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Sheldon Macdonald and Nathan Sweeney talk about the topics driving the markets in their weekly Monday update.
Monday Espresso Podcast – 6th November 2023
[00:00:00] Sheldon MacDonald: It's the 6th of November today. Last week when we spoke to you, the mood was rather gloomy. We'd struggled with weaker equity markets in particular.
[00:00:08] Sheldon MacDonald: This week, a much brighter picture. Record moves for the week at least. The strongest weekly gains of the year seen in the US in all three of the big indices there and good follow through in UK markets, up a good couple of percent. Asian markets were stronger, China also stronger, but the big news is that the US, over 5 percent gains last week.
[00:00:29] Nathan Sweeney: Yeah, so some extraordinary moves in markets last week and it really is one of those lessons that we talk about in investing, trying to time the market very difficult because the market can move on a dime.
[00:00:40] Nathan Sweeney: So the big question is, what was the catalyst for all of this? So Sheldon, what do we have on that front?
[00:00:46] Sheldon MacDonald: Yeah, central banks clearly were in focus last week. So the US and UK central banks both meeting. In the US it was the second sequential hold, i. e. no rate move, second time in a row. We'll come back to that in a minute.
[00:01:00] Sheldon MacDonald: And we also had the UK bank of England holding rates steady. The European Central Bank hasn't met just yet, but they are likely to hold the inflation number that we saw out of Europe last week. Lower than expected, 2.9% versus the 3.1% expected.
[00:01:16] Nathan Sweeney: And there was a couple of other things that the market was latching onto last week.
[00:01:20] Nathan Sweeney: So we know that central banks now have probably hit the peak in terms of interest rate rises, but we've also started to see some softening economic data. So you might think that's bad, but actually the market perceives that as good, because it means that inflation is likely to continue to come down.
[00:01:37] Nathan Sweeney: And then the other thing that the market is very much focused on is company earnings. So company earnings have been better than expected. So despite all of these higher interest rates and higher inflation, companies have been able to weather the storm. And when you put all of that together, it helped to really lift equity and bond markets last week.
[00:01:56] Sheldon MacDonald: So let's just speak about earnings for a second, we'll circle back to bond markets. We're still in the middle of Q3 earnings results. The picture there really is solid earnings. Now the story though has been one where the positive earnings have come more from cuts in costs rather than top line revenue growths.
[00:02:15] Sheldon MacDonald: Now that, as we say, isn't a great picture for the future outlook, but for the moment at least earnings are solid, companies are doing okay.
[00:02:23] Sheldon MacDonald: Now let's just come back to the bond side, because we also had a particularly strong bond rally last week. As you said, those inflation expectations coming down means the higher-for-longer narrative is starting to break down, and we are seeing expectations for rate cuts next year rising.
[00:02:40] Sheldon MacDonald: So at the moment, we have an 85% chance priced into the market that we'll get at least one rate cut. We have just below 50 percent chance that we'll get at least two rate cuts in the first half of next year. That's really boosting the bond markets.
[00:02:57] Sheldon MacDonald: We had the US 10 year treasury, which in the previous week had traded with the yield over 5%, that fell to below 4.5% yield during the course of last week. Now let's just do a bit of boring bond maths here. The maths isn't going to be precise, I'm rounding for ease of use here, but go with me.
[00:03:16] Sheldon MacDonald: If we assume that a US 10 year bond has a duration of 10 years, that equates to a gain of 10% for every 1% fall in interest rates. So we had a 50 basis point fall in those yields, so that equates to something like a 5% gain in the 10 year bonds. So particularly strong moves in the bond markets as well last week.
[00:03:41] Nathan Sweeney: Actually, it's one of the areas which we've been more positive on adding to duration because we did expect to see central banks pausing interest rates because we can all see that inflation is coming down. So that's definitely benefited us last week.
[00:03:53] Sheldon MacDonald: Those lower bond yields equating to higher bond prices, that brought some benefit too for what we call long duration equities. Equities where the growth projections far into the future are being discounted at the lower rates. That gives you a benefit, a boost to those future earnings. And we also saw some short squeezes last week. Now that's where companies or players who have short positions on stocks suddenly see those stocks rising and they clamour to buy back those stocks because they're exposed to future growth that would lead to negative results for them.
[00:04:31] Sheldon MacDonald: So they clamour to buy back those willing to pay almost any price and you get a squeeze upwards of the prices and we saw that happening in some of the stocks last week.
[00:04:40] Sheldon MacDonald: Now let's just return to the theme that we mentioned at the beginning though it is one though where, it's a bad news is good news scenario. So the economy is stagnating, we saw, in the US, the pace of hiring is slowing. Andrew Bailey, in his comments after the Bank of England meeting, spoke about the stagnating economy. It's a global phenomenon that we're seeing that was reflected in the oil price last week. That was lower by almost 6%. We're also seeing lower earnings forecasts for companies, especially in the US.
[00:05:12] Sheldon MacDonald: So, the stagnating economy is not great from an economic growth perspective, but, as we say, it gives the central banks a bit more room to manoeuvre to cut rates perhaps sooner than previously feared.
[00:05:23] Nathan Sweeney: The thing to remember is that markets will be very much focused on those rate cuts because they have the potential to drive future growth, and so ironically, you could have poor economic conditions and yet the market could be rallying because it thinks central banks will cut rates a lot quicker in that environment.
[00:05:40] Sheldon MacDonald: Speaking of the future, what does next week hold for us?
[00:05:43] Nathan Sweeney: Yeah, so this week is actually going to be a much quieter week on the data front. We do have GDP growth figures in the UK. We mentioned weaker economy, we are expecting a slowdown in economic growth. So growth to come in at negative 0.1%, so just slightly negative.
[00:05:58] Nathan Sweeney: Company earnings continue to roll out. So we've got the likes of Berkshire Hathaway, Uber and Walt Disney this week. And in China, we've got the release of inflation and trade data.
[00:06:07] Sheldon MacDonald: We look forward to speaking to you about all of that next week.