Monday Market Update – 11th September 2023

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Oil prices up and an ill wind for renewables

So far Markets have been generally quiet during September, but energy is again becoming an issue. Oil prices have risen since the start of the summer, with Brent crude having bounced along a bottom of $73 per barrel for the first half of 2023. Compared with the wild swings of 2019 to 2022, it doesn’t feel like much, however, it has been a factor in pushing bond yields back above 4.2% in the US and German yields to 2.6%. Much of the rise in near-term prices is driven by the seasonal variation in prices, with the passage into autumn meaning the nearer contracts now cover cooler months. The rise in oil prices is not enough to seriously create disturbance by itself, but US government bond yield levels are close enough to their recent highs to suggest a build-up of market tension. In a sense, the risks for government bonds are higher because risks are lower elsewhere. Credit spreads rose slightly on the week, but the extra return from higher coupons allows higher yielding bonds to outperform.

Returning to energy, no offshore wind projects won contracts in this year’s annual auction for UK Government subsidies last week, a significant setback for increasing capacity to 50 gigawatts by 2030. Keith Anderson, chief executive of offshore wind developer Scottish Power, said the “economics simply did not stack up” and the results were a “wake-up call for the government”. It’s not just the UK. There has been a marked change in sentiment towards the developed world’s renewable energy companies. Orsted (previously Danish Oil and Natural Gas), which is a leading player in wind power development, announced it was seriously considering abandoning its US wind power development projects unless the US government guarantees more support. Mads Nipper, Chief Executive of Orsted said that future projects need consumer prices for energy to increase. He said. “And if they don’t, neither we nor any of our colleagues are going to build more offshore. It’s very simple”, sounding just like Keith Anderson.

Offshore farms may be critical to environmental goals but are capital and labour-intensive. At the same time, input costs have shot higher, partly because of the large size of the IRA. Similar large projects run by Vattenfall AB and Iberdrola SA have also been scrapped. This is putting some supply chain companies under substantial pressure, and one potentially difficult consequence is that the companies facing problems are the ones widely owned by ESG investors. Many recognise that their ESG principles are more important than any near-term investment return problems, but many also thought that the inevitable demand forced through climate change would ensure these companies would be winners. ESG investors, perhaps more so than others, will need to be prepared to stick it out for the long term.

It’ll cost an Arm and an IPO

Last Tuesday, Japan’s SoftBank unveiled initial public offering (IPO) plans which would bring microchip designer Arm, one of Britain’s biggest tech companies, to public markets with a valuation of around $52 billion. The tech sector’s big hitters have already lined up to buy a big chunk. Cornerstone investors including Apple, Google, Nvidia, Samsung, Intel and TSMC have indicated they will purchase up to $735 million in Arm shares. Since SoftBank plan to list only around 10% of the tech company’s stock in New York, analysts estimate that around 15% of the IPO’s demand is already accounted for, although not date is confirmed.

Some analysts and commentators think the price is too high. Arm designs key parts of the microchips that feature in most of the world’s smartphones. The crux of the issue is how Arm relates to the artificial intelligence (AI) growth story that has captivated the tech sector. Arm’s designs are currently indispensable to global tech, their role in the next decade’s predicted AI-related boom is considered fairly small (of course, this is disputed by the company itself).

Untangling the tech and chip sector noise for Arm specifically is difficult, so a valuation based on industry fundamentals is hard to gauge. From our perspective, it makes it a great test case for the mood in wider capital markets and on that front, it looks like investors have a big appetite for equity. Things may change, but the fact that so much capital is already lined up from cornerstone investors shows that there is certainly money and demand. Even if SoftBank fall short of their $4.9 billion target to raise, the fact so much can be raised for an IPO when interest rates are so high is quite something.

The failure of significant IPOs was one of the big factors underlying the change in market sentiment in the run up to the dotcom bubble bursting in 2001. Back then, it became apparent that there was no demand for investment, and investors got valuation vertigo. It seems quite apt that, in the midst of another tech investment craze, there should be another stern test of market resolve. Anything close to SoftBank’s valuation would be a sign that confidence is still high, and we will be watching closely to see if investors are still willing to pay an Arm and a leg.

UK COMMENTARY

  • The price of a typical UK home dropped 4.6% in the year to the end of August, to a value of £279,569, according to the UK’s largest lender, Halifax. This was a sharper decline than economists’ forecast of 3.45%, falling to levels not seen since early 2022. However, it still leaves average house prices around £40,000 above pre-pandemic levels.
  • The Society of Motor Manufacturers and Traders reported that 85,657 new vehicles were registered in August, almost 16,800 more than a year earlier. This marked the 13th consecutive rise in monthly sales, but sales are still 7.5% below pre-pandemic levels.

NORTH AMERICA COMMENTARY

  • The US Labor Department reported 216,000 initial claims for unemployment benefits for the week ending 2nd September, a 13,000 fall on the previous week and a low level in historic terms, despite higher US interest rates. This also moved the four-week moving average down by 8,500, to 229,250.
  • The US Federal Reserve reported that consumer credit growth slowed in July to 4.9%, down from June’s figure of 5.3%. The slowdown was driven by little growth in non-revolving credit (arrears that have fixed payments until the debt is settled), after a solid gain in June. Revolving credit (arrears that don’t have a fixed number of payments), rebounded after a decline in June.

EUROPE COMMENTARY

  • Eurozone gross domestic product (GDP) growth for Q2 was downgraded from 0.3% to 0.1% according to the European Union’s statistics office Eurostat. After the fall in business sentiment surveys in July and August, and with construction and industry struggling and the labour market easing, fears have increased that Europe could fall into recession later this year.
  • Manufacturing orders in Germany – the Eurozone’s largest economy – declined 11.7% month-on-month in July, a bigger fall than expected. On an annual basis, factory orders were 10.5% lower than in July 2022. Statistics body Destatis said much of July’s sharp decline in new orders was due to a very large order reported in the manufacture of air and spacecraft in June.
  • Annual inflation in Turkey surged to 58.9% in August, up from 48% in the year to July. Economists had expected a smaller increase, to 55.9%. In August, Turkey’s central bank finally committed to opting for more traditional means to combat inflation via monetary policy, and increased interest rates to 25%. Under pressure from president Recep Tayyip Erdoğan, the central bank had cut rates throughout 2022, which weakened the Turkish Lira considerably.

ASIA COMMENTARY

  • Recent data from China showed headline inflation, as measured by the Consumer Price Index, returned to positive territory in August with a reading of 0.1% year-on-year.

GLOBAL COMMENTARY

  • Brent crude oil hit $90.40 per barrel last week, its highest level of the year so far, after Saudi Arabia and Russia extended their voluntary production cuts until December. Markets were volatile, as investors grew more concerned over the path of inflation. This price level could also raise alarms for central bankers as they continue to battle price rises, as it pushes the cost of fuel higher and weighs on business profits.

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