The month of October saw elevated volatility and lacklustre global returns. The S&P 500 fell by 1.0%, the Dow Jones decreased by 1.3%, and the Nasdaq slipped 0.8%. In international markets, Japan's Nikkei 225 rose by 3.1%, while the FTSE 100 and Euro Stoxx 50 saw declines of 1.5% and 3.5%, respectively. Global bond markets posted negative returns, largely due to a significant rise in U.S. Treasury yields driven by stronger-than-expected macroeconomic data from the U.S.

Source: Bloomberg, Fiducia Capital Limited

In the U.S., September's Consumer Price Index (CPI) inflation edged slightly higher at 2.4% year-on-year, just above the forecast of 2.3% but lower than August’s 2.5%. Month-on-month, prices increased by 0.3%, matching August’s figure and surpassing expectations of 0.2%. Core inflation also rose to 3.3%, up from 3.2%. On the GDP front, the U.S. economy grew at a 2.8% pace in the third quarter, below the Dow Jones forecast of 3.1% and down from the 3.0% growth rate in the second quarter.

Beyond the minor inflation increase, U.S. economic data came in stronger than anticipated. Non-farm payrolls added 254,000 jobs in September, significantly above the revised 159,000 in August and the expected 140,000. This marked the strongest job growth in six months and exceeds the average monthly gain of 203,000 over the previous year. Additionally, ADP reported that private companies hired 233,000 workers in September, surpassing the revised 159,000 and far exceeding the Dow Jones estimate of 113,000. In light of the robust jobs report, the Federal Reserve is expected to adopt a more cautious stance on rate cuts, moving away from the initially suggested 50 basis point reduction. Market expectations have shifted to forecast two cuts in 2024 and three to four in 2025.

Historically, when examining the last four decades of Fed Funds rates, we find that during the six instances of rapid interest rate hikes by the Fed, there were five hard landings and only one soft landing in 1995. Aggressive Fed hikes often lead to disruptions, either in the economy or financial markets. The key question is not “what” will break but “when.”

For instance, in 2000, it took 12 months for the Fed's tightening to push the economy into recession the following year, while in 2008, it took over two years. Understanding that macroeconomic lags are long, and variable is crucial. This time, the lag may be even longer, as U.S. corporations and households have strategically extended their debt at low rates, resulting in limited refinancing needs and a small share of floating-rate debt. Additionally, pro-cyclical fiscal stimulus is helping the economy maintain momentum.

Source: Alfonso Peccatiello, Bloomberg, Fiducia Capital Limited

While the U.S. equity markets continue to reach new all-time highs, it’s notable that the Equity Risk Premium (ERP) has been contracting. The ERP measures the excess return investors expect when buying risky assets, like stocks, compared to safe fixed-income instruments. It is calculated by subtracting 30-year Treasury yields from the S&P 500’s 12-month blended earnings yield. Currently, the ERP stands at -0.26%, indicating that investors are receiving virtually no excess compensation for investing in stocks.

Historically, the ERP has turned negative during periods like 1999-2000, leading to poor forward returns over the following 1-3 years. The Equity Risk Premium serves as a critical macroeconomic indicator; when it reaches zero or negative levels, it often signals weak subsequent returns for equities.

Source: Bloomberg, Fiducia Capital Limited

As the U.S. election approaches, betting markets suggest a growing likelihood of a Trump victory, leading investors to consider the potential implications of new trade tariffs. While economic theory indicates that tariffs could be inflationary, the actual impact on consumers is nuanced and may vary. Increased costs might be absorbed by retailers, and fluctuations in foreign currencies relative to the U.S. dollar could also influence pricing. Historically, market volatility tends to increase in the weeks leading up to an election, with stock markets often experiencing pullbacks due to uncertainty surrounding fiscal policies. However, in the weeks following Election Day, markets typically rebound, regardless of the winning party, as uncertainty diminishes, and investors shift their focus to future opportunities.

Source: Bloomberg, Fiducia Capital Limited

In the UK, September inflation registered at 1.7% year-on-year, significantly lower than expected and well below the Bank of England's (BOE) target of 2%. This suggests that the Monetary Policy Committee (MPC) may take a more aggressive approach to rate reductions, with markets now anticipating back-to-back quarter-point cuts by the end of 2024, bringing the policy rate down to 4.5%. Meanwhile, the European Central Bank (ECB) implemented a 25-basis point cut to its deposit rate in October, following similar reductions in September and June. This decision reflects an updated assessment indicating that disinflation is progressing well, with Eurozone inflation falling below the ECB's 2% target for the first time in over three years. Additionally, the Eurozone economy grew by 0.4% in the third quarter, surpassing expectations for a 0.2% expansion.

