Weekly market update: The Osgood Market and the slow fuse of the UK budget

Jack Lemmon’s character, who has spent most of the movie pretending to be Daphne, a female musician, is proposed to by Osgood, an eccentric billionaire. He tries to wiggle his way out of the proposal, by saying that she’s a terrible cook, a bad person, can never have children and is not a natural blonde. Osgood remains cool and unmoved and continues to declare his love for Daphne. Lemmon throws his wig down, and shouts “I am a MAN!”. Osgood continues to smile: “Well, nobody’s perfect”. 

Financial markets remind me a bit of Osgood nowadays. No matter how uninspiring earnings are, equities continue to rally, with US large-caps delivering almost all an average year’s returns (7.5%), before February is out. The US economy added 275k new jobs. Sure, but let’s focus on unemployment, a known lagging indicator, which rose. Wages continued to grow. Yes, but at a slower pace.

The Fed tells us in all possible ways to remain vigilant with inflation (corroborated by PMI reports which show lingering wage pressures). Let us lower our rate expectations faster.

As of this morning, markets have gone back to pricing in four rate cuts this year, starting in June.  Yields are coming back down again.

There seems to be nothing this market can do to disappoint investors. It’s not just stocks and bonds. Gold has rallied without responding to any sort of crisis, gaining nearly $200 since Valentine’s Day. And let’s not even dwell on Crypto, our age’s bellwether of market sentiment.

If there is one cardinal rule in markets, it is this: a bull market doesn’t stop until everyone has bought into it. The more seasoned investors warn that the rally is stretched and that bond markets are pricing in a perfect rate scenario, the more the bullishness persists. This isn’t karma or some odd market Murphy’s law. It’s simply cash flows. The more money sitting out of the rally, the more cash can come in at every market turn.

So we would not discount the rally just yet. If for no other reason than because we are being constantly warned about it.

The slow fuse budget

The second subject I would like to touch upon is the budget. Overall, and on the face of it, it was a modest event. Scrapping of the non-dom status and diverting funds towards tax cuts has a very clear goal of undermining the Labour agenda ahead of the general election later in the year and boosting consumption in an attempt to lift the economy at least above the recession line.

Legislation of a British ISA provided a modest boost to UK equities, but nothing to write home about. For the week, European stocks rose more. Scrapping the multiple dwellings relief on stamp duty will probably hit the buy-to-rent market. The message to investors in the buy-to-rent sector is simple: “We will not help practices that cause real estate inflation”

However, three elements of the budget worry me over the longer term. All of these pertain to how international investors see the UK.

The British ISA. The measure, small to be sure, amounts to a subsidy for British stocks. In theory, if locals invest more, international investors might be induced to follow. However, for long-term investors things don’t necessarily work that way. Long-term investors want strong fundamentals. If a future government takes the subsidy away, then investors could lose money. A government subsidy doesn’t send a positive signal for those who would like to see London’s return as a financial market powerhouse.

The message to international investors: if you are a non-dom, we will not support you anymore. If you want to buy property as an investment, we will not support you anymore. There are many cohorts of High Net Worth and Ultra High Net Worth individuals and international investors who might not look at those changes with a positive eye.

The UK, like the US and other G7 countries, has a history of a peaceful transition of power. Such stability is the most important signpost for international investors. However, as politics turns more acerbic, we see an increase in the practice of purposefully limiting the next government’s ability to deploy an effective budget. This practice usually includes running high deficits (check), lowering tax intake (check) and possibly leaving an inflationary legacy (like the US in 2021). From my experience in less developed countries, this can be a slippery slope. The way out for the next government is invariably higher borrowing. And the signal to investors (foreign or domestic) is one of growing acrimony and more instability. The UK is, of course, nowhere near my Balkan experience - yet. But the pool of investor patience with the UK is not infinite, as the September 2022 mini-budget debacle clearly illustrated.

Britain has thrived as an open economy. The steady emission of signals that it would prefer to focus on solving growing internal problems might appeal to voters today, but it could come at the expense of economic growth tomorrow.

George Lagarias – Chief Economist

Market update

Developed market equity performance was mixed last week. UK equities rose slightly, just +0.1%, while European equities advanced by +0.7%. Conversely, US equities underperformed materially in GBP terms, falling -1.9% thanks to material Sterling appreciation, as the GBP/USD exchange rate rose to 1.29, up +1.8% over the week. Japanese equities were the most significant outperformers, posting gains of +0.9%, whereas emerging market equities experienced a modest decline of -0.6%.

In the bond market yields fell across the board as central banks in developed economies hinted at future rate cuts. The US 10-year Treasury yield fell 10 bps, settling at 4.09%. The UK 10-year Gilt yield and German 10-year Bund yield also declined, falling by 11bps and 14bps to 3.98% and 2.26% respectively.

Volatility continued in the commodities market last week. Gold significantly appreciated, up +4.1%, finishing the week at $2171.2/oz. In contrast, oil prices declined sharply, dropping by -4.1% to $78.01/barrel.

Macro news

The UK Chancellor of the Exchequer Jeremy Hunt introduced a 2% cut in the main rate of national insurance contributions this week, during his last Spring Budget announcement before the general election. Other changes in the budget included the abolition of the ‘non-dom’ tax regime, a loosening of child benefit rules, the introduction of a British ISA, and increased taxes on vapes, tobacco and premium flights.

Federal Reserve Chair Jerome Powell said on Thursday that the US central bank was “not far” from reaching the required level of confidence needed to begin cutting interest rates. Powell stated that if the economy continues to deliver strong growth while inflation continues to cool, the process of cutting interest rates “can and will” begin over the course of 2024.

The US economy added 275,000 jobs in February, beating economist expectations of a 200,000 rise. However, this news came along with a large downward revision of figures in January and December, which showed that 167,000 fewer jobs were created over these two months than had been previously thought. The unemployment rate was reported to have risen to 3.9% from 3.7% previously, while wage growth slowed, rising 0.1% in February compared to 0.5% in January.

The week ahead

All eyes will be on US inflation this week, as investors continue to scramble for any hint of the timing and magnitude of coming interest rate cuts. Current expectations by economists are a 3.1% year-on-year rise, unchanged from the previous number. In the UK, labour market data will be released on Tuesday, including unemployment rate and wage growth, while GDP growth data for January will be released on Wednesday.