This week in the markets: investors look past the politics

The headlines continue to be dominated by politics, but investors are shrugging off events on both sides of the Atlantic. Earnings, valuations and the cost of borrowing remain the key drivers.

Political uncertainty

The UK is once again an outlier - and this time it’s for all the right reasons. The electoral landslide for Labour was well-flagged, and arguably overstates the party’s popularity because its share of the vote was historically low and less than the combined totals for the Conservatives and Reform. But the first past the post electoral system here ensured a massive parliamentary majority for the new government under Sir Keir Starmer.

Investors like stability and markets responded positively to Friday morning’s news. Shares, bonds and the pound were all higher. But the reaction was muted. Markets move on surprises and there were none. Attention will quickly shift to delivery of Labour’s growth agenda and how it proposes to fund its promises. All the old challenges remain - too much debt, too little growth and low productivity. An electorate that wants European style public services but American style taxation.

But the UK is turning out to be a relative beacon of stability in an unstable world. Over in France, the weekend delivered another political shock. The centre and left joined forces to keep Marine Le Pen’s Far Right out of power. The result is now political gridlock, a three-way split of seats that leaves no-one with any effective power. That’s not necessarily bad news for investors, though. Again, markets responded in a positive but subdued way to the news.

Meanwhile, over the pond, speculation continues to swirl around President Joe Biden. Will he, or won’t he stand in November? It’s widely agreed that the next couple of weeks will be key. If he holds out, then the Democrats will no doubt rally around their man. But there are serious doubts about whether, after a dismal debate performance, he can keep Donald Trump out of the White House.

Earnings - here we go again

So, markets have shrugged off the politics. That’s reasonable because in the long run, elections don’t matter much to investors. Whatever the make-up of White House and Congress, and whichever party wins over here, markets press on regardless, focusing on what really matters - corporate earnings and the price that investors are prepared to pay for a share of them.

This week sees the next round of company results kick off, with the banks as usual first out of the blocks on Friday. They are not the main driver of the markets, though. That’s still the prerogative of the giant tech stocks which continue to leave the rest of the market standing. Over the past three months, the Magnificent Seven have risen by 23 percentage points more than the equal-weighted S&P 500 index. Year to date they have done 13 percentage points better.

It's one of the most bifurcated markets ever and that is worrying some investors. Although just in terms of valuations, the market is by no means as stretched as it has been during previous periods when a handful of companies have led the charge. Shares are cheaper than during the dot.com bubble and the Nifty 50 period during the 1970s. Strip out the leaders and the rest of the market does not look stretched at all, especially with earnings growing at a near double digit rate.

The pivot draws closer

Meanwhile, the other main driver of markets - interest rates - looks increasingly positive. This week, the US will unveil its latest inflation figure, a key data point for the Federal Reserve as it decides whether to finally pull the trigger on lower rates. The odds on a September cut now stand at 75%. Here, too, the Bank of England is expected to cut as soon as August, now that inflation has finally returned to target, albeit with still persistent wage and service sector inflation muddying the waters.

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