---

Equity Markets

U.S. equities continued their upward trajectory in October as third-quarter earnings reports were released. However, we remain cautious about U.S. equities, which currently appear stretched at 21 times forward earnings, especially given persistently weak manufacturing PMIs. Additionally, global cash allocations among non-bank investors have fallen to their lowest levels in at least 25 years. This indicates a scarcity of cash to support financial assets or to provide a buffer against potential market declines, which we see as a significant vulnerability.

Source: Bloomberg, Fiducia Capital Limited

From a valuation perspective, most MSCI sectors are trading at elevated levels, significantly above their 10-year average P/E ratios. We maintain a positive outlook on the Small Cap Value, Energy, Biotech, and Real Estate sectors. We believe small caps are particularly attractive over a 1–2-year time horizon. Biotech and Real Estate are expected to benefit from the impending rate-cutting cycle, while Energy is poised to gain from a combination of China’s stimulus efforts, rising geopolitical uncertainty, and the Fed's easing measures. This sector is bolstered by lower equity ownership and investor interest, appealing valuations, and bearish positioning in oil markets. In other markets, we continue to remain overweight on UK equities and expect them to outperform the broader markets. The combination of disappointing relative returns over the past seven to eight years—resulting in a notable valuation discount—along with the positive outlook for many UK-listed companies and the increased stability of UK institutions post-election compared to other countries, gives us confidence that medium to long-term return opportunities could be substantial.

Source: Bloomberg, Fiducia Capital Limited

Interestingly, within the Technology, Media, and Telecom (TMT) sector, companies are facing exceptionally high expectations this earnings season. The TMT segment accounts for 35.8% of earnings, significantly lower than its 42.0% share of market capitalization. Historically, the earnings contribution of the TMT sector has closely aligned with its market cap share. However, the current substantial gap suggests that market cap may decline unless companies exceed these lofty consensus forecasts. Notably, the "Magnificent Seven" show the largest disparity, representing 32.0% of market cap while being forecasted to contribute just 22.9% of average quarterly earnings through Q3 2025.

Source: Bloomberg Intelligence

 

 

With earnings season in full swing, the Financial sector emerged as a standout performer for the month, benefiting from robust earnings and favourable revisions to forecasts. We anticipate a higher re-rating for the financial sector as a whole. In contrast, semiconductor stocks faced increased volatility due to mixed earnings reports from key industry players. Dutch semiconductor equipment manufacturer ASML reported a significant decline in bookings, with the CEO indicating that the anticipated recovery in semiconductor end markets by 2025 would be more gradual than previously expected. Consequently, ASML’s shares fell by over 20%. AMD also reported its Q3 earnings; despite strong growth in AI, the stock retreated due to weaker-than-expected revenue guidance ($7.5 billion vs. consensus of $7.55 billion).

Among the "Magnificent Seven," Meta shares declined despite beating both earnings and revenue expectations, as the company reported weaker-than-expected user numbers and warned of a significant increase in infrastructure expenses projected for 2025. Microsoft also delivered an earnings and revenue beat for its fiscal first quarter, but its stock fell due to a forecast indicating slower growth than anticipated. On a positive note, Alphabet Inc. rallied after reporting earnings that exceeded estimates.

---

Fixed Income Markets

Global bond markets posted negative returns in October, driven by a notable spike in U.S. Treasury yields. Short-term yields rose sharply, with the U.S. 2-year Treasury yield increasing by 14.5%. Longer-term yields also climbed, with the U.S. 10-year and 30-year yields rising by 13.3% and 8.6%, respectively. The Bloomberg U.S. Treasury Index lost 2.4% last month, while the Bloomberg Global Aggregate Index declined by 3.4%. The Bloomberg Global High Yield Index also fell by 0.6% in October. This rise in yields reflects several contributing factors: stronger-than-expected U.S. macroeconomic data, commodity price inflation driven by Chinese stimulus measures, and recent comments from Federal Reserve officials advocating for a higher terminal rate, as highlighted by central bank officials Neel Kashkari and Christopher Waller. The MOVE index, which measures bond market volatility, reached a one-year high on October 29, exceeding levels observed during the Silicon Valley Bank collapse and the Fed's 75-basis-point rate hike in June 2022.

Source: Bloomberg, Fiducia Capital Limited

Source: Bloomberg, Fiducia Capital Limited

Rising political uncertainties, particularly the increasing likelihood of a Republican "sweep" (presidency, Senate, and House) associated with a potential Trump victory, have also contributed to the spike in bond yields. This political landscape has heightened market anxieties as investors prepare for possible new tax cuts and a potentially ballooning federal deficit—both factors that historically exert upward pressure on bond yields.

