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Luckily, IPS is not (yet) a user of Microsoft Azure and 365. This means (unlike Sky News) I am able to keep on with my weekly reporting. And on this front, there have been a couple of bigger macro themes emerging over the last few weeks that are worth talking about. First, Trump looks more and more likely to be in power by year end. This is generally deemed to be good for US growth and bad for US inflation. Tariffs will obviously help US manufacturers but they will also push prices up and so make inflation worse. And any clamp down on immigration should, at the margin, mean higher wages. Goldman Sachs have run the numbers here and estimate a 1.1% boost to inflation and (contra to the popular view) a -0.5% hit to growth if the Trump Tariffs are enacted in full:
What is interesting to me is that markets look to have this the other way around to the economists. The more growth sensitive part of the equity market (like small and medium size equities) have been doing better recently whereas areas more sensitive to interest rates (like government bonds) are not showing any signs of renewed inflationary worries.
To illustrate the growth part of this, US small and medium size companies have under-performed all year as AI and technology companies have dominated equity returns. But in July this has reversed sharply. One example is to compare Semiconductor manufacturers (today’s purest AI play) to US regional banks (which are very sensitive to interest rates and the state of the economy). As of the 10th of July, the US semiconductor ETF was 65% ahead of the regional bank ETF for the year to date. Over the next 6 trading days regional banks have outperformed September semiconductors by over 20%:
Equity markets are not bearish growth right now! Another way to think about this is the equity market is broadening beyond a narrow range of AI and technology focussed stocks (which are having one of their inevitable momentum reversals right now). This is what you would expect if the economic growth picture firmed: cyclical stocks should catch up with their more growthy counterparts. Microsoft’s problems today will only add to the pressure for investors to rotate out of the year’s winners so far and into some of the potential winners of the US economy under Trump. I wrote in our second quarter overview that I thought equity diversification was starting to work again. The (short term at least) recovery in small and mid-cap stocks is a good example of this.
The other side of this is that markets don’t seem too worried about the Goldman inflation projections under Trump. Higher inflation should mean interest rates are higher than they would have been otherwise. One benchmark measure of longer term interest rates is the US 10 year government bond yield. This has been trending down recently (not up) and today’s level of 4.2% is well below April’s peak of 4.7%.
The main reason for this is the second major macro theme of the last few weeks: namely the reversal of the Q1 inflationary spike and the start of a new (mild) disinflationary trend in both the US and UK. There is now a 50/50 chance of a UK interest rate cut in August and this rises to almost 90% for September. The US is similarly priced to be very likely to start rate cutting in September. Much of the recent strength in inflation looks to be coming from sectors (like car insurance) that are still looking backwards to Covid era disruptions. As these lags continue to unwind, inflation should (I hope and the markets seem to think) carry on being under control.
Of course, good news on growth while interest rates fall really is a good backdrop for any investor. What could go wrong? My instincts are it is the growth story that is more likely to break first. US growth data has already started to slow a little and we are a while away yet from Trump actually being able to have an impact. But in the meantime, our diversification into US mid-caps is (finally) starting to bring some benefits. I don’t want to jinx all this by writing much more especially as today’s troubles for Microsoft (one of the most widely owned stock in the active management community) are not going to help much in the short term. But the big picture is the macro backdrop still looks pretty attractive today
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.
