Global equities last week rose 1.4% in local currency terms and are now slightly above the top of the trading range seen since last summer. In sterling terms, the move up has been a little less marked due to the recovery in the pound but equities are also towards the top end of their range.
The latest push higher has been down to a couple of factors. First, the US finally reached an agreement to extend the federal debt ceiling, removing the tail-risk that the game of chicken between Republicans and Democrats might end in a US default.
Second, US employment posted an unexpectedly firm gain in May, suggesting the economy continues to hold up reasonably well. Meanwhile, wages rose slightly less than anticipated.
The report was basically strong enough to reassure investors that there is still no sign of an imminent recession without fuelling worries that extra Fed tightening will be required. Even so, the market is now pricing in a 50% chance that the Fed will raise rates a further 0.25% to 5.25-5.5% in July, while leaving rates unchanged this month.
The question of whether a recession in the US, and the West more generally, is looming remains far from answered. Leading indicators all continue to flash red even if lagging indicators such as employment are not sounding the alarm bells.
Inflation remains key as it will ultimately determine how much further tightening there will need to be. Recent data has been mixed. In the US, the April numbers contained no big surprises with the Fed’s favoured measure of core inflation edging up to 4.7% but remaining below last year’s high of 5.4%.
The latest Eurozone numbers, by contrast, provided a pleasant surprise with inflation declining more than expected in May. The headline rate dropped to 6.1% and the core rate to 5.3%. Even so, inflation remains way too high for the ECB which still looks all but certain to increase rates by a further 0.25% in both June and July.
The nasty surprise came in the UK. While headline inflation fell back in April to 8.7% from 10.1%, the core rate unexpectedly rose from 6.2% to a new high of 6.8%. This in turn triggered a racheting up of forecasts for further monetary tightening and a sell-off in gilts, with yields re-testing the highs seen in the aftermath of last October’s mini-budget. Markets have calmed down a bit subsequently, but they still see rates peaking 0.5% or so higher than before at 5.25-5.5%, up from 4.5% now.
The good news though was that the IMF was forced to admit it has been too pessimistic on the UK economy. Like the Bank of England, it is now forecasting a modest 0.4% gain in GDP this year, rather than a decline. Still, the UK is not out of the woods yet, particularly with rates now expected to peak rather higher.
OPEC did its bit to boost inflation over the weekend. It extended the 3.7mbd of production cuts already in place to end-2024 and in addition Saudi Arabia agreed to cut its output by 1mbd. Oil prices duly have rallied but not by a lot and the Brent oil price is still only $77/bbl. This remains close to the bottom of its recent range and way below the high of $125 touched last summer.
Essentially, many of the key questions markets have been wrestling with for months remain unresolved. Equities, helped in good part by the AI-related surge in US mega cap tech stocks (AI is good at generating plausible but sometimes erroneous stories), are currently looking on the bright side.
The reality is that the outlook remains quite uncertain. Even with AI, its impact may not be quite as clear cut and positive as the market believes. While there seem to be a few obvious beneficiaries such as Nvidia (the semiconductor chipmaker), Microsoft, Alphabet, Meta and Apple, the experience of the Dotcom bubble is that the ultimate winners are hard to predict.
The bottom line is that now does not seem a time for taking big positions one way or the other and a well-diversified portfolio looks more necessary than ever.
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