Key Takeaways
- Stock markets have largely priced out worst-case Iran war scenarios and the direction of travel remains positive.
- Despite recent political turmoil, UK gilts could be poised for recovery after “extreme underperformance.”
- European growth remains a challenge but selective opportunities exist in defense sectors.
Karen Gilchrist: Global markets continue to exhibit resilience, even as uncertainty bubbles away beneath the surface. A resolution to the Iran war remains elusive, fresh political turmoil rattles the UK, and growth challenges weigh in Europe. To discuss what this means for the global outlook—and the risks and opportunities therein—I’m joined by Neil Wilson, UK investor strategist at Saxo. Neil, thank you for joining us.
Let’s kickstart with the macro outlook, particularly as it pertains to the war between the US and Iran. We don’t seem much closer to a resolution, but markets do seem to be taking this in their stride. How are you thinking about the outlook there? How are you positioning for it, and what do you see as the risks going forward?
Iran War Worst-Case Scenario Priced Out But Inflation Risks Loom
Neil Wilson: So I think the Iran war has sort of been rumbling along, and I think we saw the market kind of bottom around the end of March, certainly the US market. I think gradually it’s more about the direction of travel. And I think markets have kind of priced out the extreme left tail risks: So that sort of complete meltdown kind of situation. So I think the focus now is on just how durable the inflation picture is.
There was quite a hot PPI print, the producer price inflation number from the US, coupled with some data and import prices, CPI numbers as well. And I think that just seems to have unleashed a bit of a push in global bond markets. We’ve seen the 30 year Treasury yield hitting a 19-year high. Also in Japan you’re seeing bond yields move out. So there’s a bit of inflation angst around the Iran war but I think broadly speaking markets are becoming less worried about that extreme situation. And the direction of travel, although it’s slow and uneven, is in the right direction.
And then coupled with that, in the US in particular, you’ve got really resilient earnings growth profiles. Earnings growth of 20%, 25% for the S&P 500 this year. That, combined with a very robust labor market, it’s set up for potentially a positive year for the market. I think there’s a scope for a pullback in around early June. I think that it’s very much a sort of flow-driven kind of pullback that we anticipate, and the real question about how much that goes is to do with yields.
Karen Gilchrist: And what of the supply chain disruptions? You mention these positive elements that are providing some momentum to the markets, but it does seem as though there are many as yet untold issues with supply chains, potentially.
Neil Wilson: There are and I think clearly there’s going to be an impact on food pricing and so on with the fertilizers. But again, I just reiterate I think that to a degree a lot of that has been discounted. And there is going to be dispersion in global markets. I think that clearly the US is a lot more insulated, and it’s so easy to end up talking about the US as the market. It’s not the market overall. But certainly among our clients, the focus is on the US and the UK. And a lot of our clients are very much heavily into US equities, as people have become, more recently. So there are risks, clearly, the longer it goes on. But I think the direction of travel seems broadly positive. I don’t think that Donald Trump wants to be fighting midterm elections in November with an Iran war escalating.
Will the Bank of England Cut Interest Rates on Labor Market Weakness?
Karen Gilchrist: Absolutely. Now let’s turn the focus a little bit more to the UK and Europe. You mentioned those inflationary pressures. What are you thinking about the outlook there? How much are central banks going to have to step in if we do see that inflationary spike?
Neil Wilson: So I’ve been on the side of “the market’s got this wrong.” The market’s pricing in hikes by the Bank of England, and that is underestimating the negative impact on the economy and the labor market. We’ve had some very soft labor market figures in the UK. The latest CPI numbers pull back. Now obviously we do expect them to go up again, come May, June, July, because of the base effects in those numbers and the impact of the energy price capping that the government’s carrying out.
But I think that the situation is not 2022. So this is not a wage-price spiral dynamic. You don’t have this huge demand surge for goods and services that you had post-pandemic, combined with a very tight labor market. So this is a very different situation, and I think the Bank of England is trying desperately to look through it, it’s trying desperately to sit tight. Hopefully those CPI numbers that we’ve had will allow it to do so in June. And I think the Bank of England, as long as the doves just about are holding sway at the moment, that they’ll sit through this and then actually the next move will be to cut rates.
UK Political Turmoil Presents Opportunity for Bonds
Karen Gilchrist: OK so potentially holding tight for now. But of course this comes at a time of great renewed political turmoil in the UK. And we’ve seen bond markets be very concerned by the prospect of a new incoming Labour leader, potentially more left-leaning, even as we’ve had commentary from some of the challengers to say that won’t be the case. What are you thinking about the UK landscape now? How much of an issue is this fresh turmoil?
Neil Wilson: I think we clearly need to get a bit of resolution around where the government’s going to be going. I think UK assets do look a bit tricky at the moment. Gilts have been very volatile. I do think that probably the market’s pricing in a bit too much risk premia for gilts. We’ve seen that Andy Burnham, the main challenger really, the favorite, he’s stuck very clearly to say that we’re going to stick to the fiscal rules, we’re not even going to exempt defense spending. That was something that had been talked about.
Now that means probably tax hikes. Again, that’s not such a good outlook for the UK economy. But broadly speaking, I think a lot of the risk, the fiscal and political risk, has been priced into gilts. And we have seen them come off those highs. And I think really it’s going to be hard for gilt yields to move up much beyond those highs. So I think potentially combined with the Bank of England at least sitting tight for now, the labor market looking a bit soft, and the Labour government, really whoever is in charge, being constrained by the bond market, by the fact that they can’t really risk going up against it, that actually gilts could perform quite well over the next few months as a result of, really, the extreme underperformance that we’ve seen.
ECB Seen Raising Rates Even as Growth Challenges Weigh on Region
Karen Gilchrist: Interesting. Now looking at Europe, what is your base case for the year coming? Where do you see Europe going?
Neil Wilson: Europe is a tricky one. I think the ECB is probably more likely to be raising rates than the Bank of England. The market is pricing not that differently between the two. But I think the ECB will be likely to raise rates. I think really there’s huge structural problems in Europe, and it’s less about the Iran war and more about whether or not they can sort of carry out any of these Draghi reforms and really push forward on some of these changes.
You’re seeing some of the real engines of growth in Europe struggling. You know the German carmakers, for example, that’s a great totemic example of it, and really Europe falling behind in terms of AI, in terms of tech. So I think in Europe we could see some slight outperformance versus US in the short-term because the US has run up, Europe’s been a bit stagnant. But I think that longer-term, it’s just this question of just how much can Europe structurally outperform anywhere else, and I think that’s the real problem for Europe.
Utilities, Materials, and Housebuilders Present Opportunities in Defensive Play
Karen Gilchrist: Yes, much to prove, for sure. Are there any sectors that you see as potential growth drivers, any that stand out to you?
Neil Wilson: Well, I think in the near term, if you’re positive or a bit more positive on gilts than maybe the market is, then maybe you’re looking at some of the bond proxies, for example utilities, maybe materials, maybe housebuilders. Metals, miners, they’ve had a bit of retracement after a really good run up. I think you get some resolution in Hormuz and Iran and maybe that starts to improve a bit, particularly if gilt yields come down and bond yields come down a bit. So I think there’s definitely a few sectors there.
Karen Gilchrist: OK. And final word: any that you’re avoiding, that we should stay clear of?
Neil Wilson: I’m not 100% sure about the banks, so we’ll see about that one. But I don’t want to be too down on any one area.
Karen Gilchrist: Neil, thank you so much for joining us. For Morningstar, I’m Karen Gilchrist.
