Weekly Digest: Events, dear boy…

It was a welcome change to be able to zoom out a bit in last week’s Weekly Digest and take a longer perspective. However, we’re going to have to re-attach the macro lens this week as many events are set to demand investors’ attention. We’re moving into the thick of the third-quarter company results season, while the geopolitical and monetary outlook remains very fuzzy. Government bond markets have rallied from their lows (with bond yields falling commensurately) but traders remain nervous about fiscal deficits – the gap between governments’ revenue and spending. Addressing ours in the UK will be a key objective for Chancellor John Healey in Wednesday’s Budget. 

And then, in a week’s time come the US mid-term congressional elections, with the Democrats strongly backed to regain control of the House of Representatives and more tentatively backed to win the Senate too. We’ve already written about what this might mean for investors. But after Sunday’s shock win for the less fancied incumbent President Lula da Silva in Brazil – he’d come only second in the first round – nobody is going to take anything for granted. We don’t expect any of these to shift our current asset allocation in the light of all I’ve set out above, as we seek to invest well to help our clients live well. But, as the late UK Prime Minister Harold Macmillan is said to have noted with his laconic “Events, dear boy, events” comment, what happens in political and public life can force change. 
 

Marking the score card

As I previewed a few weeks ago, the global quarterly earnings season is set to provide either confirmation or rejection of what has been a strong upward cycle. Looking mainly at the US, it’s still early days: only around a quarter of the constituents of the US S&P 500 Index have reported so far – and few of those that are going to hog investors’ attention. The big banks always set the ball rolling. Their results, in aggregate, were very respectable without shooting the lights out. 

There was some disappointment about the outlook for trading activity given delays to various high-profile initial public offerings, or IPOs (notably frontier AI model developers OpenAI and Anthropic). There was also lingering suspicion that the high net interest margins derived from low cash deposit rates might be vulnerable to disruption from AI agents being let loose to shift money to more generous borrowers – one of those threats in a fast-moving technology cycle which is impossible to fend off entirely. Interest margins are high when there’s a large gap between what banks are paying lenders and what they’re charging to borrowers.

But the key point was the limited signs of a deterioration in consumer or corporate credit. That speaks to two main factors. One is that the private sector, following almost two decades of putting its house in order after the Global Financial Crisis, is not particularly highly indebted – in contrast to the federal government. The other is that steady gains in wealth continue to support personal balance sheets. Meanwhile the economy trundles on, with third-quarter GDP growth expected to come in at just over 3%. 

We get into the meaty section of third-quarter earnings this week. That includes three of the ‘hyperscalers’ - Alphabet (parent company of Google), Microsoft, and Amazon - that are investing unprecedented amounts of capital into data centre construction and providing a decent chunk of that American growth. We’ll also get reports from several other companies that sit in different parts of the supply chain, from semiconductor chip manufacturers (Korea’s SK Hynix and the US’ Intel) to power companies (GE Vernova) and component suppliers (Corning, Amphenol). Every statement will be scoured for evidence of the returns to be made on all this investment. This is especially the case now that frontier model developer Anthropic has filed for its IPO, potentially creating another $2tn company that will be finding its way into equity indices. 
 

Healey's constraint

This sounds like it could be some sort of medical condition but reflects the fact that Chancellor John Healey is pretty hemmed in when it comes to delivering his first Budget. His predecessor, Rachel Reeves, had built up a ‘fiscal headroom’ of around £25bn – the amount by which tax could come in lower than estimated, or spending higher, before the government broke its fiscal rules. But higher bond yields have increased the cost of servicing the country’s debts, halving that headroom. This gives Healey limited scope to pursue ambitious spending plans without either cutting spending elsewhere or raising taxes. The former route seems to be permanently blocked off by members of his own party (who have already seen off one Prime Minister who tried to navigate it). But any attempt to raise taxes features the hurdle of the party’s last election manifesto, which precludes raising the levels of income tax, corporation tax, VAT, or employees’ national insurance. 

This list includes by far the biggest contributors to the Treasury’s coffers, putting the onus more on taxing wealth. However, the message seems to be getting through (at least to some degree) that this has a more negative impact on Britain’s long-term growth potential. Hence, for example, a pre-announcement that there are no plans to bring the capital gains tax rate in line with income tax. 

It looks as though, instead, Healey will unveil a smorgasbord of small adjustments with no main course. Markets seem to like that, for now. Although gilt yields have been rising this year, our bond market has not fared worse than most other major developed countries – and much better than France’s. Sterling’s trade-weighted index is testing its post-Brexit highs again, and the pound has risen about 4% versus the euro this year.

If former Prime Minister Liz Truss performed one service for her country, it was blowing up the bond market in such a fashion that it will keep future administrations from doing anything too imprudent for years to come. Even so, and despite the plaudits the UK government has received from the International Monetary Fund for a viable plan to keep our deficit under control as well as a persistent run of better-than-expected growth, the UK is still fiscally challenged. To meet its fiscal rules, it needs to generate sustainable growth from government spending in the first half of this parliament before tightening the belt closer to the election. I think you can see how that plan might yet fall foul of the electoral cycle. 
 

An eye on 2028 

The US mid-term congressional elections usually see the dominant party from the previous Presidential election losing at least one of either the House of Representatives or the Senate. It’s difficult to keep voters as happy as you promised you would – and retribution is swift. Not that said voters will ultimately be any happier with the new majority, but it creates at least some sort of illusion that the democratic process is proving effective. If that sounds too cynical, just look at the US’s ever-increasing debt pile and widening social divisions under both parties, exacerbated by economic and fiscal policies. 

In fact, if the Democrats do regain control of both Houses of Congress, that is unlikely to cause a major change in direction for policy as directed from the White House. If anything, a severe loss could make the President even more belligerent in his foreign policy, with implications for the oil price. 

The key thing to look out for will be the magnitude of the shift towards the Democrats and what signals that might generate for the Presidential election in 2028. This might be one of those cases of ‘be careful what you wish for’. A more progressive President would probably be more in favour of regulating AI. This might possibly be right for humanity, but it might not suit the more near-sighted investment community. And the same goes for possible increases in corporation taxes, which could play some part in narrowing the fiscal deficit but would dampen earnings growth. 
 

Fiscal incontinence

Joe Biden narrowed the deficit after the pandemic, but it remained well above the historical average. Under Donald Trump, it’s projected to grow even larger.