Market report: Sober start to October for the Footsie amid inflation fears and AI warnings
Susannah Streeter, chief investment strategist, Wealth Club: ‘’It’s been a sober start to October for the Footsie, as investors eye up soaring borrowing costs, and digest unpalatable warnings about the AI boom. The blue-chip index has taken a dive in early trade, with confidence hit by concerns about the potential for higher inflation, more refinancing costs and the knock-on effect on spending.
The bond market is adding to the pressure cooker ahead of the UK Budget, with the 10-year gilt yield climbing to around 5.49%, the highest level since July 2007. The warning lights are flashing in a week when the government paid the highest yield on a 10-year gilt auction since 1999, underlining how much more expensive it is becoming to borrow. With debt already high and interest payments eating up a hefty chunk of public finances, sustained yields at these levels could further squeeze the chancellor’s wiggle room when he sets out his spending plans.
Amid predictions the Bank of England is poised on the edge of another rate hike cycle, it’s kept house buyers fearful, unwilling to stump up for big loan payments. Typical property values fell by 0.2% in September, according to Nationwide, an unexpected fall at what is usually a brisk time for buying, especially as it came off the back of a 0.2% rise in August. It means the value of a typical home has now fallen to £274,251.
Markets are currently pricing in around an 84% chance of a rate hike in November, following by multiple hikes next year. The latest pricing has moved around significantly since the Bank’s September meeting, when the probability of a November hike was reported at around 64%, showing the change in sentiment. Central bankers are expected to turn on the screws and increase the cost of borrowing to stop inflationary pressures sparked by the war with Iran rippling through the economy. In this climate, even help for first-time buyers to get onto the ladder, offered by the Burnham administration, is not going to meaningfully move the dial, when higher up the chain homeowners are struggling with the burden of higher mortgage costs, at a time when energy bills are also set to rise.
Brent Crude has started to tick higher again after falling in previous sessions, trading close to $100 a barrel again. The fact that oil is getting through the Strait of Hormuz has been encouraging, but flows are not yet regarded as completely secure or guaranteed, particularly while the wider conflict remains unresolved. Insurance costs for tankers remain elevated, reflecting the perceived risk of operating in the region, which adds to the cost of moving crude even when shipments are getting through. There is also no guarantee there won’t be a resurgence of attacks from Houthi rebels, given how complex the situation has become. The market has got used to a cycle of hope before another dash of disappointment, so there is still a geopolitical risk premium baked into the price of crude. Brent remains more than a third higher than before the conflict began.
Strategic oil reserves have also been heavily relied upon by nations including the US to cushion the shock and bring prices down. With those stockpiles now significantly depleted, there is a thinner buffer if there is another disruption, which is helping to keep a floor under crude prices.
The Governor of the Bank of England, Andrew Bailey, has again sounded the alarm about the AI boom, and the risks that the bets being made on the technology don’t pay off. In a BBC TV interview he acknowledged the potential to boost growth, but that the surge in asset values across the tech leader board was a risk the Bank was monitoring, given that history has shown that not everyone is a winner. The Bank has also highlighted the sharp increase in debt being raised to finance AI infrastructure, with AI-related debt issuance reaching around $450 billion in the year to September.
It is clear that the AI trade is doing a huge amount of the heavy lifting, particularly in the US, with investors continuing to pile into a relatively small group of mega-cap technology companies. That concentration is making the US market look considerably healthier than the broader market underneath it. However, trying to call the top of the AI trade is a very difficult game. If you sell too early, the risk is that you can lose out on potential gains to come, but if you wait for the warning signs to become obvious, markets may already have turned. So rather than trying to time the market, it’s better to do a portfolio health check and assess how much exposure you have and where that sits within the wider portfolio.
That could mean retaining exposure across a broad range of companies benefiting from AI, rather than betting heavily on just a handful of mega-cap names, while making sure you have plenty of diversification across other sectors and geographies. It would be far from wise right now to put all your eggs in the AI basket.’’