Global equities had a strong week with markets up around 3.5% in both local currency and sterling terms. The US led the gains, rising 5% on the back of Trump’s resounding victory with the Republicans on course for a clean sweep – they have retaken control of the Senate and look set to retain their majority in the House of Representatives.
The market’s initial reaction to the news was pretty much as expected. US equities bounced on hopes of tax cuts – which will be made easier if there is a clean sweep – and deregulation. Small cap stocks fared particularly well, rising 9%. As for bonds, yields increased on the expectation that Trump’s plans to jack up tariffs and reduce immigration would raise inflation while tax cuts would boost the budget deficit. Finally, the dollar rallied on the prospect of reduced Fed easing.
But some of these moves have already faltered. Notably, 10-year US Treasury yields ended the week slightly lower following the Fed meeting on Thursday. The Fed cut rates by 0.25% to 4.5-4.75% as expected and said it would only take into account Trump’s policies as and when they were enacted. Chair Powell, who surely won’t be on Trump’s guest list at Mar-a-Lago, also said he had no intention of resigning before his term ends in 2026.
As for US equities, they sustained their immediate gains and the US economic backdrop should remain supportive. Still, the background concern for any longer term investor remains their excessively high valuation. The US P/E ratio is back up to 23x, close to the high touched briefly in 2021, and their valuation premium over other markets is at a new all-time high of 68%.
Trump’s threat to impose a 60% tariff on China and a more general 10-20% tariff on all imports also carries risks both for US and other markets. That said, it is unclear whether this is just a bargaining ploy and if such large hikes will actually materialise. The response of its trade partners is also far from clear. In our view, the risks posed by US valuation levels and the tariff proposals make it all the more important to have a well diversified investment portfolio but the uncertainties argue against taking much more specific action beyond that.
Chinese equities also rose 3% last week and were up a bit more this morning, even though the authorities failed to announce on Friday a support package for the consumer. Instead, the headline-catching $1.4tn package of measures focused on bailing out the local governments and increasing the funds available to buy up land and property for affordable housing. However, the authorities continue to say that more direct fiscal stimulus will be forthcoming and these soothing words should eventually be backed by concrete action, particularly with the looming drag on growth from Trump’s tariffs.
Here in the UK, equities were down 1% over the week, held back by the weakness in the more defensive sectors such as consumer staples and healthcare where the UK index is overweight. The latest Bank of England meeting may also have weighed a bit on sentiment. It cut rates as anticipated by 0.25% to 4.75% but Governor Bailey turned more cautious on how far and fast rates could be reduced from here.
The new caution was driven by an upward revision to its inflation forecasts. It sees the Budget at its peak adding ½% to inflation, driving it back up again to 2.7% at the end of next year and delaying the eventual return to 2% until 2027. More encouragingly, it also raised next year’s growth estimate by ¾% on the back of the Budget.
UK rates are now not anticipated by the markets being reduced again until early February and are only seen declining to 4.0% by the end of next year, rather than 3.25% at peak optimism in September. The scaling back of expectations for UK cuts has been in part driven by the US where hopes for rate cuts have also been reduced substantially.
Finally in Europe, where equities were down 1.7% over the week, the coalition government in Germany collapsed. While inevitably heralding in a period of uncertainty, there is also some speculation that the election could lead to a government rather less paralysed than the last one. Hope springs eternal.
After all the drama of last week, investors will now be forced back to the rather more dreary task of poring over the entrails of the latest economic data releases. The US inflation data on Wednesday will be front of mind but Friday also sees the release of the third quarter UK GDP numbers and the latest clutch of figures on Chinese activity.
Rupert Thompson – Chief Economist