Weekly Comment: Markets and an age-old question

Ever wondered if the glass is half empty or half full? It’s a question worth asking when navigating financial markets.  How so? Well, most of the time markets are driven (in both directions) by key economic or corporate data—think inflation readings, GDP growth, corporate earnings—but there are also times when these same indicators don’t hold quite the same sway they may previously have had. Instead, sentiment grabs the reins and when it does markets can forego standard operating procedure: strong inflation numbers may not lead to a tick-up in government bond yields; stellar results from market leaders may not generate handsome share price gains. For an example of these half-full/half-empty moments, look no further than last week’s price action in global markets.

Market overview

Exhibit#1: Stock markets

Global equities ended the week in negative territory. The culprit? The previously high-flying technology sector. This was despite forecast-busting Q3 numbers from one of the big five artificial intelligence (AI) hyperscalers, Meta. The Facebook owner clocked up a 26% year-on-year jump in revenues to US$64.6bn, beating the company’s own guidance of US$61bn-US$64bn and market forecasts of US$63.3bn. And then there was market newbie Space X which reported a 161% increase in Q3 revenues to US$14.6bn, comfortably ahead of the US$12.9bn that had been pencilled in. US$4.4bn net profits also blew away expectations of US$2bn thanks to a surge in cloud computing revenues to US$7.6bn compared to the previous quarter’s US$2.56bn.

Strong numbers on both counts and yet the respective share prices of the two companies closed down on the week: Meta -9%; Space X -0.5%. Not an obvious price reaction to the two sets of results, but one that can be explained by the current glass half-empty outlook of markets. This can be traced back to growing concerns over the sustainability of the great AI infrastructure roll-out. Specifically, will AI usage and returns reach the levels required to justify the trillions of dollars being invested and, related to this, how will all the infrastructure be funded?

So, rather than focus on the forecast-beating headlines, investors latched on to Meta’s capital spending plans (US$145bn for the full year) and accompanying comment that it is an “increasingly challenging environment for raising capital”.  Space X too is spending heavily on AI infrastructure: capital expenditure is forecast to double to US$35bn-US$40bn in Q4 from Q3’s U$19.6bn. Not too long ago plans to invest such large sums would, more likely than not, have generated a more positive share price reaction, but that was when markets had a glass half-full outlook.

Exhibit#2: Government bond markets

The week ended Friday 23 October saw 10-year government bond yields in the US, Germany and the UK all tick lower. It is not uncommon for yields across the three jurisdictions to move in the same direction. Less common, especially during these past few months, is for yields to move lower when oil prices rise meaningfully, as they did last week when Brent Crude rose to around US$116 per barrel. The reason? Speculation that the US and Israel plan to renew strikes against Iran once November’s US midterm elections are out of the way.

Rising oil prices and the negative implications these have for inflation and interest rates are one reason why US government bond yields have risen to multi-decade highs in recent weeks. For yields to drop back rather than increase in response to another lurch upwards in the oil price is a departure. But it is consistent with investors seeking the relative safety of government bonds during an AI wobble. The risk-off move trumps inflation concerns, for the moment at least.

Half-empty then

In terms of today’s financial markets then, it would appear the glass is half-empty. The thing is, we’ve been here before with AI. In The balance of risks and opportunities for AI investors, we note how there have been seven major pullbacks since the AI trade began almost four years ago. And yet, markets soon regained their appetite for AI stocks. Will the latest pullback follow the same pattern?  In addition to running through key market concerns dominating sentiment today, the above article also identifies seven AI trade positives. All of these could well come to the fore again. That is, should markets adopt a more glass half-full perspective once more.

Weekly market moves:

The MSCI All Country World Index (MSCI ACWI) ended the week 0.9% lower. The year-to-date (YTD) gain now stands at 11.9%.

United States:

US stocks outperformed their global peers after ending the week down 0.5% (+12.4% YTD). AI concerns in the technology sector saw large-cap growth stocks decline 1.5%, meaning the market’s outperformance was down to value (+0.7%) and small-cap names (+2.0%). On a YTD basis, growth stocks are barely in positive territory (+1.5%) while value (+23.9%) and small caps (+13.1% YTD) are the ones boasting growth-like returns.

Risk-off sentiment enabled US Treasuries to shrug off the latest US Composite Purchasing Managers’ Index (PMI) reading. This came in at 57.6, a little lower than September’s 58.4, although still comfortably in expansion territory (readings above 50 indicate expanding activity). The yield on the 10-year Treasury fell eight basis points to 5.00% (up 83 basis points YTD); while the 2-year Treasury yield declined by a more modest three basis points to 4.68% (up 121 basis points YTD).

United Kingdom:

UK large caps gave back some of their recent gains. A 1.7% loss for the week trimmed the YTD rise to +10.5%. Mid-caps fared a little better (-1.2%). YTD, the smaller end of the UK market is now up +10.8%. This week’s Budget perhaps one reason for the weakness but then again sterling strengthened against the US dollar to US$1.34 compared to US$1.33 previously, suggesting forex markets aren’t overly concerned with what will or will not be in the chancellor’s statement.

The same could be said for the gilt market after the yield on the 10-year note edged one basis point lower to 5.36% (up 88 basis points YTD), even though there was an unexpected fall in UK unemployment to 4.7% in August from July’s 4.9% and a higher-than-expected rise in inflation to 3.5% in September. The data fed the narrative that the Bank of England could raise interest rates at the next Monetary Policy Committee on 5 November.

Europe ex UK:

The MSCI Europe ex-UK Index also underperformed after registering a 1.3% loss for the week (+8.5% YTD). As an energy importer, the region feels the impact of higher oil prices more than the US, while political uncertainty and unrest, notably in France, also weighed on sentiment. This was reflected at the national level with traditional safe haven Switzerland posting a weekly gain of 0.5% (+12.4% YTD), while German stocks declined 1.7% (+2.8% YTD). Elsewhere France’s large-caps retreated 2.2% (-1.6% YTD), while their Italian peers gave up 2.6% (+11.4% YTD). The euro was unmoved however ending the week unchanged at US$1.12.

In line with the US and UK, the 10-year German Bund yield fell six basis points to 3.42% (up 57 basis points YTD). Not all, government bond yields moved lower. Rioting and looting across France, together with ongoing worries over the state of the country’s finances, pushed the yield on French 10-year paper to over 5%.

Important information

This material is a marketing communication provided for information purposes only and does not constitute independent investment research. References to financial instruments are for general information purposes and are not subject to requirements applicable to independent investment research.

Any references to securities or financial instruments should not be regarded as a personal recommendation, or as an offer, solicitation or invitation to buy or sell any financial instruments. The views expressed are those of the authors at the time of publication and are subject to change. Past performance is not a reliable indicator of future results.

This material does not constitute tax, legal or accounting advice. You should seek independent professional advice appropriate to your individual circumstances before making any financial decision or engaging in any transaction.

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