We hope you are all extremely well and haven’t felt too much anguish considering the recent budget? We recognise, that could be a touch optimistic, and no doubt at least some of you are feeling a little uneasy, nevertheless, we wish you well in navigating this rather radical moment.

Turning to investments and we observe the ‘Global’ stock market accrued further gains in October, however, this aggregated statistic belied mixed performance beneath the surface. Once again it was left to US equities, powered by its dominant, ‘loosely defined’, Technology businesses (and largely the Magnificent 7) to do the heavy lifting. Outside of the US performance was much more pedestrian.

Nor was it a particularly prosperous month for bond markets. Sovereign bonds, including US Treasuries and gilts, struggled as better growth outcomes (and prospects) reduced expectations for interest rate cuts, lifting yields. In keeping with the mathematical identity, higher bond yields meant falling bond prices.

But other factors may have also encouraged higher bond yields? We note Trump’s ascent to President-elect may have had an impact; it certainly caused a further spike in US stock markets growing on the back of his policies to increase trade tariffs for overseas imports. The thesis in relation to falling bond prices being Trump’s deficit enhancing tax cuts would likely require (potentially material) additional funding; certainly, in the short-term. This extra funding means more borrowing, more borrowing means more bonds, and more bonds means weaker prices and higher yields.

We should also acknowledge investors have gradually increased their assessment of the long-term ‘neutral rate’. This theoretical rate is considered neutral in that a higher level of interest rates would prove economically restrictive, whilst anything lower would be a stimulant. Given the US economy seems increasingly at ease with higher levels of interest rates, so the long-term neutral rate has climbed, bringing bond yields along for the ride. Supporting both the resilient growth and higher neutral rate narratives has been the strength of the US labour market. This feature was emphatically reinforced in October, with a bumper US payrolls report far outstripping expectations; going so far as to imply the US was headed away from recession rather than creeping toward one.

Of course, at the very end of the month, the well-trailed UK Budget may have also placed additional upward pressure on domestic bond yields. At the time of writing the market is still digesting the plethora of changes proposed, however, from a high-level perspective anxiety is certainly building. Despite the high levels of taxation increases, if the gilt market remains unsettled then the Chancellor may be forced to U-turn on some of the spending commitments or ask for an even greater tax-take. The prospect of some softening to early term spending commitments or lifting the freeze on Fuel Duty are surely being floated within the government’s inner circle.

Returning to equity markets and we note, just as in the early stages of this year, the asset class is showing considerable resilience to higher bond yields. Offering further comparison to early 2024, we might also suggest equities are coping (so well) with higher rates as it is an improving growth backdrop driving the relative hawkishness of central banks, and not inflation. Provided inflationary pressures continue to moderate, therefore, we would anticipate a slower pace of interest rate cuts rather than an extended pause, or even a reversion to hikes. Given the trends we’re seeing in inflation and commodity prices, there appears no imminent need to abandon this dovish perspective.

Summarising, resilient labour markets, ebbing inflation and interest rate cuts point to a more enduring runway for growth and is supportive for equity allocations within portfolios. However, despite this positive framing, we’d be keen to stress the risks to equities remain prominent, particularly that of recession. Despite the delivery of lower interest rates, most borrowers will likely suffer an increase in debt service costs at any imminent refinancing event; a dynamic which may yet squeeze the growth out of a (gradually) slowing US economy.

We would also highlight the risk of resurgent inflation should the US Federal Reserve push too hard on shielding/stimulating the economy. In such a setting, we suspect the Federal Reserve would be forced to reverse course (again), swiftly and dramatically raising interest rates to finally see-off the menace of inflation. Such an outcome would threaten a more material downturn for both the economy and stock markets.

Kind regards,

iPensions Wealth Team

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