Last week saw the release of the much-anticipated US Consumer Price Index report for April. Broadly speaking, the news is positive: inflation has resumed its downward path following a string of hotter-than-expected reports.
Overall, core CPI fell to 3.6% on a year-on-year basis. This is the lowest reading in three years – it peaked in September 2022 as supply chains began to rectify, input prices started to moderate and the Fed's restrictive policy started to bite.
Although Wall Street welcomed this development – the large-cap indices of the Dow Jones Industrial, S&P 500 and Nasdaq Composite all climbed to record highs – inflation in the US remains above the Federal Reserve Bank's target, and big borrowers are still feeling the pinch of higher interest rates for significantly longer than anticipated. Corporate profitability, however, is providing a cushion, protecting against inflationary pressures and the monetary backdrop.
The likelihood is therefore that for the rest of the year, the market will pivot around directional swings in inflation – whether or not the Fed decides to cut interest rates, and regardless of how the economy evolves over the coming months. So the bears will lie in wait for any bad news while the bulls will remain ready to propel the markets higher on the back of any euphoria or positive happenings.
Another newsworthy development was the Dow Jones Industrial Average Index hitting 40,000 for the first time in its 128-year history. But for many of us in the industry, the Dow Jones is a somewhat pointless index: it tells you very little about how corporate America is faring. The S&P 500 Index, on the other hand, gives far more in the way of insights into what is actually happening.
Similarly, the 30-stock index has been restructured and results are not particularly meaningful. It has taken the Dow a little over seven years to double since it hit 20,000 during the first week of Donald Trump’s presidency in January 2017. It is underweighted in the big tech stocks that have dominated growth since then, meaning that it has lagged behind the S&P 500 by more than 25 percentage points. It has, however, managed to come close to replicating the result of the equally weighted S&P 500, in which each constituent receives a weighting of 0.2%. Furthermore, three of the Magnificent Seven are now constituents of the Dow.
It is also interesting to gauge the performance of the index in relation to the performance of gold. Since the price of gold is regarded as a measure of confidence in currency, the stocks/gold ratio can provide an idea of the extent to which appreciation is due to monetary debasement, rather than corporate growth.
When denominated in gold rather than dollars, it turns out that the Dow has remained almost flat since it first hit 20,000. Furthermore, since the pandemic and the interest rate hikes over the last couple of years, it looks as though the Dow Jones has been pushed up to its most recent record by liquidity and money creation rather than anything else.
In the US Treasury market, the latest inflationary report and growth surprises helped drive the yield on the benchmark 10-year US Treasury note down to its lowest level in over a month. It is now looking likely that the 5% yield on the Treasury note that was recorded in October will prove to be the peak within this Fed-tightening cycle. Perhaps more interestingly, though, China sold a record number of Treasuries and US agency bonds over the first quarter of this year. This confirms that it is moving away from US assets as trade tensions continue.
According to the US Department of the Treasury, Beijing disposed of US$22 billion of Treasuries during that period. Meanwhile, its gold holdings increased by nearly 6% relative to the same period last year and now stand at some 308.9 tonnes for the first three months of 2024. This is despite the global gold price surpassing US$2400 per troy ounce. According to the World Gold Council, the People’s Bank of China has been adding to its gold reserves for the past 16 months, as have some of the other emerging markets.
China is evidently heavily reliant on the US dollar for trade with the rest of the world, something in relation to which Beijing is wary, given how poor relations with the US have been in recent years. It is therefore no surprise that the country's central bank is looking to gold as an alternative and a way to diversify its reserves.
This goal of diversification is shared by many of the world's other economies – the ones that are set to dominate the global economy by 2050. In January, five new members joined the BRIC bloc: Saudi Arabia, the United Arab Emirates, Egypt, Iran and Ethiopia. This means that five new currencies are now in the pot for payments and mutual holdings, joining those of Brazil, Russia, India, China, and South Africa.
The BRIC countries have even mooted the idea of a shared currency at some point in the future – one that could potentially challenge the US dollar as the world’s reserve currency. These nations are concerned over Washington’s tendency to “weaponise” the dollar and use it to safeguard its global economic and geopolitical position.
Russia's invasion of Ukraine in February 2022 followed by the US and the European Union imposing sanctions on Moscow (freezing Russian central bank foreign reserves) have made many central banks think carefully about what they hold in their reserves and what might happen in the event of economic downturns, financial crises or conflict.
In the UK, the latest wage data has given some members of the Bank of England's Monetary Policy Committee further reason to keep interest rates on hold. That said, the jobs market does indeed appear to be softening, even though there is still some concern over continuing wage growth. Although a rate cut in June remains likely according to Andrew Bailey, much will depend on inflation data for last month, slated for release this week.
In Europe, meanwhile, ECB policymakers have indicated that a rate cut is likely in June. And any cuts will herald the end of the Eurozone's stagnation. But there is still a measure of uncertainty.
On the international front, Friday saw Chinese President Xi Jinping rolling out the red carpet for Vladimir Putin. The talks that ensued have only been partly shared with the global community. There will no doubt be plenty in the way of clandestine discussions between the two superpower leaders.
Solutions for routing products around the world and avoiding US sanctions will be high on their agenda, together with China's alternative financing and settlement system. Both countries will be keen to find new markets to replace lost Western business as they suffer bans, higher tariffs and sanctions at the hands of the US and NATO.
But doing so is likely to create further tensions between Washington and Beijing. China is in a stronger position than Russia in this regard, but President Xi will not want to be seen as helping Moscow. His country gets cheap energy from Russia, so diplomacy will have to prevail.
Despite global uncertainty, the financial markets are still trending positively and indeed climbing. That said, this new bull market has not been without its corrections and setbacks. With sticky inflation and central banks unwilling to begin cutting interest rates, they ebb and flow on daily sentiment. Nevertheless, the S&P 500 has had a return of nearly 52% since October 2022 and has risen by more than 10% this year.
A significant portion of the market’s ascent since 2022 can be attributed to the prolific gains in the tech sector (predominantly those registered by the so-called Magnificent Seven) and to enthusiasm about AI. But recently, the market has begun to broaden out – a positive sign, and an indication that the current bull market will enjoy some longevity.
There will be bumps along the way, but we believe that both equity and bond markets will continue to take their cues from expectations regarding future Fed policy decisions. The eventual cuts in interest rates and the positive backdrop for corporate earnings should in our view create a positive outcome for both asset classes for the remainder of the year.
