The US introduced santions on Russia’s two biggest oil companies, Rosneft and Lukoil, as part of their effort to bring the war in Ukraine to a close. This is the first move of this scale taken by the US. In response to the news, investors concerned about possible decrease in supply drove oil prices up over 5% in early trading last Thursday. These sanctions are in addition to ongoing efforts from the US to reduce Indian buying of Russian oil.
In Japan, Sanae Takaichi, became the country’s first female prime minister. The news was well-received by investors who anticipate that her appointment will boost government spending and drive growth. In response, the Nikkei 225 index closed last Tuesday up 0.3% and touched record highs during day trading. The Nikkei is up almost 24% since the turn of the year.
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US Equity Market:
Last Tuesday US carmaker General Motors revised down the impact that tariffs would have on its bottom line and consequently raised its earnings forecasts. In response to the news, the stock surged almost 15%.
US based electric vehicle manufacturer, Tesla, was the first member of the so-called “Magnificent 7” to report Q3 earnings last week. Tesla recorded a 12% increase in earnings over Q3 after consecutive quarterly declines. Despite this, profits came in below analysts’ expectations and the share price fell almost 5% on the news. Tesla attributed the fall in profit to reduced electric vehicle prices and increased operating expenses linked to AI research and development.
Over the week to Friday, the S&P 500 and Nasdaq indices were up 1.93% and 2.18% respectively. Sterling currently trades around 1.33 against the dollar.
UK Equity Market:
An article last week estimated that the recent cyberattack on UK company, Jaguar Land Rover, cost the UK economy at least £1.9bn. The attack has been labelled as the “UK’s most economically damaging cyber event” and production at the company has only just restarted following the initial shutdown on August 31st.
Elsewhere, the government announced plans to fast track the development of a third runway at Heathrow airport last week. The announcement is driven by the government’s aim to get the project off the ground before the next General Election and is part of Chancellor Rachel Reeves plan to boost UK productivity.
Over the week to Friday, the FTSE 100 index rallied, closing 3.13% up. The performance last week has propped up index performance over the month and is driven by gains in the pharmaceutical sector, energy sector, and the recent rally in the precious metals space.
Inflation, Interest Rates and Bond Markets:
Figures released last Wednesday showed that UK inflation unexpectedly remained at 3.8% in September, below the 4.0% peak forecasted by the Bank of England. This surprise prompted a shift in market expectations, with the probability of an interest rate cut in December rising to over 70%, up from 40% previously.
The gilt market responded positively: the two-year gilt yield fell by 8 basis points to 3.78%, and the ten-year yield declined by 6 basis points to 4.42%. As a reminder, gilt yields move inversely to prices.
According to a Reuters poll, the Federal Reserve is expected to cut interest rates by 25 basis points at both the meeting this week and again in December. This marks a change in consensus expectations from last month when only one cut was anticipated, reflecting a shift to prioritising a weakening labour market over persistent inflation.
What’s on the horizon
Last week was a busy week for central banks and economic data releases. The Federal Reserve and Bank of Canada are set to meet on Wednesday, followed by the Bank of Japan and European Central Bank on Thursday. Meanwhile, key inflation data will be published for Australia (CPI) on Wednesday, and for the Eurozone (HICP), Japan (CPI), and the US (PCE) on Friday. In addition, third-quarter economic growth figures for the US, Eurozone, and Germany are scheduled for release on Thursday, offering further insight into the global economic outlook across those regions.
Corporate earnings continue into last week with Microsoft, Alphabet and Meta all reporting their third quarter results on Wednesday. Apple and Amazon will follow on Thursday, while Nvidia is not due to release its figures until mid-November, completing the Magnificent Seven earnings cycle after Tesla reported earlier this week.
Are we in an AI bubble
Year-to-date, the S&P 500 and Nasdaq indices are up around 15% and 19% respectively despite the volatility in April. Over the last 3 years, the indices are up around 80% and 110% respectively[1]. As we are all aware, a significant proportion of this performance has been driven by big-tech, especially investments in artificial intelligence or associated industries. However, the rapid growth and sky-high valuations are starting to raise concerns amongst investment professionals that we are in an AI bubble.
The cyclically adjusted price-earnings ratio (CAPE ratio) is a typical metric used to identify a market bubble and is calculated by dividing the current share price by 10-year average inflation adjusted earnings per share. For the S&P 500 index, this ratio has now risen above 40 for the first time since 2000. As shown in the below graph, the only other occasions where this ratio has risen above 30 were just before the Great Depression in 1929 and the Dot-com bubble in 2000.
[1] Returns are in local currencies.
This could suggest that there is now a big asymmetric return distribution; there is a lot more room for the P/E ratio to fall back to historical averages than there is for it to increase further. A worsening of the broader economic situation could trigger investors to demand a lower price for each dollar of earnings.
A small disappointment in earnings or a slight decrease in expected growth could cause investors to cash in their profits and sell out of some of the expensive tech stocks which have helped drive market prices to their current level. This change in sentiment could propagate through markets incredibly quickly and induce severe volatility into global equity markets.
There are two ways in which a stock price increases. Either the P/E multiple increases or the earnings per share (EPS) increases. In the chart below, Peter Oppenheimer from Goldman Sachs Research compares the return contribution from these two factors to the sources of total returns back in the early 2000s. One can see that whilst earnings played a huge role in the returns at the turn of the millennium, there was also an extraordinary contribution from upwards re-evaluations, something we are seeing on a much smaller scale today.
While equities may appear expensive by historical standards, this largely reflects a collective bet that AI and other productivity-enhancing technologies will drive earnings growth over the coming decade – justifying the high price one has to pay to own shares. Whether those earnings ultimately meet, fall short of, or exceed expectations remains uncertain. In the face of that uncertainty, the most prudent course for investors is to hold well-diversified portfolios. Diversification means you should expect some investments to underperform. What matters is that the portfolio as a whole is performing through time.