Global equity markets experienced drawdowns last Tuesday as weak US factory activity data ignited growing concerns around a potential AI bubble.
Asian markets were disproportionately affected given their close relationship to some of the big tech stocks that have driven returns in the US. Year-to-date, Asian markets have performed particularly strongly, taking advantage of the global wave of optimism around big tech and AI. The Hang Seng Index in Hong Kong has risen c.30%, the Nikkei 225 in Japan has climbed c.25%, whilst the KOSPI Composite in South Korea has led developed markets with a gain of c.67%. However, a large proportion of these gains have been driven by AI-related stocks, such as technology hardware companies (i.e. chipmakers) and internet companies.
The changing investor sentiment in the US last Tuesday reverberated into these markets and resulted in notable drawdowns. Some of the indices recovered through the week, whilst the KOSPI and Nikkei remain below levels at last Monday close.
US Equity Market:
As referenced above, US equity markets experienced drawdowns last Tuesday as investors concerns about the sustainability of AI valuations intensified. The S&P 500 and the NASDAQ indices fell 1.2% and 2.0% respectively on the day and continue to remain below the levels at close the previous week. Over the week to Friday, the S&P 500 and Nasdaq indices have fallen 1.6% and 3.08% respectively.
Investment activity from famous investors, Warren Buffet, CEO of Berkshire Hathaway, and Michael Burry, the main feature of the movie ‘The Big Short’, has further heightened investor speculation of a bubble. Berkshire Hathaway has continued to stockpile cash, with reserves hitting record highs, and Michael Burry disclosed short positions on US tech firms Palantir and Nvidia. Palantir is one of the mostexpensive stocks in the US, trading on a forward price-to-earnings ratio of over 200x. Despite reporting impressive results last Monday, its share price fell over 10% last week, reflecting the harsh reality of stocks with sky high valuations.
UK Equity Market:
Ahead of the autumn budget on 26th November, UK Chancellor Rachel Reeves made a speech last Tuesday morning setting out her economic priorities. She refused to rule out increasing the three main tax revenue drivers – Income tax, VAT and National Insurance – to help ease the fiscal deficit that the UK is currently facing. She did not announce specific tax hikes; the speech was mainly about preparing the ground for “hard choices” and signalling that increases could be coming.
Rumours emerged last Thursday that provided some reassurance to Britain’s banks on potential tax rises at the budget. Reeves made it clear that the government was aware that UK banks already pay a relatively high level of tax, and also identified the sector as a target for driving future UK growth. Shares in NatWest and Lloyds were both up around 2.5% in early morning trading last Thursday, demonstrating the risk premium that investors had baked into the share price.
Over the week to Friday, the FTSE 100 index fell marginally (-0.26%), shedding the gains made earlier in the week.
Inflation, Interest Rates and Bond Markets:
Last Thursday, the Bank of England’s Monetary Policy Committee (MPC) elected to hold rates steady at 4% in line with analyst expectations. The vote was close, with five votes in favour of holding, and four in favour of cutting. Market expectations for future rate cuts remained broadly unchanged following the anticipated decision, with odds of a December rate cut remaining around the 66% mark.
In their communication of the decision, the MPC highlighted that they believe UK inflation has peaked, and that “gradual” rate cuts will continue to occur in the future.
What’s on the horizon
Another week of key economic releases lies ahead. The National Bureau of Statistics of China released Consumer Price Index figures for the month of October, today (+0.2%). This release gives investors insight into the inflation situation within the world’s second largest economy.
German inflation data is due on Wednesday, with the Harmonized Index of Consumer Prices (HICP) expected at an annualized rate of 2.3%, near the European Central Bank’s 2% target. This reinforces expectations that eurozone inflation remains under control, supporting the case for stable monetary policy in the near term.
On Thursday the Office for National Statistics is set to release third quarter GDP figures for the UK. This figure represents the total value of all goods and services produced in the UK during a given period, and will be closely watched by investors and politicians alike ahead of the government budget looming at the end of the month. Rachel Reeves is bound by rules requiring government debt to fall as a share of GDP. A higher-than-expected GDP number improves this ratio, giving her more room to avoid tax hikes or spending cuts. A weaker figure does the opposite, forcing deeper consolidation. Higher GDP growth also reassures markets, potentially lowering gilt yields (which are essentially borrowing costs for the government) and reducing the cost of servicing debt.
You can read our October asset returns review here: October Review