory that the level of indebtedness and the inexorable rise of government debt, not only in the United States, will ultimately oblige the monetary authorities to place the fight against inflation in priority behind their respective governments’ ability to pay the interest on their debt piles. The logical result would be levels of inflation that consistently and at some point irreversibly outstrip interest rates which in turn debases the value of the currency. This form of a rising negative real return scenario is gnawing at the Japanese yen. The Bank of Japan is facing a government debt pile of 263%. If it begins to raise interest rates to a level at which they might be deemed to be appropriate to the prevailing levels of inflation, it risks bankrupting the country.
The US is still a long way from that point and the IMF yesterday confirmed that Washington’s level of indebtedness – even at 123% – is not yet systemically dangerous. Debt servicing charges do, nevertheless, chew up an increasing proportion of the Federal tax take and the sooner the cost of borrowing can be brought down the better, not least of all because the accelerating rate of borrowing does not look as though it will slow or decline, irrespective of who wins in November.
Although the headlines are all about the Biden-Trump head-to-head, the former’s pig-headedness with respect to the calls for him to step back risk costing the Democrats not only the White House but also both the House and the Senate. When Donald Trump won the Presidency in 2016, he also carried both houses but then the GOP lost control of the House in the 2018 midterms. Prior to that, one has to go back to 2008 to Barack Obama’s first term to find the White House, the House of Representatives and the Senate of the same colour and that also only lasted until the first midterm elections in 2010. Joe Biden has never had that luxury and fiscal conservatives will have been heaving a sigh of relief that he never did.
So, risk asset markets are bullish about the prospect of rates imminently heading south. As are bonds, where the yield on the US 2 year note has, since early June, fallen from close to 5% to below 4.5 %. Gold is telling us that the value of the dollar as a fiat currency is about to be sacrificed as the Federal Reserve steps back and lets Mr Inflation begin to repay some of the nation’s debt. Meanwhile, bitcoin, having rallied by nearly 14% in just a week, looks to be buying into the same narrative. One big move on a day is fine and dandy but it is not until one sees whether there is follow-through that directional leaps are proven. Also the calendar today reads 17 July so, strictly speaking, we are already in the dog days of summer and anything that happens now will not be properly verified until tested in the weeks after Labor Day when markets are back up and running on all cylinders. The FOMC meets on 19/20 September and unless Powell and his merry band of FOMC members decide to jump the gun and cut at the July meeting next week – not expected – that is when the rubber will properly hit the road.
On the subject of the IMF, it yesterday released its revised growth forecasts in which, for 2024, it has lowered the US from 2.7% to 2.6% while upgrading China from 4.6% to 5.0% and maintaining its outlook for the global economy as a whole to grow at 3.2%. No signs here of some of the apocalyptic forecasts currently doing the rounds, which are predicting both the Chinese and the American economies to be ready to fall off a cliff.
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