This week in the markets: markets focus on Trump’s return to the White House; earnings season gets into full swing; and gilts bounce back on weak UK data
Donald Trump returns to the White House, only the second ever President to serve two non-consecutive terms. After four years out of power he is vowing to hit the ground running with a flurry of executive orders right from day one of his second term.
Areas of focus are likely to include curbing immigration, implementing trade tariffs and deregulating sectors including energy and cryptocurrencies.
From a market perspective, trade policies may be most influential. Trump is likely to use America’s trade leverage to force partners into deals on issues from migration to drug trafficking. Tariffs will also be used to encourage overseas companies to manufacture more in the US, so boosting US jobs.
The question is whether he introduces tariffs piecemeal, hitting important sectors and industries, or imposes across the board levies on all US imports.
Other early moves are likely to focus on boosting the US oil and gas industry, part of a promised era of US ‘energy dominance’. He is looking to slash red tape and reverse Biden era restrictions on energy production.
Other Biden measures likely to be overturned in short order include emissions crackdowns designed to promote electric vehicle adoption.
Markets have been volatile since the New Year as inauguration day has approached. Stocks have zigged-zagged as investors tried to assess how much of the Red Wave has already been priced in. The S&P 500 surged again last week in the final days of the Biden era and the percentage of stocks above their 200-day moving average increased to 61%. Still not high by the standards of last year, but better than it has been in the recent weeks.
In particular, the equal weighted index - a better measure of the overall market than the capitalisation weighted index that is dominated by the big tech stocks - bounced back after a New Year correction. With just 17% of shares above their 50-day moving average last week, the broader market had become quite oversold in the short term as investors started to view the glass as half empty after the initial post-election euphoria in November and December.
Sentiment remains quite subdued following the January drawdown. Surveys show more bears than bulls, which is actually good news because it suggests there are still investors on the sidelines despite markets being close to all-time highs.
How markets progress from here will depend in large part on how earnings season pans out. Fourth quarter results season is still young, with only around 10% of companies having reported. But more than 80% have beaten estimates by a good margin. It’s too early to tell, but signs are good that the fourth quarter will follow earlier quarters by delivering ahead of expectations.
That matters because earnings have picked up the baton from valuations as the principal driver of markets. Double digit gains in the year ahead are still the consensus but they need to be achieved if the market is to keep rising.
That will be particularly so if inflation remains above target, the jobs market stays strong and the prospect of further interest rate reductions fades away. Shares are riskier than bonds so investors expect them to yield more than the safer fixed income alternative. As bond yields hover in the 4-5% range, equity investors are keeping a close eye on the bond market too.
The Fed doesn’t seem to be in any hurry to cut rates further. The recent US inflation reading suggests that interest rates of 4% or more will be close to the neutral rate. There doesn’t seem to be a strong reason to lower them much further this year.
The bond market has been in the spotlight on this side of the Atlantic too. Here the spectre of stagflation - sluggish growth but persistent inflation - has pushed longer-term bond yields to high levels, at least by the low standards of the past 17 years since the financial crisis. 10-year yields rose from 3.75% in September to nearly 5% recently as investors decided that higher for longer inflation would make it difficult for the Bank of England to cut interest rates from their current 4.75%.
But gilts enjoyed their best week since July last week as a string of weak UK economic data suggested that the Bank may have to cut rate more aggressively than feared in order to kick-start growth. The numbers included lower than expected inflation in December, disappointing GDP figures for November and weak retail sales in December. The 10-year gilt fell to 4.66% by the end of the week. Yields move inversely to prices.
Although the outlook is poor for the UK economy, the FTSE 100 hit a record high on Friday as the weak data weighed on the value of the pound. The FTSE 100 rose 1.4% and now stands at just over 8,500, surpassing its previous high struck last May.
Traders now expect at least two quarter point rate cuts in the UK this year. That has pushed the pound down to around $1.22, well below the $1.34 level it reached in the autumn. A weak pound is good news for exporters and overseas earners, which boosts the value of the internationally-focused FTSE 100 blue-chip index.
The strength of markets in 2023 and 2024 has led to a surge in interest in exchange traded funds, which can be a cheap and simple way of tracking a rising market. Global ETF flows hit a record $1.5trn last year, easily beating the previous record of $1.2trn struck in 2021 as the world emerged from the pandemic.
ETFs are largely a passive vehicle and their popularity reflects a shift from active strategies to index trackers in recent years. That has been encouraged by the difficulty active managers have had in matching a market which has been dominated by the performance of a handful of big, US companies. About a fifth of total ETF flows went into just three S&P 500 trackers managed by the industry leaders, Blackrock, State Street and Vanguard.
But the industry has also accelerated its transition away from simple trackers and the amount of assets held by actively managed ETFs topped $1trn (out of a total of nearly $14trn) for the first time.
