Harvesting gains - the week ahead

After three years of sharply higher share prices, it is perhaps unsurprising that investors are considering taking some gains off the table. As ever, in a maturing bull market, no-one can know whether heightened volatility is the pause that refreshes or a sign of something more worrying around the corner.

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Tech stocks bear the brunt

The S&P 500 lost only a modest 100 points last week to close at just over 6,700. But that disguises a significant loss of momentum over the past month or so. Shares have moved sideways, and done so in a volatile fashion.

It’s not surprising that they should have stopped for breath. Since April the US benchmark has risen by 35%. That headline figure is somewhat misleading, however. It hides a more modest 22% gain for the equal weighted S&P 500 and points to the continued dominance of the AI-driven technology story.

Looked at another way, the Magnificent Seven have risen by a fifth year to date, while the equal weighted benchmark is up by just 7%. It’s a narrow market and one that is priced for perfection at the top end but more reasonably valued further down.

Look at the more speculative investments and the effect is even more noticeable. Goldman Sachs’s non-profitable tech index has more than doubled since the spring but lost 40% of its gains in recent weeks. Bitcoin, too, has tumbled from a high of over $125,000 to under $100,000.

Balancing the pros and cons

Where markets head from here will depend on whether investors focus on the glass half full earnings picture or look instead at the less supportive valuation outlook.

As the third quarter results round comes to an end, things have turned out much better than expected. Profits growth of 15% is about twice as good as the 7% expected just a few weeks ago. Most announcements are in the bag now, but one key result is due this week. Nvidia, the biggest stock of all, and by itself a big driver of the market rally, unveils its latest figures on Wednesday.

The valuation picture is more nuanced. On the face of it, a market trading on around 25 times earnings is historically highly priced. But compared with valuations during the dot.com bubble 25 years ago, there could still be some headroom. This is even more the case for the equal weighted US benchmark, which is priced in the high teens as a multiple of earnings. Non-US shares, such as the UK market, are even more attractively priced.

UK in focus

Not exclusively a markets story, next week’s UK Budget is nonetheless in the spotlight for investors. That’s due to an apparent change of heart by Chancellor Rachel Reeves on the political risks of an income tax hike that had become conventional wisdom by the end of last week but now seems to have been dismissed as an option.

That unsettled fixed income investors who are desperate for signs that the government is prioritising fiscal prudence over political expediency. The latest apparent U-turn on income tax casts doubt on that, and gilt yields suffered their biggest one-day hike since July on Friday. Higher yields equate to lower bond prices. Shares and the pound also fell at the end of the week.

Exactly how the government plans to bridge an estimated £30bn shortfall in the public finances is the subject of feverish speculation again. Markets fear that attempts to fill the hole in a piecemeal way will be much less likely to succeed than a politically painful but possibly more prudent across-the-board tax hike.

• Read: What can we expect in the Autumn Budget?

Sentiment sours in Asia too

Investors’ nerves are not restricted to US tech shares or UK gilts. Shares in Chinese and Japanese tourism-related stocks took a hit on Monday after an escalation over the weekend of tensions between the region’s two most important economies. China responded angrily to a suggestion by Japan that any future invasion of Taiwan could trigger a self-defence response under the country’s pacifist constitution. China said that amounted to a military threat and warned its citizens against travel to Japan.

That’s a big deal for Japanese stocks because Chinese visitors have become a key contributor to retail, transport and tourism-related revenues in recent years. Shiseido, a cosmetics company popular with Chinese tourists, saw its shares fall by more than 10%. As did those of Isetan, a big Japanese department store.

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