Tom Stevenson, Investment Director, Fidelity International comments on what’s driving markets this week: “There’s no doubt about the market’s main focus this week. After 10 months without a move, the Federal Reserve is expected to cut interest rates for the first time this year. And that’s fuelling new highs for shares all around the world.
Global bull market
“The US remains in the vanguard of the rebound from April’s tariff-related market volatility. But the rest of the world is joining in the party. Three quarters of stocks in the MSCI All World global index are trading above their 200-day moving average. Momentum is strong. In part that’s a bet on lower interest rates. But it also reflects continuing belief in the AI transformation narrative. It’s why shares in Asian markets - home to much of the world’s computer chip industry - are leading the charge. Japan, South Korea and Taiwan all ended last week at new highs. “As always when markets surge, it’s a combination of rising earnings and higher valuations that’s driving the gains. The US market has risen nearly 90% since the October 2022 low, with around a third of that due to higher profits and two thirds a reflection of shares trading on a higher multiple of earnings.
Changing role of the Fed?
“A key reason why investors are so optimistic about lower interest is the perception that the Federal Reserve may be under greater pressure than in the past to consider the broader economic and fiscal backdrop when setting policy. For more than 70 years, the Fed has focused exclusively on inflation and growth when setting interest rates. But pressure is mounting on the central bank today to set policy to support the government’s desire for lower borrowing costs on its debts. With core inflation remaining sticky, it remains to be seen how far interest rates can actually fall but for now markets are assuming that the direction of travel is lower.
Party like its 1998?
“With the Fed set to cut rates even while the stock market is soaring, students of market history will note a worrying reminder of the late 1990s internet boom, when the Fed also poured fuel on a smouldering market fire. The result was a two-year melt-up in stock markets. It ended badly but only after an exciting ride for technology-focused investors. Back then, other signs of market froth included a booming IPO market as companies sought to cash in on high valuations. And a related rise in share-funded mergers and acquisitions as companies took advantage of the rising value of their shares to buy other companies relatively cheaply. On both fronts there are few signs of excess today. But last week was the best week for US market flotations in four years as companies from buy now, pay later business Klarna to crypto exchange Gemini raised a combined $4bn from investors.
Not all good news
“So, there’s plenty for investors to get excited about this week, but a few clouds on the horizon too. Here in the UK, inflation data is expected to emerge at twice the Bank of England’s 2% target. An inflation rate of 4% may not sound a huge problem but, as we explain here, it would wreak havoc with investors’ retirement plans if allowed to continue. And it makes it hard for the Bank of England to follow the ECB and Fed lower on the interest rate front - an issue for the government with long bond yields standing at a 30-year high."
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