Global stocks are heading for their worst week since April as concerns over lofty valuations and whether massive investments in artificial intelligence will pay off prompt investors to retreat from riskier assets.
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Valuations of global stocks fell this week after a sharp reversal on Wall Street reignited fears over the lofty valuation of artificial intelligence companies. The declines came despite strong results from a US tech giant. The news provided only fleeting reassurance to investors who have been reassessing valuations of tech stocks after a strong run over the last seven months.
On 20 November, the Vix index, Wall Street’s measure of volatility, soared from about 20 to 28, a move that underscored the abrupt bout of volatility. Our US equity team tends to view this pullback as corrective after a strong rally rather than the start of a prolonged downturn.
Fall in the probability of another Fed rate cut
This week also saw the release of the much-awaited September non-farm payrolls report, with the headline print quite strong, showing 119,000 jobs added. This is the largest increase since April and well above the (Bloomberg) consensus expectation of 51,000.
Although there were downward revisions to the data for the prior two months totalling 33,000, the three-month moving average of monthly employment gains rose to 62,000 in the July-September period, up from 18,000 in June-August and 26,000 in May-July.
This data suggests that the summer weakness in the US labour market appears to be behind us, but investors will remain wary of such conclusions until more data is available. It should be noted that the unemployment rate rose from 4.3% to 4.4%, its highest level since 2021, although broader measures of unemployment have shown no significant weakening.
This jobs report had taken on outsized importance after publication of the standalone October employment report was cancelled due to a lack of data collected. October’s data will instead be integrated into the November release, scheduled for 16 December (that’s to say, after the meeting of the Federal Open Market Committee (FOMC) on 9-10 December).
The delay to the November jobs report, along with the release of the FOMC’s October meeting minutes this week — which showed a split within the rate-setting committee over the case for a third interest rate cut this year — initially pushed US Treasury yields higher before the risk-off move elsewhere saw the 10-year Treasury yield fall to 4.08%. The US dollar has strengthened.
These developments reflect the revision of the market-implied probability for a 25bp December rate cut from around 90% probable at the end of October, down to 65% in early November, and now even lower at just over 30%.
Japan – A strong stock market, but a weak yen
Japanese stocks have had a strong run since Sanae Takaichi became Japan’s new prime minister. Despite being impacted negatively by this week’s stock market volatility, the Nikkei 225 index is up by around 10% since the beginning of October. Euro or dollar-based investors have, however, not been able to capture all of the rally as the yen has continued to weaken.
This week the yen has traded above 157.50 versus the US dollar and Japan bond yields have risen amid reports confirming the view that ‘Sanaenomics’ will resemble the ‘Abenomics’ pursued by former prime minister Shinzo Abe to revitalise Japan’s stagnant economy through fiscal stimulus, tax cuts and more interventionist monetary policy to fuel growth.
The big difference between today and the period when Shinzo Abe was in power (2012-2020) is that Japan’s rate of inflation is today running at above the Bank of Japan’s (BoJ) target 2%. This inevitably raises questions about the extent to which the BoJ will accommodate ‘Sanaenomics’ as it seeks to normalise monetary policy and tame inflation.
A weaker yen may also raise issues with the US administration as it pursues a weaker dollar policy against the currencies of its trading partners.
On 21 November, Sanae Takaichi’s cabinet approved the largest round of extra spending since the pandemic. The plan includes ¥17.7 trillion ($112 billion) in general account spending.
The announcement came after Japan issued its strongest warning yet over the recent weakening in the yen, with the finance minister specifically mentioning intervention as an option as she tried to stem falls in the currency with only limited impact.
It is unusual for a Japanese finance minister to use the word ‘intervention’ in a warning, but the message only briefly strengthened the yen before the gains were lost. That suggests market players remain unconvinced that Tokyo will intervene.
Data this week showed Japan’s economy shrank at an annualised rate of 1.8% in the third quarter. The fall in real (inflation-adjusted) GDP for the period was less severe than had been expected, but it still marked the first contraction in six quarters. It comes at a critical juncture as the central bank considers raising interest rates at its policy meeting on 18/19 December.
It is not obvious how long a rising Japanese stock market and a weakening yen can continue together. Rising inflation in Japan hurts domestic consumers and persistent yen weakness undermines the investment case for foreign investors. ‘Sanaenomics’ may run up against constraints in this environment.
