Monday Espresso Podcast - 5th August 2024

[00:00:00] Sheldon MacDonald: It's the 5th of August and we had quite a momentous week in markets last week, the movements on the equity side and the bond side. Yeah, let's get into it. I'm joined by Sarah today. Sarah, I guess from a local perspective, some of the biggest news was on the UK side with the rates decision.

[00:00:17] Sarah Todino: Yes, the Bank of England cut interest rates this week from 5.25% to 5%. So, interest rates have been on hold since August last year and at a 16 year high. So, it was a close call with the Monetary Policy Committee voting 5 to 4 in favour of a cut. And this is of course, good news for borrowers, but bad news for savers as the interest they receive will decrease over time in terms of the direction from here, the monetary policy committee will be looking for more progress on the inflation front, although annual inflation is at 2% services inflation does remain sticky.

[00:00:51] Sheldon MacDonald: Yeah, inflation is sticky as you mentioned in the UK, also in Europe, we saw no change in the prior week from the ECB. In the meantime though, bond markets are taking it quite positively and we have seen quite a surge in bond market performance in the past week. That's doing quite nicely.

[00:01:07] Sheldon MacDonald: That's in counterpoint to what's going on in equity markets. We'll come to that in a second. First though, what about the US rates decision?

[00:01:15] Sarah Todino: So, in the US, interest rates remained on hold in line with expectations, with the Federal Reserve continuing to monitor employment and inflation data. Inflation has been falling since March, but does remain elevated at 3%, and Chair Powell indicated that a cut in September could be on the tables if we do continue to see progress in inflation.

[00:01:36] Sheldon MacDonald: Regardless of what Mr. Powell said, markets do seem to be expecting that there will indeed be a cut in September. Expectations have been rising as we've seen data easing. So, fears starting to mount that perhaps the Fed is a little bit behind the curve. That they've waited too long to start cutting rates and people starting to talk about the possibility of recession in the US.

[00:01:57] Sheldon MacDonald: Now that has led into fears on the equity front. As I mentioned, some turmoil there, we've certainly seen volatility return with quite a vengeance, particularly amongst the magnificent seven. We've obviously been speaking about those for several months now, those top tech stocks that have been driving returns, earnings announcements from some of those companies, not as strong as hoped for.

[00:02:18] Sheldon MacDonald: Some fears mounting there, and that has led to, as I said, this volatility. We've seen a definite rotation in market leadership away from those magnificent seven into some of the smaller stocks. Apart from the interest rate outlook and the growth outlook, there's also the ever present geopolitical risks.

[00:02:34] Sheldon MacDonald: Uncertainty around the US election has returned. The Democrats seem back in the race. Kamala Harris certainly galvanizing her party, and some of the polls putting her neck and neck with Trump now but anyway, uncertainty, we know that markets don't like that, and that's led to some of the volatility that we've seen.

[00:02:52] Sheldon MacDonald: And then also potential escalation of the conflict in the Middle East preying on people's minds.

[00:03:02] Sheldon MacDonald: So, turmoil there, but the biggest impact that we've seen has been in Japan, right Sarah?

[00:03:07] Sarah Todino: Yes, The Bank of Japan raised its benchmark interest rate to 0.25% up from 0 to 0.1%. The Bank of Japan has been under increased pressure to raise rates in order to support the yen which has weakened significantly this year.

[00:03:21] Sarah Todino: A weaker yen can increase inflation by lifting import prices. So we've actually seen a rally in the yen since mid-July driven by some government intervention, but the yen has continued to rally since this decision amid prospects of further interest rate increases, and a lot of Japanese earnings benefit from a weaker yen.

[00:03:39] Sarah Todino: Given that Japan is an export economy, Japan equities are really seeing the impact of this with the Nikkei down 12% on Monday.

[00:03:48] Sheldon MacDonald: Yes, and that's on the back of a week a week the previous week. I think it was down something six, seven percent?

[00:03:55] Sarah Todino: That's right. And asset allocation to Japan is small worth noting in June. We also moved from overweight to neutral Japan equities.

[00:04:04] Sarah Todino: So, we saw from a macro perspective, GDP data start to soften. Inflation does remain above target Japanese equity earnings, momentum starting to fade. And we actually may saw negative fund flows from Japan after a long time of positive inflows. So, we saw that as a good opportunity to move from overweight to neutral Japan equities.

[00:04:30] Sheldon MacDonald: Yes, and on top of that, also our strategic asset allocation in Japan changed, also came down with the latest review of our quantitative model, the model reducing exposure to Japan. So, the net effect is that in our portfolios, at least Japan exposure is pretty minimal. And I guess that highlights the importance of taking a diversified view that you're not exposed to any one particular area or one particular region or asset class too much.

[00:04:56] Sheldon MacDonald: So weaker markets today, not overly weak. It's not a panic. The point is that markets are not panicking so far. Obviously, things can change and there's lots going on and we look forward to speaking to you about it again next week.