Tom Stevenson, Investment Director, Fidelity International comments on what’s driving markets this week.
With several developed economies experiencing uncertainty, it may seem strange that stock markets remain so calm. Instead, investor anxiety appears to be concentrated in bond markets and gold, while equities continue to reflect an optimistic outlook.
“In the last week, the UK has seen a major government reshuffle with many cabinet roles changing hands. In France, the government faces a confidence vote that could have significant implications and in Japan, the resignation of Prime Minister Shigeru Ishiba set in train weeks of uncertainty ahead of leadership elections for the ruling LDP party.
Bond markets and yields
“In all three cases, bond markets have shown signs of strain, with investors demanding higher income to compensate them for the perceived higher risks. Long government bond yields in the UK have risen close to a multi-decade high of around 5.5%, having been as high as 5.7% in recent days. Japanese bond yields are rising in anticipation of a push for more fiscal stimulus from leadership contenders. The gap between French and Italian bond yields has narrowed sharply as investors see France as increasingly risky.
Gold’s safe-haven role
“Meanwhile, gold, a traditional safe haven at times of political uncertainty, has soared to a new all-time high around $3,600 an ounce. The focus for gold investors is less on Europe or Japan and more on the US, where questions around the future direction of fiscal and monetary policy have come to the fore. Gold is seen as a protection against the inflation that a period of so-called fiscal dominance might lead to.
“Although gold has doubled in three years, more bullish commentators are suggesting it could have further to go. Gold has risen by 9% in the past three weeks and by 37% since the start of the year. The price of gold tends to rise as interest rates fall because the lower yields on rival assets like bonds make gold’s lack of income less of a disincentive to invest.
Equities remain buoyant
“What is noteworthy for investors is the way that all this uncertainty seems to have passed stock markets by. Shares have had a strong summer, recovering after a setback in April when concerns around new trade tariffs temporarily unsettled sentiment.
“In the five months since then the tariff narrative has eased considerably and now a more equity positive story is emerging of more fiscal spending, funded in part by tariff revenues, together with lower interest rates as a less independent central bank is persuaded to keep government borrowing costs artificially low.
“Put together with an ongoing growth narrative focused on artificial intelligence, still buoyant corporate earnings and high profit margins and investors are willing to continue viewing the stock market glass as half full.
Echoes of past cycles
“Indeed, some nervous market watchers are starting to draw parallels with the dot.com bubble years when easy monetary policy poured fuel on the fire of an already hot market, creating a melt-up which felt exciting at the time but ultimately ended badly for investors.
“As we approach the three-year anniversary of the bottom of the market cycle in October 2022, shares are now approaching the typical 90% rise achieved in cyclical bull market phase. That’s been fuelled in part by higher earnings, but also by higher valuations, especially in the US, which continues to trade at a big premium to other developed and emerging stock markets.
How long can the rally last?
“How long the bull market can continue remains uncertain, especially as the long-run secular bull market that began after the financial crisis in 2009 now looks long in the tooth at 16 years, fast approaching the length of the previous post-war bull markets in the 1950s and 1960s and then again in the 1980s and 1990s, both of which lasted for about 18 years.
“The optimistic – but dangerous – view is that, as in the late 1990s, the bull market will end with a kind of final fling, a late surge in prices on the back of easier monetary and fiscal policy and an over-arching positive growth story focused on AI.
Spotlight on the Fed
“The first big test of that positive equity narrative could be next week’s meeting of the Federal Reserve’s rate-setting committee. Investors have largely priced in a first interest rate cut for 2025 after 10 months in which the Fed has held fire, watching and waiting to understand the impact of tariffs on growth and inflation.
“This week attention shifts from growth to inflation as the spotlight moves from last week’s unexpectedly weak jobs data – just 22,000 jobs were added in August and June’s figure was revised down to a loss of 13,000 jobs, the first fall since the pandemic. This week’s key number is Thursday’s inflation data, with a 2.9% rise in consumer prices expected, slightly up on July’s 2.7%.
“A lower-than-expected inflation number could see pressure mounting on the Fed, not just to cut interest rates but to go for a jumbo half percentage point cut. On the other hand, a higher inflation rate could make it hard for the Fed to cut, undermining a key element in investors’ glass-half-full market view.”
