In the previous edition of this newsletter, we explored how markets had been through a rollercoaster few days in early August. Large losses in equities were triggered by a combination of concerns over the stretched valuations in the US tech sector, a slowing US economy and the differing interest rate policies of Japan and the US.
Markets did recover, however, through the remainder of August, while September so far has seen changeable conditions. Volatility levels have returned to more normal levels, with the end of the summer holiday season bringing improved liquidity and therefore less eye-catching market movements.
Of the three issues which drove such uncertainty, the future path of Japan has been relegated from the financial headlines, yet the prospects for Artificial Intelligence stocks and the pace of US inflation, employment and therefore interest rates, remain front and centre in investors’ considerations.
The Path of AI
Nvidia, the posterchild of the current AI investment trend, reported its quarterly earnings results in late August. Their profits beat analysts’ expectations, but they didn’t beat them by as much as had occurred in previous quarters, leading to its shares being punished, falling by approximately 20% over the following six days. The stock has recovered slightly since then, but such volatility despite what was still a large growth in profits suggests investors are nervous over the sustainability of its lofty share price. We believe a similar situation can be found in many areas of the US technology space currently, and because of this, we maintain below benchmark allocations to tech in the portfolios we manage at Future Money.
While the prospects for Nvidia and other leading tech names are important in deciding which stocks deliver the best performance within markets, what is likely to have a more meaningful impact on the direction of markets overall is the state of the US economy.
US Federal Reserve
In early August, it was the release of weak data on the number of jobs created, the non-farm payrolls measure, which contributed to the volatile conditions of those few days. In the September version of this statistic, the number of jobs created had increased from the previous month, but was still below the predicted level. With these figures coming in at lower than expected rates, it would seem that the US economy is doing worse than many have assumed.
Yet, this is just one of many data points the Federal Reserve assesses when deciding on its interest rate decisions. Inflation is another key factor, and last week’s data showed headline inflation falling by more than expected (providing evidence that rates should be cut), but that core inflation was unchanged and therefore higher than expected (reducing concerns that the US economy is slowing too quickly).
The Fed will announce its latest interest rate decision this Wednesday, and taking all the above in the round, markets believe that a 0.25% cut is the most likely outcome, but that a 0.5% reduction would not be a big surprise.
Bank of England
The path of interest rates for the UK will also be decided this week, with the Bank of England set to publish its latest decision on Thursday. There are broad expectations that the Bank will keep interest rates steady at the current 5% level, but that likely one and potentially two cuts will come by the end of the year.
The Bank’s Monetary Policy Committee is expected to favour maintaining rates, rather than cutting them, this month given that inflation within the services sector remains high, a large part of which is continued growth in wages. Yet, a factor calling for lower rates is the UK’s GDP performance, which, although it performed well in the first half of the year, has unexpectedly shown no growth over the past two months.
The Right Level of Stimulus
Markets are focusing on the decisions of monetary policymakers currently, they want moderate interest rate cuts as these would stimulate the economy, but may well prove fearful should rates be cut by a large amount. This could raise the question amongst investors of ‘What bad data does the central bank have that we don’t know about?’ The interest rate decisions and accompanying statements this week will therefore be closely watched by investors.