Weekly Comment: Sneezes, colds and tonics

“When America sneezes, the rest of the world catches a cold” is an oft-quoted saying used in financial markets, but did you know that the original phrase did not mention America at all? Instead, the sneezing country was none other than France: “When France sneezes, Europe catches a cold". The original version dates back to the first half of the nineteenth century, a time when France had significant global sway. Fast forward one hundred years to around the time of the 1930s Great Depression and America had displaced France as chief sneezer. Why the history lesson? Because, as the above highlights, sayings sometimes need a refresh. This leads on to the question, could the phrase do with another tweak now? For despite US stock indices having an artificial intelligence (AI) induced sneeze last week, not all equity benchmarks caught a cold. Some ended the week in positive territory. Take a bow the MSCI Europe ex-UK Index.

Market overview

Not another AI wobble

We’ve been here before in terms of stocks getting the AI jitters. In The balance of risks and opportunities for AI investors, we count seven major pullbacks in the last four or so years. Make that eight now. The origins of the latest wobble can be traced back to the previous week’s Q3 numbers from AI hyperscalers Alphabet, Amazon, Meta and Microsoft. These served to feed existing market concerns over when the industry would start to see meaningful returns on the huge investments being made in AI. The worry being that widespread opposition to data centres in the US, increased calls for regulation from the industry itself and the higher cost of capital arising from elevated bond yields threaten to slowdown the pace of AI roll-out. The point at which all that investment generates the returns promised is therefore in danger of being pushed further out into the future, reducing its present value and increasing the timeline for risks to occur.

Then along came the US midterms

The blue wave that saw the Democrat Party wrest back control of both houses of Congress failed to translate into a blue week for US stock markets. An initial rally on the day of the results appears to have been borne out of relief that the scale of the Democrats’ victory made it unlikely that President Trump would contest the results. Relief soon gave way to those AI anxieties. For not only did the Democrats win back Congress but they also won key gubernatorial battles in states, such as Texas, where many of the data centres are set to be built. Elected on anti-data centre tickets, the wave of newly elected governors only fed the narrative that the great AI pay day isn’t coming any day soon.

The red wave

Cue across-the-board falls in the share prices of key AI suppliers, including previously high-flying semiconductor manufacturers, memory storage companies, and neoclouds. The weakness was not confined to the US but spread to other stock markets too, specifically those home to key AI suppliers. And here’s the thing, these markets did catch a cold as they underperformed US equities by a wide margin. South Korea’s main stock index ended the week around 12% lower in local currency terms, as did Taiwan’s, while Japan’s finished the week down 6.5%. There’s life in the old saying yet!

A European tonic

But not all stock markets caught a cold. Those with little exposure to the AI trade outperformed the US. Some, such as European large caps and UK midcaps, even ended the week up. Being AI-lite was not the only thing going for European stock indices. The market also interpreted the Republican party’s electoral drubbing as increasing the likelihood of a peace deal between the US and Iran—the price of Brent Crude oil dropped below US$100 per barrel, having traded at US$118 as recently as 30 October. As a net importer, Europe is more exposed to higher energy prices compared to the US. Peace in the Middle East would therefore remove a significant headwind for the region. A further positive is that a Democrat-controlled Congress could limit the risk of a tariff war breaking out between the US and Europe.

Low exposure to AI, high exposure to peace in the Middle East, reduced threat of tariff wars—it’s easy to see why European and UK markets outperformed. Enough to warrant tweaking the old saying to something along the lines of “When America sneezes, Europe gets a tonic”? Perhaps that would be a tad premature. For now, at least, the outperformance of European and UK equity benchmarks highlights how the benefits of geographic diversification in client portfolios are alive and well. That on its own should be enough of a tonic for the time being.

Weekly market moves:

The MSCI All Country World Index (MSCI ACWI) ended the week 2.7% lower so that the YTD gain now stands at 8.6%.

United States:

US stocks ended up matching the global benchmark point for point. The 2.7% weekly loss for large caps brings the YTD gain down to +8.8%. With AI-related stocks leading the overall market lower, large-cap growth names were always going to find the going tough. In the event they fell 5% over the course of the week (-5.1% YTD). Compare that to value stocks which edged down just 0.5% (+23.8% YTD), while small caps fell 2.0% (+12.2% YTD).

The risk-off sentiment and increased prospect of lower energy prices drove US Treasury yields lower: the 10-year Treasury yield fell seven basis points to 4.86% (up 69 basis points YTD); the 2-year yield declined eight basis points to 4.51% (up 104 basis points YTD). Lower yields were not a given though. A stronger-than-expected October non-farm payrolls report (165,000 jobs added while estimates for August and September were revised higher by a combined 84,000) upped the chances of a rate hike at the December Federal Reserve meeting to around 80%. The unemployment rate ticking down to 4.1% from 4.2% and an increase in the ISM Manufacturing Purchasing Managers’ Index to 55.5 in October from 54.5 (readings of 50 or above indicate expansion) further fed the interest rate hike narrative.

United Kingdom:

As mentioned earlier, UK stocks outperformed US and global indices. UK large caps finished down 0.5% (+10.4% YTD) but it was London’s midcaps that stood out with a 0.3% gain (+12.1% YTD). The midcaps’ performance was all the more impressive given that this more domestically focused segment of the market had to deal with a first rise in UK interest rates since 2023—the Bank of England (BoE) raised rates by 25 basis points to 4.0%. What’s more BoE Governor Andrew Bailey hinted that, should inflation pressures persist, another increase could be on the cards in December. The gilt market didn’t appear overly fussed—the yield on the 10-year note fell 13 basis points to 5.15% (up 68 basis points YTD). Neither was sterling which was unmoved at US$1.34.

Europe ex UK:

For the second week running, the MSCI Europe ex-UK Index was the top performer thanks to a 0.5% gain (+11.3% YTD). At the national level, French large caps’ 2.1% rise caught the eye (+2.9% YTD), closely followed by their Italian counterparts which tacked on 1.1% (+14.9% YTD). Germany’s main equity index meanwhile was unchanged (+5.4% YTD), while Switzerland’s was down just 0.1% (+15.0% YTD). Like sterling, the euro was unmoved, ending at US$1.11. Finally, the 10-year German bund followed the global trend and finished the week seven basis points lower at 3.25% (up 40 basis points YTD). That was despite an increase in Eurozone headline inflation to 4.0% in October from September’s 3.8%.

Important information

Investors should remember that the value of investments, and the income from them, can go down as well as up and that past performance is no guarantee of future returns. You may not recover what you invest.

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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