•    November 5th Marks a Significant Date: Fireworks and a pivotal election could drive notable shifts in sentiment.

•    US Equities Facing Near-Term Volatility: Increased downside risk as U.S. government debt re-enters value territory.

•    China’s Economic Boost: Upcoming policy forum may introduce further support to stimulate growth.

•    UK Budget Insights: Highlights Europe’s ongoing fiscal policy and growth challenges.

•    Crypto Gains Institutional Backing: More support from institutions strengthens the crypto market.

As November 5th approaches, two nations will observe this date in markedly different ways. In the UK, it’s Guy Fawkes Night—a celebration marked by fireworks and bonfires commemorating the failed attempt to blow up the Houses of Parliament. Across the Atlantic in the United States, however, this date holds another significance: it’s the Election Day.

Not an easy verdict 
This year's election in the US is anticipated to be a defining moment for the democratic process in the country. The markets, wary after the drama that unfolded on US Capitol in January 2020, will be watching closely, hoping for a decisive and uncontentious outcome. Yet, while fireworks light up the sky in Britain, investors may brace themselves for a period of uncertainty and volatility as the results unfold. In the absence of a clear verdict, the path forward may be even more choppy.

Bonds sell off
The US economy has generally surprised to the upside so far, and the Federal Reserve is expected to cut interest rates by an additional 25 basis points at its meeting on Thursday. With polls showing a tight race, a final, decisive outcome may take some time. Bonds have already seen a sell-off, driven by market concerns about potential inflation risks from further fiscal expansion and large ongoing supply. The 10-year government bond's real yield is now approaching some of the highest levels observed in the past nine years.

Chart 1: US 10-Year Government Bond Yield Close to Recent Real Highs
US 10-year yield adjusted for inflation

Source: Bloomberg

The US equity market, however, appears vulnerable in the near term. While some investors argue that a Trump victory could be beneficial for equities due to hopes of greater economic growth stimulus, current market valuations are considerably higher than in 2016, the year before Trump took office for the first time. Any substantial fiscal boost would likely take several quarters to pass through a divided Congress, which may delay its impact. Additionally, some market fundamentals, such as earnings revisions, are currently challenging. The third-quarter earnings season has delivered mixed results, with the S&P 500's expected earnings level continuing to trend lower, a pattern observed throughout much of this year.

Chart 2: S&P500 Forecast P/E at Close to its Highs Even as Earnings Forecasts Drift LowerSource: Bloomberg 

China’s Debt-funded Bazooka?
The upcoming National People's Congress (NPC) meeting in China is poised to address several critical economic and social issues. There may be no fireworks but there could be something resembling a debt-funded bazooka coming from China’s National Policy Committee meeting this week.

Key areas of focus are expected to include:
Economic Growth Targets: China has set a GDP growth target of around 5% for 2024. Recent data indicates a 4.6% growth rate in the third quarter, slightly below this target. The NPC may introduce additional fiscal and monetary policies to stimulate the economy and achieve the annual goal.

Property Market Stability: China's property sector has experienced significant declines, with property investment and home sales seeing steep drops. The NPC may propose measures to stabilise the real estate market, including support for developers and policies to boost consumer confidence in property investments. The market expects a significant lift in the government debt ceiling to boost capital support for banks and local government debt swaps. According to a Reuters report, the Committee will also approve 10 trillion yuan (equivalent to about 8% of GDP) in extra debt in the next few years, with 6 trillion for addressing local government debt risks and 4 trillion for idle land and property purchases.

Youth Unemployment: The youth unemployment rate for individuals aged 16 to 24, excluding students, decreased to 17.6% in September from 18.8% in August. Despite this improvement, the rate remains a concern. The NPC is expected to discuss strategies to further reduce youth unemployment, such as job creation programs and vocational training initiatives.

Ordinarily you might have expected the prospect for a good performance for Chinese equities on the wake of the meetings. However, things are rather overshadowed by developments in the US!

UK Government Budget: Another European Attempt at Fiscal Reform

The UK government’s budget last week was another episode of the attempts Western countries have instituted to reset fiscal policy to cope with mountains of debt. The eurozone has already announced fiscal consolidation, which is likely to detract markedly from growth in the coming years. In her first budget, UK Chancellor Rachel Reeves aimed to establish a reputation for financial stability and credibility, a balancing act familiar to many Western governments. She pledged to avoid austerity while promising not to increase taxes on "working people," despite the country’s slower growth outlook.

Here are three key themes that stand out in the global context:

1.      Strengthening Financial Oversight
The Chancellor has empowered the Office for Budget Responsibility (OBR) with a new, stronger charter to enhance its independent oversight of public finances. Although the initial market reaction has been lukewarm, with 10-year government bond yields rising by 0.25%, one interesting global takeaway is her approach to measuring government debt. Reeves introduced a new calculation – "public sector net financial liabilities" – which considers both the costs and benefits of debt. For this to be effective, the government will need to stick closely to its timeline for reducing debt.

2.      Shifting the Tax Burden
Reeves’ budget shifts more of the tax burden to businesses and wealthier individuals rather than “working people.” Of the £40 billion in proposed new taxes, £25 billion will come from businesses, with the impact spread over the next few years. This approach aligns with Labour’s commitment to be business-friendly as the UK competes to attract global investment.

3.      Boosting Public Investment
One of the most notable aspects of the budget is the allocation of an additional £125 billion for public investment over the next five years. This funding covers a wide range of projects, which some critics say could "crowd out" private investment. The OBR projects stronger growth through 2025-2027, although it may weaken in later years. For this investment to succeed, Reeves will need to ensure that projects are rigorously evaluated and that the government responds effectively to calls for public sector reform and streamlined planning regulations.

Chart 3: UK FTSE100 and UK 10-Year Bond Price and Sterling Initially Fall on UK Budget

Source: Bloomberg 

Time for ‘alternative’ assets?

Cryptocurrencies have performed strongly of late, partly on anticipation of a favourable outcome for Donald Trump in the presidential election. However, attributing this momentum solely to an election outcome would oversimplify the complex dynamics driving the market, especially given the potential volatility if Trump fails to secure victory.

A recent article on the Chief Investment Officer website highlighted growing institutional interest in digital assets, citing the Florida State Board of Administration, which oversees $245 billion in pension assets. The Board's CFO has advocated for a Digital Currency Investment Pilot Program, describing it as "a perfect fit, offering potential benefits we cannot afford to overlook." This trend is echoed across other institutions as well: the Wisconsin Pension recently invested $160 million in Bitcoin ETFs; the Employees' Retirement System of Jersey City announced plans to allocate funds to cryptocurrency; and the State of Michigan Retirement System committed a modest $6.6 million from its $100 billion portfolio. These moves underscore the increasing institutional embrace of digital assets as part of a diversified strategy.

Chart 4: Bitcoin Increasingly Becoming an Institutional Asset Class?
Bitcoin/USDSource: Bloomberg 

Gary Dugan - Investment Committee Member

Bill O'Neill - Non-Executive Director & Investor Committee Chairman

4th November 2024

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