deVere Group: Investment Outlook Sept '24
Andrew.J. Barros ACSI
Area Manager at deVere Spain SL | Wealth Management Consultant for the Expats and International Investors
Investment Outlook
Tom Elliott
A fortnightly look at global financial markets
16th September 2024
Market sentiment: Cautious. Three major central banks meet this week. Their ability to surprise financial markets, often unintentionally, should not be underestimated. Remember the impact of the Bank of Japan’s surprise rate hike at the end of July on global stock markets? Investors are betting on a 25bp cut from the Fed, as it starts its rate cutting cycle, with no change from the Bank of England or from the Bank of Japan.
Investors are also wary of politics. As we get closer to the November U.S elections, there is growing speculation, and some unease, as to what either a Trump or Harris White House win might look like for the U.S economy and financial markets. In the U.K, the October budget is likely to shed light on the economic direction of the new Labour government for the next five years– is it really pro-growth, which means prioritising investment spending, or will it be a throwback to the 1970s Labour governments, raising taxes to spend on public sector wages. Meanwhile, geo-politics continues to cast a shadow; whether it’s the fear of a broader conflict in the Middle East, the Ukraine war or conflict over Taiwan.
Gold, a classic defensive asset during times of political uncertainty, closed on Friday at a new high of $2,580 an ounce.
Investors should remain diversified by region and asset class. Financial history shows that diversification is the key to maximising long-term risk-adjusted returns.
Interest rates. Following the ECB’s 25bp interest rate cut last Thursday, investors are optimistic that the U.S Fed will start its own rate cutting cycle on Wednesday. Financial markets are certain of a 25bp interest rate cut, and are giving a 47% chance of a larger 50bp rate cut.
U.S inflation is down to levels that the Fed can probably live with, as last week’s CPI data demonstrated. Headline CPI came in below expectations, at +2.5% year-on-year. But the Fed -and therefore financial markets- remains sensitive to the risk of an uptick, given that wage growth continues to outstrip prices, and so fuel demand. Reassuringly, Friday saw the University of Michigan year-ahead inflation expectation survey fall to 2.7%, the lowest level since December 2020.
If the Fed surprises, and does not cut rates, we can expect a negative reaction on global bond and stock markets, and a bit of dollar strength. If the Fed cuts more than the expected 25bp, stocks will rally, as will the short end of the Treasury yield curve. However longer durations may be afflicted by worries that the Fed has forgotten inflation altogether.
Big Tech share prices. Big Tech stocks are no longer recording all-time highs, even as the S&P500 index comes close to its July all-time high of 5,667. The Bloomberg Magnificent Seven index is down 9% from its 10th July peak. With U.S interest rate cuts around the corner, investors appear to have shifted their attention to dividend-paying value stocks, cold shouldering growth stocks. Indeed, the 8.5% fall in Nivida’s stock price, since a recent $130 peak on 19th August, is despite releasing stronger than expected second quarter results on the 28th August.
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In recent years we have seen many instances of this type of sector rotation, from growth to value stocks. It has then reversed. Driving the reversal have been two themes; first the combination of falling share prices, and rising corporate earnings, quickly brings down forward price/earnings ratios and other share price metrics. Second, global economic growth has been slowing over the last year, leading to only modest earnings growth for value cyclicals. These two same themes are likely to provide a floor to Big Tech share prices, if it hasn’t already been found.
Trump, tariffs and the Fed’s response. Barclays released a global outlook last week, that included comment on the implications for the dollar, U.S interest rates, and financial markets, should Trump win the presidency in November and put in place the import tariffs that he has promised.
The bank calculates that, whereas the 2018 increase in tariffs added 2% to the overall surcharge on imports into the U.S, Trump’s current proposals would add 17%. This is because Trump is proposing a 10% on all imports, in addition to a 60% tariff on imports from China. It would be one of the single largest tax increases in U.S history.
What would the Fed do, when import prices rise by an average of 17%, pushing up goods prices across the economy? It may well choose to pause the interest rate cuts that we expect to see start this week, knowing that the increase in prices is a one-off shock, but nervous of this leading to higher wage claims. If pay growth accelerates in response (from the current approx. 4% year-on-year level), it will have to then tighten monetary policy. But if pay does not increase, and real household income falls as a result of higher prices on imported goods, fear of recession might return and we can expect the Fed to resume interest rate cutting.
FX analysts expect the dollar to strengthen if Trump does go ahead with his tariff increase, as imminent Fed interest rate cuts are put on hold. Also, the initial effect of raising tariffs tends to be to boost the domestic currency, as imports drop while exports continue as before (though this ends as trading partners erect their own tariffs on imports in response).
The effect on Treasuries and equities may be negative, if expectations for imminent interest rates cuts are dashed. But if pay increases in response, equities may perform relatively better than Treasuries. Conversely, if real household income falls, Treasuries will outperform equities.
Trump can implement tariffs through an executive order. In contrast, Kamila Hariss’ tax increases will need to pass both houses of Congress, meaning that even if she wins the White House, there is a good chance of them being watered down, or even binned.
U.K to increase tax on pensions? Chancellor Rachel Reeves will announce her first budget on 20th October. She has already said that there is a £20bn black hole in the government finances, of unfunded spending commitments made by the previous government. This is defined as the excess spending that was not included in the Conservatives’ five-year spending and borrowing plan, announced in the spring, and which the Labour government has committed itself to.
Filling the hole means curbs on total public spending, perhaps raising it just enough to keep up with inflation. This guarantees friction with public sector unions over pay, and/or continuing with the low level of investment in public services of the last decade, that has damaged the country’s economic growth. The choice will be between confronting the powerful public sector trade unions, or investing in economic growth.
Filling the hole will also mean higher taxes. Labour have ruled out increasing income tax, National Insurance and VAT. There is much speculation that the pension system may be required to pay more tax.
Squeezing the pension system. Around 17% of taxpayers are on the 40% tax rate, and they -together with the much smaller number on the 45% rate- receive around two thirds of the total income tax relief paid by the Treasury. This makes reducing the size of the tax relief available a politically easy option, answering demands from within the Labour Party that the ‘rich’ should be taxed more. (It is worth noting that the same top 17% of tax payers also pay about two thirds of the total income tax collected by the Treasury, which may suggest that the broadest shoulders are already carrying the heaviest burden).
One idea is to reduce or abolish the amount that can be withdrawn tax free. The current figure is 25% of the total pension pot, to a maximum of £1,073,100. Removing this entirely, according to the Institute for Fiscal Studies, would raise around £5bn a year. A second is to restrict tax relief on income put into a pension, by limiting the relief available to 40% and 45% taxpayers to a lower figure – perhaps 30%. Making pension pots taxable when inherited has been discussed, as has applying National Insurance to pension income.
It appears unlikely that the pension system will avoid higher taxes, in one form or another.