If economies and markets were in a race, the US would be lapping rival advanced nations. Its economy recorded growth last year of more than 2.5 per cent, easily outpacing the UK (0.5 per cent), and Germany (-0.1 per cent), according to IMF figures. The S&P 500 delivered a 21 per cent gain versus a loss of 3.8 per cent for the FTSE 100. And the US index got off to a flying start this year, accelerating in January to hit a new all-time closing high of 4,924.97. It’s a record the market had been toying with for months on the back of the AI-powered rally in technology and investors’ anticipation of stronger corporate growth and increased capital flows into the market as rate cuts are fed through.
Some of the positive sentiment has extended to London too. Quite simply the prospect of monetary loosening is driving optimism everywhere. Solid progress is being made on the inflation front here and CPI inflation could fall back to 2 per cent by the second quarter. Certainly, shop price inflation dropped last month and analysts are flagging falls in mortgage rates.
We shouldn’t get ahead of events, though. Assessing the landscape invites big questions. In a week of two key rate decisions, one is, naturally, when will cuts come, and how many will there be? Market participants also want to know if war and disruption in the Red Sea and Suez Canal could become new inflationary forces. And can the chancellor really afford tax cuts? Is the risk of recession now off the list? Other questions focus on whether US market growth can be maintained.
On the issue of rate cuts, it's still an unclear picture following this week’s Fed and Bank of England announcements. The first Fed rate cut was widely expected to come in March, with 1.5 percentage points expected to be snipped off this year. However, the Fed has made it clear it intends taking a safe and slow path. March is now off. As ING noted, "the US data continues to refuse to convincingly break one way or another. This will leave members of the Federal Reserve unconvinced there is enough evidence to justify cutting interest rates as soon as March".
The Bank of England approach is much the same although it was not expected to change direction in any case until May or June. As one pointer to the timing, Capital Economic points out that history shows when one MPC member votes to cut rates, a majority of the nine members agree about two meetings later. By the end of the year UK bank rate could be 4 per cent, then fall to between 3 and 3.75 per cent by the end of 2025.
Not everyone has discounted new inflationary risks. The IMF warns the final descent of inflation to target could be disrupted by supply and other geopolitical shocks. Adam Hetts at Janus Henderson cautions that US economic resilience may prove fragile as consumer spending falls once savings are run down, while many companies have yet to see the full pass through of prior interest rate increases.
The IMF highlights another impediment to growth: world trade is projected to come in below its historical growth rate of 4.9 per cent at just 3.3 per cent this year. One reason is that more than 6,000 new restrictions have been imposed on trade by countries in the past two years.
Jeremy Hunt’s pre-election tax giveaway may not be lavish if the headroom from tax receipts and debt interest payments is lower than expected. Indeed, the IMF has advised him against tax cuts.
With its AI tailwind, the US market is well placed to maintain its lead. Investors’ confidence in the enduring qualities of certain members of the Magnificent Seven will have been strengthened this week with good numbers from Microsoft – now a member of that elite $3tn market cap club, overtaking Apple in the process. But while the FTSE is likely to underperform the S&P 500, says Capital Economics, given the boost to the US economy from AI will be bigger than in the UK, and falling energy prices will be a further headwind for UK equities relative to the US, it has identified triggers that could power the FTSE 100 from around 7600 now to 8700 this year and to 9700 in 2025. That would be a gain of 27 per cent. Drivers include falling interest rates, an expected weakening of the pound, and the AI boost.
AJ Bell notes that 62 per cent of all analysts’ recommendations in January on FTSE 350 stocks were buys and just 7 per cent were sells.
The question of how the dominant super stocks in the US market will fare this year deserves an article all of its own. But it’s worth noting some market observers think they could be heading for a sell-off given the concentration similarities to the dotcom boom.
