Last week saw UK equities rise 2.2%, UK gilts return 0.9% and the pound strengthen 1.3% against the dollar – altogether seemingly representing a resoundingly positive endorsement of the Chancellor’s Budget by the markets. The truth as ever is a bit more complicated. While investor reaction was mildly positive, the more important factor behind these gains were developments abroad.
Global equities were up a strong 3.3% last week in local currency terms and 2.3% in sterling terms. The US actually fared better than the UK with a gain of 2.6% in sterling terms, while Europe gained 2.2% and emerging markets 1.2%. US Treasuries also saw a positive return, albeit smaller than that of UK gilts, and the dollar weakened generally – rather than just against the pound.
These gains take global equities back up to within 0.5% or so of their late October high. So why the rally in markets after the jitters of late? A firming of hopes that the Federal Reserve will reduce rates by a further 0.25% on 10 December certainly helped after another key Fed official chirped up with comments supporting a cut.
So too did a renewed burst of enthusiasm for the Magnificent Seven and tech stocks more widely, following their wobble in recent weeks. An enthusiastic reaction to the release of Alphabet(Google)’s latest AI model and semiconductor chips was a factor with its shares up 7% over the week.
While Alphabet’s latest successes are good news for itself and the world at large, they are a mixed blessing for other members of the Magnificent Seven and indeed OpenAI given they are all competing in the same arena. This latest development only highlights how difficult it is to predict just who will be the ultimate AI winners. Even Nvidia’s dominant position in AI chips is now not looking quite as secure as it was. Whereas Alphabet’s share price is up 20% over the last month, Nvidia’s shares are down 12%.
The macro data rather took a back foot last week, not least because up-to-date data releases on the US economy remain few and far between. The numbers also presented a mixed picture. Jobless claims were lower than expected in mid-November, suggesting the labour market is still holding up reasonably well. However, consumer confidence has deteriorated further as affordability concerns take their toll, at least on the least well-off. It remains to be seen whether the sour mood affected Thanksgiving sales over the weekend.
Back to the UK Budget and Rachel Reeves’ never ending woes. Enough has already been said about the lead-up to the Budget and whether or not the Chancellor intentionally led us all up the garden path and straight back down again. Instead we’ll just focus on the end-result which is what matters to the markets …assuming the pre-Budget shenanigans don’t lead to the Chancellor’s premature departure.
Taxes were raised by £26bn, broadly in line with expectations, but were even more backloaded than expected. While the extension of the income tax allowance freeze beyond 2028 was no surprise, many of the other smaller new tax hikes also don’t kick in until later in the Parliament.
The result is that there should be no additional drag on the economy over the coming year from the latest tax hikes. Growth has slowed in recent months – just as it did last year – in response to the incessant drip feed of negativity running up to the Budget. But now the uncertainty is behind us, the hope is that growth will pick up again just like last year, helped by a further reduction in interest rates.
The good news here is that the OBR’s estimate of the fiscal hole – as we are now all too aware – ended up being smaller than feared. This meant the Chancellor was able to increase her headroom in meeting the fiscal rules to £22bn from £10bn, making it less likely that she will be back once again in a year’s time needing to raise taxes even further.
The less encouraging news is that the Budget did nothing to reform/cut back welfare spending – even though this in theory remains a key priority for Labour – and contained little in the way of new supply side reforms to boost the long-term growth potential of the economy. Still, the market reaction was broadly positive.
UK equities overall may have risen last week no more than other markets but small and mid-cap stocks – which are rather more sensitive to budget developments than large cap due to their greater exposure to the UK economy – were up a strong 4.3% and 3.4% respectively. If growth continues to trend around 1-1.5% as we expect, this should allow UK equities to see further gains across the board, benefiting from relatively attractive valuations across all market cap sizes.
10-year gilt yields are currently 4.5%, down 0.1% over the week and 0.3% from their highs earlier in the year. We believe yields should remain around this level, with fiscal worries now reduced and interest rates declining, and look quite attractive. As for the pound, which is currently at $1.32, we expect it to strengthen a bit more but largely due to further weakness in the dollar.
This coming week is quite light on data, and the focus is likely to be on US business confidence numbers for November.
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