Equities and Gold have the Edge over Bonds
Gary Dugan, Chadi Farah, Bill O'Neill
The Global CIO Office
- Economists upgrade their US and China GDP forecasts
- The equity markets are enjoying the growth more than bonds which fear a slowdown in monetary easing
- While equities have run strongly old economy stocks have still to see upgrades to profit forecasts
- Gold and Silver have their own strong dynamics – we see further upside
The risk-on sentiment in the market remains evident, firmly supported by recent economic data flow. We note that economists – not wanting to be caught off guard – have been busy upgrading their current-year GDP forecasts for the United States and China over the past few weeks. Even the European economy appears to be finally stabilising. The consensus GDP growth forecast for the US is up to 2.6%, with some more upbeat estimates suggesting an even better 3.0% growth. Economists are also increasingly confident that China will hit its 5% growth target. In our view, the recently announced government policies can pull forward a good measure of activity to the current quarter.
Chart 1: Consensus US GDP Forecast for 2024 on the Rise (%, year-on-year)
Source: Bloomberg
Last week, the US equity market posted its sixth weekly rise, with market talks of a broadening of the current performance gaining significant traction. There are hopes that the market will see some rotation of its performance away from the Magnificent 7. However, the fundamentals for the market, excluding the Magnificent 7, are still not strong enough to warrant much absolute performance from here. As Chart 2 shows, year-to-date the earnings forecast for the Dow Jones 30 has fallen by close to 7% whilst the index is up 12%. In essence, the Dow has seen a nearly 20% increase in valuation. The earnings revisions have almost consistently been down throughout the year. Although the chart shows a tiny blip up in the expected earnings of the constituents over recent days, it’s far from being a convincing trend.
Chart 2: The Rise in the Dow has Received Little Support from Earnings
Dow Jones 30 and Expected earnings rebased to February 2024=100
Source: Bloomberg
As we mentioned last week, investors are increasingly placing their bets on a Trump victory in November, even if the polls are still very tight. Indeed, there is even talk of a “red wave” whereby a Trump Presidency would have the backing of a Republican party majority in both houses of Congress. But, what is good news for the equity market is not so good for the bond market. A freely spending Trump-led US government could lead to significant investor concerns about the impact of a sharp increase in debt levels and the prospect of higher inflation. President Trump’s economic plans “would increase the US national debt by $7.5 trillion,” the Committee for a Responsible Federal Budget wrote recently. The bond market has already taken fright with US five-year inflation-linked bonds pricing a break-even inflation rate of 2.25%, up from 1.90% a month ago.
Chart 3: US 5-year Break-even Inflation Rate on the Rise
Source: Bloomberg
The bond market sell-off we have seen over the past month could extend further on a Trump victory, with the US 10-year government bond yield pushing as high as 4.30%-4.50%, particularly if a “red wave” indeed supports his presidency.
Chart 4: US 10-year government bond yield (%)
Source: Bloomberg
All that shines…is Gold!
The gold price reached a new all-time high last week of $2721 an ounce, up 32% on the year, significantly outpacing the NASDAQ index +23% gains. Lower US interest rates could lead to significant geopolitical challenges around the world, which are all factors that can be used to explain the strength in the gold price. However, no perfect quantitative model will explain why the fair value price for gold. While the earlier-mentioned factors explain the week-to-week movements in the gold price, the more fundamental sharp increase in its value in recent quarters probably has more to do with the ongoing diversification of central bank reserves, particularly in emerging countries. The World Gold Council reported record levels of central bank buying in the first half of this year, with 14 emerging market central banks being active buyers of the yellow metal. For central bankers, higher prices are not a reason for holding back from purchasing gold but more a vindication of why they are buying. This past week, several EM central bankers spoke at the London Bullion Market Association’s conference in Miami, reiterating their wish to continue diversifying their currency reserves through gold purchases.
We never believe there is much sense in ascribing a ‘fair value’ to gold. We know it is an asset with limited supply but robust investor demand. We believe gold warrants a significant strategic allocation of at least 5% in a multi-asset portfolio.
Chart 5: Gold Strikes a New Record High… Again
Source: Bloomberg
Some mining analysts are excited about the potential for silver to have a further spike in performance. Silver is often seen as the poor cousin of gold, but when gold is on a solid run, silver tends to have a delayed but very positive reaction. On this occasion, silver also has its supportive dynamics. Russia announced it plans to significantly increase the holdings in precious metals in its sovereign wealth fund. This includes an intention to acquire gold, platinum, palladium and silver for the first time. In other news from the EM world, China and India are to significantly increase the scale of their solar energy generation, which only adds to the industrial demand for silver.
