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If part of the job of this note is to tell you what is going on, here is what has happened in equity markets since the end of March:
- There has been a technology rally for the ages, led by AI investment and the real-world earnings associated with it: the US Nasdaq index is up over 20% for the quarter as I write.
- As I wrote last week, around one third of the Emerging Markets index is comprised of semiconductors which are front and centre in the AI demand boom. The MSCI Emerging Markets is also up over 20% for the quarter, but not for the reasons you might think, and in no way are you diversifying yourself from the US and AI investment theme.
- If you worry this is all a bit bubbly, one point I would make is that US earnings growth for Q1 is tracking at 25%. This means US valuations are quite a bit lower today than where they started the year.
- Oil and Iran are last quarter’s story. But the large energy importers (including Japan and Europe) are still rallying when progress on a deal is leaked
If you haven’t worked this out already, going to cash on a bad Trump headline is a pretty dangerous strategy. And standing in the way of the US technology earnings juggernaut has also been just as dangerous this quarter. Our job is to (responsibly) capture some of the returns I mentioned at the start. This means our equity strategy has (for a while) been a barbell of technology heavy US and Emerging Markets balanced by boring old-world companies in Europe and Japan. This has been working this quarter and really for the last 3 years now, even in a world of Trump headline roulette. I can see no compelling reason to change it right now.
So the question is where are the opportunities outside of equities? The good news is the first one I see is in a market I have been consistently wrong about for the last 3 years. For a while now I have thought that UK gilts should have yields below US treasuries. For one thing, we have a weaker economy and a smaller government deficit. And that borrowing picture is set to improve as tax rises kick in over here compared to Trump’s tax cuts over there. I continue to think that UK base rates should be closer to the 2% found in the Eurozone than the 3.75% found in the US (which is where they are today).
Instead, the doubling in oil prices and the pressure this puts on inflation has seen the UK 10-year yield rise above 5% for the first time since 2008. Today sees a potential political revolution as council elections might see the stranglehold of two-party politics broken in the UK. I will write more about the UK and the potential opportunity in gilts next week.
And secondly, some absolute return strategies such as trend following and (computer driven) equity strategies have done a good job of diversifying away from all things inflation and Trump. As neither of these two risks look to be going away any time soon, we are looking once again at the role these sorts of strategies might play in our portfolios.
And finally, here are a couple of charts to back up the two points I started with. First selected market returns for the quarter so far:
And here you can see this has been driven by earnings growth rather than (more bubbly) multiple expansion. US earnings growth is currently tracking at 25% year on year, so US valuations are actually falling not rising:
Finally, I’d note that the US jobs market has remained stronger than many had feared (which has helped the US small and mid-cap market rally). Part of this is because there isn’t much evidence that the AI revolution is slowing hiring right now. AI automation is at its most advanced for the types of tasks performed by a software engineer. So, it is interesting to me that demand for software engineers has been rising and not falling for the last 12 months. It looks like all those newly minted computer science degrees will have a use after all.
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.
