October Wrap Up - Elections and Earnings

Like a New Zealand west coast beach there were complex and sometimes confused under currents driving markets over October. Safe haven assets like gold rallied to all-time highs, longer term interest rates rose sharply, shares drifted backwards, and the kiwi dollar fell. It was the twin impacts of a possible leadership change in the US (which has since come to fruition) and corporate earnings releases that were the most consequential influences over the month. History suggests changes of governments have a smaller medium-term effect on markets than we might think. But with a potentially less trade friendly, isolationist stance from the US, allied with fiscal expansion on top of what is an already very stretched budget this time could be different. At least market price action in October seems to suggest that.

Elections are noisy in the short term and can move prices.

Investor attention in October has been focused in two key areas. The US presidential election and company earnings announcements for the third quarter. Both moved markets.

It has been impossible to escape the drama and headlines of this year’s US presidential election. As much as the mainstream media and the ‘Twittersphere’ has been obsessed by it, so has the market. Asset prices have moved as new policy initiatives have been announced and poll results released.

While it’s always challenging to ascribe specific market movements to individual causes, market movements in October increasingly reflected a possible Donald Trump victory.

The most obvious place where this has been evident is in the significant rise in long term interest rates over the month. This reflects two potential impacts from a change in presidency.

The first is the risk of higher inflation from the United States adopting a more isolationist stance impacting both trade and military policy. From a trade perspective this is likely to result in increased supply chain costs along with tariffs on imported goods. Both of these push prices and inflation higher. Fixed income investors hate inflation and demand higher interest rates to compensate for that risk.

The second is the impact of the US governments borrowing program should it run a higher fiscal deficit. The argument here is simple. If you borrow more, you have to pay more in terms of a higher interest rate.

The moves have been dramatic. US 10-year treasury bond rates soared by 0.5% to 4.3% over October[BW1] . This same trend has been echoed around the world albeit not as aggressively even though the economic circumstances in those countries may be very different. Here for instance our 10-year government bond yield rose by 0.3% over the month to 4.5%.

Rising rates hurt the value of fixed income investments flowing through to returns of conservative funds in particular.

A lot of research has been done in the United States on the impact of differing parties controlling the presidency and other branches of government. This work suggests that the composition of government is not a major long-term driver of share prices, The numbers indicate that there is not a meaningful difference in returns in democrat or republican presidencies.

For the record, over the period 1926 to 2023, it was the combination of a democrat president with a republican house that posted the highest average annual returns. This beat out other combinations including an all democrat or all republic government. Maybe gridlock and policy inaction is the best formula for markets!

Thomas Poullaouec and Nathan Wang of T Rowe Price say it well, “We believe that investment decisions should be based on longer‑term fundamentals, not near‑term political outcomes.”

The drivers of long-term share returns are the fundamentals of earnings, how much profit companies deliver, and the value that the market ascribes to those earnings. That makes updates from companies on earnings an important gauge of how those fundamentals are playing out.

There are a couple of key takeaways from the Q3 2024 earnings season that help paint a picture of these longer-term fundamentals.

Results in the United States suggest that overall, the economy remains resilient and consumer spending, that while not growing strongly is moving in the right direction supported by continued strong employment. Company fundamentals look sound.

That said a number of companies specifically noted that their optimism is somewhat predicated by recent Federal Reserve interest rate cuts. A spike in inflation, as discussed above, could impact the ability of the Fed to lower rates further and would be a risk.

The other interesting takeaway from the earnings season has been comments around AI and how this is translating to profit growth. Late in the month Meta Platforms, the owner of Facebook and Instagram, and Microsoft highlighted the even more massive spend required to support ongoing development of AI capability.  The numbers are eye watering and amount to billions of dollars more than investors had expected. As yet, the earnings uplift from this spend may be years away.  Investors are rightfully cautious.

Digital disruption and AI remain a key mega trend that we believe will be powerful over the years to come.  We are leaning into this theme in our portfolios but looking to do that in a nuanced way. We do this by combining investments in the hyperscalers, like Microsoft, but also through service providers to the AI ecosystem like data centre operators and electrical utilities.