Additionally, there has been a revaluation of the terminal rate since the FOMC meeting on September 18, with markets now pricing in a higher terminal rate due to data indicating the U.S. economy remains resilient. However, two key factors could help stabilize or reduce yields from current levels. First, a divided government would likely constrain fiscal expansion, making it more challenging to pass significant spending measures. Second, weaker-than-expected macroeconomic data could lead to a more cautious policy response, potentially delaying or scaling back anticipated fiscal changes, which would ease upward pressure on yields. We continue to believe that the Federal Reserve will implement more aggressive rate cuts in response to a slowing economy, which should bring terminal rate expectations back to September levels.

Source: Bloomberg, Fiducia Capital Limited

Fixed income remains our preferred asset class for the final quarter of 2024. We view the current spike in yields as an opportune moment to allocate capital to bonds. Investment-grade corporate bonds, government bonds, and government-backed high-yield bonds offer attractive options for cash deployment. Given the strong macroeconomic data in the US and the upcoming elections, we anticipate that the Federal Reserve will take a more cautious approach to rate cuts this year. Rather than the previously expected 50-75 basis points reduction, we now foresee a cut of 25-50 basis points this year, with a more aggressive cutting cycle likely in the following year. We favor the medium to long end of the yield curve to position ourselves for more aggressive rate cuts from the Federal Reserve than the market currently anticipates for next year.

---

FX Market

After two months of disappointing U.S. economic data that weakened the dollar, recent positive reports have helped the USD regain some ground. Additionally, as former President Donald Trump gains traction in the political arena, "Trump trades," including a stronger USD, have gained momentum. The Dollar Index (DXY), which measures the U.S. dollar against six major currencies, increased by 3.2% in October, while the Euro, British Pound, and Swiss Franc fell by 2.3%, 3.6%, and 2.2%, respectively, against the U.S. dollar. We believe the upcoming election remains too close to call, and we continue to anticipate more aggressive rate cuts than the markets currently project, which could lead to a weaker U.S. dollar in the medium to long term.

In Japan, the yen depreciated significantly in October, falling by 5.8% against the USD to reach a three-month low amid notable political changes. The ruling coalition lost its parliamentary majority for the first time in 15 years following snap elections called by Prime Minister Shigeru Ishiba. This outcome has raised concerns about the future direction of the country's monetary policy. Pending clarity on the political situations in both Japan and the U.S., we maintain a medium to long-term bearish outlook on the USD/JPY exchange rate, expecting it to decline towards 130 by the end of 2025. With the Federal Reserve likely to continue cutting rates over the next 12 to 18 months, alongside gradual rate hikes from the Bank of Japan, the narrowing of U.S.-Japan yield differentials is expected to push the USD/JPY lower.

Source: Bloomberg, Fiducia Capital Limited

In the UK, the pound sterling is the only G7 currency that has appreciated against the dollar this year, rising by 1.9% year-to-date. We maintain a positive outlook on the GBP and expect it to strengthen further against the USD in the medium to long term. With the Federal Reserve beginning its easing cycle later than most other central banks and from a higher starting point, we expect it to implement more aggressive rate cuts next year, particularly in comparison to the Bank of England (BoE), which should strengthen the pound.

---

Commodities Market

The Bloomberg Commodities Index declined by 2.2% in October, yet precious metals had a stellar month, with gold and silver rising by 4.2% and 4.8%, respectively. While we maintain a bullish outlook on both metals in the long term, their current levels appear stretched. Silver, in particular, is highly volatile and could see a pullback from its current levels.

 

Source: Bloomberg, Fiducia Capital Limited

We remain bullish on uranium, especially as a reliable energy source for AI hyperscalers. Our conviction is strengthened by recent announcements from major tech players like Amazon and Google in the small modular reactor (SMR) space. In October, Amazon entered agreements with Dominion Energy and Energy Northwest to advance SMR nuclear development in Virginia and Washington state, reinforcing its commitment to achieve net-zero carbon emissions by 2040. Similarly, Google has signed a Master Plant Development Agreement to procure nuclear energy from SMRs to be developed by Kairos Power..

 

Crude oil prices were significantly affected by geopolitical tensions in the Middle East last month. Comments from U.S. President Joe Biden regarding potential Israeli strikes on Iranian oil facilities briefly pushed Brent crude above $80 per barrel. However, oil experienced its worst day in two years, dropping c.6%, after Israel chose not to target Iranian crude facilities in its attacks in the last week of the month. Toward the end of October, oil prices increased following a Reuters report that OPEC+ might delay a planned production increase set for December by a month or more due to concerns about soft demand and rising supply. Despite these fluctuations, we believe that the current geopolitical concerns, along with China's stimulus measures, will help establish a floor for oil prices at their current levels.