By Michael Brown Senior Research Strategist at Pepperstone
DIGEST – The equity sector rotation continued yesterday, as the USD gained ground against most peers, and the quid slumped after a dismal jobs report. UK CPI and a host of US releases highlight the docket today.
WHERE WE STAND – The return of US desks after the long weekend brought ‘more of the same’, yesterday, at least as far as the equity complex is concerned.
Clearly, participants continue to take a relatively dim view of the tech sector, with the Nasdaq again underperforming peers on the day, as jitters over the broad AI theme persist. While last week the concern seemed to be that AI would eat traditional business models for breakfast in various sectors, we now seem to have flipped to something of an opposite worry – namely, that insane capex from hyperscalers shan’t produce meaningful RoI over a reasonable period.
As I mentioned last week, it’s impossible for both of those two things to be true at the same time, and reality probably lies somewhere in the middle. However, perhaps reflecting how crowded the ‘long AI’ trade is, investors seem to be in a mindset for now of selling first, and asking questions later.
In any case, while it’s not impossible for the S&P 500 to rally without the tech sector, it is pretty damn difficult, given the huge weighting (approx. 33%) that the sector progresses. In fact, on a YTD basis, only four of the index’s eleven sectors trade in negative territory, however those four account for two-thirds of the index by weight.
This, in turn, mechanically, creates a very high bar for gains at the index level, even if the fundamental bull case (strong macro data + robust earnings growth + monetary/fiscal tailwinds) remains robust. A look at the equal-weight S&P, up 6% YTD, compared to flat for the ‘traditional’ cap-weighted index, explains that divergence quite nicely. Furthermore, with there being numerous convincing reasons for the rotation into stocks exposed to the ‘real’ economy to continue, this suggests that a more selective sectoral approach leaning into that rotation could bear more fruit than indiscriminately buying the dip, at least for now.
Closer to home, I have to address yesterday’s UK jobs data. In short, the report was rather woeful – unemployment rose to fresh cycle highs at 5.2% in the three months to December, public sector earnings growth again vastly outpaced that of the private sector, and PAYE payrolls fell for a 5th month running in January. While this does all support the case for another BoE cut as soon as the March meeting, it is also almost all reflective of policy choices made in Westminster.
By raising the cost of employment (higher NICs, higher min wage, etc.), and by raising the risk associated with hiring (Employment Rights Act), government have created ample disincentive for businesses to pull back on recruitment. At the same time, welfare uplifts and the removal of the two-child benefit cap have created less of an incentive for some to find work. Combined, this has triggered the ‘perfect storm’ that we now see playing out, resulting in the labour market falling off a cliff. At the end of the day, everything is a policy choice; although, the consequences of these ones were so blindingly obvious it’s infuriating that folk now act surprised when data of yesterday’s ilk emerges.
Unsurprisingly, the dismal jobs data and subsequent dovish BoE repricing, with the GBP OIS curve now fully discounting 2x 25bp cuts by year-end, posed some fairly chunky headwinds to the pound yesterday, with cable falling to near 2-week lows just north of the 1.35 figure. In truth, though, there was a fair chunk of USD demand helping to drive this move, with the greenback well-bid against most G10 peers, albeit in a move which lacked an especially obvious catalyst, and one which still leaves us in the 96 – 100 range that the DXY has been stuck within since last summer.
LOOK AHEAD – January’s UK inflation data highlights the docket today, likely further paving the way to a 25bp Bank Rate cut next month, after the aforementioned soft jobs data we received yesterday.
Headline CPI is set to have fallen to 3.0% YoY last month, which would represent not only further disinflationary progress, but also the slowest annual inflation rate since March of last year. Services inflation, meanwhile, which policymakers watch closely for signs of inflation persistence, is also set to decline, to 4.3% YoY, representing the slowest pace in almost four years. Barring a materially hotter-than-expected print, a rate cut from the ‘Old Lady’ next month seems all-but-assured.
Elsewhere, a handful of US releases are due, including the latest durable goods orders, housing starts, building permits, and industrial production figures. None of that, though is likely to be especially market moving, nor is the release of minutes from the January FOMC meeting, with the Committee now firmly in ‘wait and see’ mode amid continued economic resilience.