What a difference a weekend can make. Last week reminded us that shares really do fall as well as rise. This week, an apparent truce in a long-running US government funding stand-off means the glass once again looks half full.
Tech wobble
The latter stages of a bull market are often characterised by heightened volatility. So last week’s 3% fall in the US’s tech-heavy Nasdaq, after six months of strong gains, was not a huge surprise. But, after a buoyant past few months, it came as an unpleasant reminder that bull markets are never a straight line.
The fall in the US market was driven by its biggest, most artificial intelligence (AI)-focused stocks, including Nvidia, Meta, Palantir and Oracle. The top eight lost US$800bn in value as investors fretted about high valuations, heavy expenditure that may or may not earn a decent return in due course, and the growth of debt-funding with echoes of both the dot.com bubble and financial crisis.
Worries about tech valuations have been heightened by early signs of deteriorating consumer sentiment. The University of Michigan index fell to a three-year low in November, adding weight to concerns that the US economy is splitting along wealth lines. The richest are benefiting from a buoyant stock market while the poorest are suffering from a persistent cost-of-living crisis.
Uncle Sam re-opens for business
The tech wobble was unrelated to a month-long government shut down in Washington. But it was accentuated by an unclear economic backdrop as limited data has made investors nervous that the labour market may be weakening more than expected.
Over the weekend, however, eight Democrats crossed party lines to endorse a compromise plan that keeps the government funded until the end of January. It’s no way to run the world’s biggest economy, but resolution of the stand-off means investors can stop guessing what’s happening on the ground.
Monday saw an immediate relief rally around the world. Korea’s Kospi, hit hard by last week’s retreat, bounced back by 3%. Shares in Hong Kong and Japan also rose. And that fed through into a bounce back in Europe and expectations for a stabilisation on Wall Street.
Earnings continue to deliver
With more clarity on the economic data front, investors can also take at face value the stronger than expected profits growth that the July to September quarter has so far delivered. Having started results season with a 7% growth forecast, it now looks likely that the third quarter will actually deliver around twice as much.
Earnings usually do better than initial expectations but the scale of outperformance this time is unusual. It suggests that companies are coping much better than feared with the post-tariff trading environment.
Full year forecasts now stand at about 11.5% growth. And the good news is not restricted to the US. Earnings in the rest of the world are improving too. And that has helped fuel outperformance by non-US stock markets. The gap is wider than at any time since 2017.
Priced for perfection?
Knowing what the right valuation for markets should be is an inexact science. And the mixed messages in markets today make it harder than ever. Clearly a lot is riding on hopes for AI. But if the new technology is a game-changer, it arguably needs to be, with valuations higher than at any time since the late-1990s internet boom.
The good news is that talk of a bubble still looks premature. The gap between the valuation of the top 50 S&P 500 companies and the other 450 remains narrow. Between 1998 and 2000 the valuation of the top 50 doubled while the rest stood still. Sentiment also looks less stretched this time around.
Where next for the Bank of England?
The focus on the economic front this week is the UK: labour stats on Tuesday and GDP data later in the week. Both will give the UK a useful guide to where the Bank of England (BoE) might go next.
Last week, it left interest rates unchanged at 4% but Governor Andrew Bailey hinted that further disinflationary signs might persuade the monetary policy committee to resume the year-long easing cycle.
With unemployment expected to edge higher to 4.9% and wage growth modestly in retreat to 4.6%, GDP growth expected to fall from 0.3% to 0.2% and a possible income tax hike in a couple of weeks at the Budget, the BoE may soon have the ammunition it needs to pull the trigger on a December rate cut.
