Back
I was back this week from a later than usual summer break. While I was away, I followed the news flow a little and was amazed how steady equity markets were in the face of oil spiking higher once again and 10-year yields rising above 5% in the US and UK (and selling off by much more in France for example). And all this in September, which is seasonally the weakest month of the year for equities. If this is also you, then it is probably worth repeating this chart which shows where equity returns have come from since January 2025:
The light blue bars here are profit growth. If (forward-looking) profits are up over 90% in 21 months (as they are in Emerging Markets) then equities are going to do well, whatever the oil price. And I think this story is staying intact. Much of the emerging market earnings growth has come from a few memory and semiconductor companies that make the chips needed for AI growth. Based on September industry conference feedback, AI demand and AI investment remain strong. The latest positive catalyst was the launch last week of the Muse personal assistant by Meta (which is not available in the UK yet). AI for the consumer is moving from a chatbot to an agent that can do things (book restaurants, buy your shopping, complain to airlines) on your behalf. If this proves popular, which it has so far in the US, then the AI investments that power it – and which are powering US growth – should have some sort of positive payback.
And strong AI investment means strong US growth. Here is the Atlanta Fed Q3 growth estimate for example:
My guess is there are some one-off quirks driving this higher, but still US economic growth is strong. And if growth is strong and (as is the case today) inflation is above target then interest rates should go up, not down. This is, I think, the reason for the bond market sell-off rather than any existential worries about today’s government debt levels. Inflation is being pushed higher by rising energy costs. So bond yields and energy are moving in lockstep together at the moment. Here is the UK 10-year gilt yield and the Brent crude oil price for example:
If higher yields are down to stronger growth and an oil price shock, that does not mean there aren’t problems for the more indebted countries. Yesterday, for instance, yields spiked higher again globally. But you can see it is the most indebted countries (most notably France) that were hit hardest:
Even though I don’t think it is debt levels themselves that are pushing yields higher, it is clear that markets are starting to punish the biggest borrowers the most. Austerity has become an unfashionable word recently. But as government debt costs rise there is mechanically less money for everything else. So, you are back to spending cuts or tax rises (or, the government’s dream, better growth).
As investors, we are up (a little) on our fixed income book year-to-date. The carry we get on the bonds has just about offset the fall in prices due to today’s higher yields. And, of course, equities are higher driven by the earnings growth story I started with in this note. This is, I think, a fair outcome for a balanced investor, especially as today’s fixed income pain should, I hope, translate into better longer-term fixed income returns. But as a taxpayer, I am afraid that September hasn’t brought much good news. For some relief here I think we need to start with seeing lower oil and energy prices. I am not holding my breath here, but over to you Donald Trump.
Chris Brown, CIO
cbrown@ipscap.com
The value of investments may fall as well as rise and you may not get back all capital invested. Past Performance is not a guide to future performance and should not be relied upon. Nothing in this market commentary should be read as or constitutes investment advice.
