When Technology Fails
Equity rotation away from Mag 7 technology stocks to smaller companies.
A software update from US software group Crowdstrike causes global IT outage
The UK Labour Party wins a landslide parliamentary victory
Weaker US inflation and economic data raise hopes of a September interest rate cut from Fed.
President Joe Biden ends his re-election campaign. Kamala Harris becomes the Democratic nominee
Former US president and Republican presidential candidate Donald Trump survives assassination attempt
Mr Trump announced Ohio senator JD Vance as his Republican running mate.
Hamas political leader Ismail Haniyeh assassinated
French election results in a hung parliament
Sterling hits highest level since Brexit referendum
The summer months are often thought of as quiet ones for markets, but that did not prove to be the case in July as markets had several notable economic and political developments to deal with. Geopolitical risks in the Middle East heightened with the assassination of Hamas political leader Ismail Haniyeh. We also had the attempted assassination of former US president and Republican presidential candidate Donald Trump. The current president Joe Biden announced that he would end his re-election campaign, with Kamala Harris becoming the Democratic nominee. Closer to home, The UK Labour Party won a landslide parliamentary victory. Against this backdrop, global equity markets broadly ended the month where they started, with a small total return gain for the MSCI World Index, when measured in Sterling terms. Sterling itself was relatively strong, achieving its highest level since the Brexit referendum against a trade-weighted basket of currencies.
Although overall markets were flat, there was plenty of action under the bonnet. The so-called Magnificent Seven (Mag 7) US technology stocks fell back, as investors grew more sceptical about the potential for future returns from investment in artificial intelligence (AI). Four of the seven stocks reported in July, which broadly underwhelmed.
On that theme, we had an unfortunate but important reminder of the power and importance that large tech companies have over our daily lives when global travel and payment systems were brought to a standstill by the IT company Crowdstrike during the month. A routine but faulty software update was implemented automatically, leading to millions of computers around the world crashing with the infamous “blue screen of death”. The error has resulted in investors wiping tens of billions from the market value of this company. Beyond the financial costs, thousands of travellers and families were unable to enjoy much anticipated holidays because of this catastrophic error from a supposed superstar tech company. This latest example serves as a warning of over reliance on large tech companies, a warning which might also extend to some investor's portfolios over the last six months.
For some time we have been concerned that equity markets in the US, like the S&P 500 index, have been extremely reliant on these tech companies for almost all of their returns. The financial term for this is “concentration risk”. With extreme increases in share prices in such a short space of time, too much of what is supposed to be a broad and diversified market index becomes overly exposed to just a few large companies. This could be a larger issue when these companies are on expensive valuations and expectations for earnings growth are sky high. An encouraging sign is that corporate earnings for many of the more reasonably valued companies outside of the concentrated tech sector are now starting to show meaningful growth. This helped to fuel a rotation into smaller stocks in July
Despite a weak US inflation print, combined with soft US labour market data, the Federal Reserve chose not to cut rates during their monetary policy meeting at the end of the month. However, Fed chair Jerome Powell indicated that he expected the Fed to start cutting rates soon. Investors now expect the first Fed rate cut in September and are currently pricing almost three US rate cuts this year. Powell noted that recent data shows substantial progress toward the Fed's target of reducing inflation to 2 percent. However, he stressed that officials would need even “greater confidence” before moving to cut rates. His comments provided the clearest signal yet that the central bank is gearing up for a policy shift, more than two years after it began its aggressive campaign to tackle inflation. This caused yields for most flavours of bond to fall sharply, which pushed up prices.
Expectations of rate cutting helped interest-rate-sensitive equities. The perception of a relatively stable political environment coupled with stronger-than-expected economic growth for the second quarter helped UK stocks to outperform. A bounce back in the Japanese Yen, triggered by The Bank of Japan raising its key interest rate, helped Japanese equities to a strong return.
A significant rift developed between the Chancellor and the Shadow Chancellor towards the end of the month. It started when Rachel Reeves, the new Labour Party chancellor, announced that there was a black hole of £22bn in the UK’s finances that, she claims, the Conservative party had sought to cover up during the election. Cue an emotional debate in Parliament with the now Shadow Chancellor Jeremy Hunt fiercely denying this. It appears now that the UK’s spending watchdog, the Office for Budget Responsibility (OBR), has been asked to investigate Hunts previous forecasts.
The claim of identifying a hitherto unseen black hole in the public finances was somewhat expected and allows the new Chancellor to put in place possible tax increases in areas such as Inheritance Tax and Capital Gains Tax, that have not been mentioned during the election. Chancellor Reeves stated, “Upon my arrival at the Treasury three weeks ago, it became clear that there were things that I did not know, things that the party opposite covered up: covered up from the opposition, covered up from this house, covered up from the country.” Serious accusations indeed.
Hunt retaliated by claiming that he had been very honest about the state of finances, “those public finances were audited by the OBR just 10 weeks before the election was called. We are now expected to believe that in that short period a £20bn+ black hole has magically emerged. She wants to blame the last Conservative government for tax rises and project cancellations she has been planning all along.” Rob Jenrick, who recently launched his bid to lead the Conservative Party, lifted the mood by comparing Reeves to a “dodgy car mechanic”. You give her your Volvo for a week, she comes back with new problems and a higher price; “and you both know she planned this all along”.
This is a story that will develop over the weeks and months that comes as we head towards a Budget date of the 30th October. What is clear is that an element of austerity is returning and quite how the new Chancellor manages to balance her tax plans with supporting a growing business culture in the UK and encouraging these businesses to invest and grow and attract new talent will be quite a juggling act.
Elsewhere, gold achieved a new all-time high during the month, but despite rising tensions in the Middle East, the price of crude oil fell. Investors focussed on slowing growth in China, which also pushed copper to a three-month low.
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