FTSE 100 nears record high, as markets welcome US political change

Financial markets are still digesting news that the Democrats have won control of Congress, and that President Donald Trump has taken the results with some grace. There has been no escalation of the war in the Middle East, and this is weighing on the oil price and boosting the market mood.

The FTSE 100 broke above February’s record high, even though UK oil majors are weighing on the index. Gilt yields are falling, even though the Bank of England is set to raise interest rates later today, and the pound is holding onto gains vs the USD above $1.3450, and is higher by 2% in a month. 

Political rally in stocks set to slow 

The markets have spoken, and they are happy with the outcome of the Midterms. On the Index level, markets surged on the back of the blue sweep of Congress. The Dow Jones surged by 3% on Wednesday, the S&P 500 rose by 1.5% and the Nasdaq lagged, rising by only 0.9%. 

Moves of this magnitude are usually caused by economic data, however, Wednesday’s moves were driven by politics and a relief rally that the worst of Trump’s policies could be behind us. Futures markets are pointing to a lower open for the S&P 500 and the Nasdaq on Thursday, and the Dow is pointing to a moderating rally, with futures rising 0.5% so far.

AI trade struggles in wake of Democratic win 

‘Good’ political news doesn’t tend to impact stock markets for the long term, and Democratic control of Congress comes with its issues for the tech trade. Increased scrutiny of data centres is expected, and this is hurting some sectors of the AI trade. For example, CoreWeave, the neocloud company, slumped by another 9% on Wednesday, and made a fresh 12-month low.  and is down 2% in premarket trading on Thursday. 

Why the hyperscalers will benefit from a slowdown in the AI buildout

The outlook for the AI trade is interesting. Chip stocks have been struggling for some time, and the political rotation in Washington is adding to their list of problems. The Semiconductor index in the US slumped 3% on Wednesday and is down 20% in a month. This is bad news for the likes of Nvidia, down 3% yesterday, and AMD, which is projected to fall 2% today. However, a rethink of the AI trade, and greater political pressure to slow the AI build out is good news for the hyperscalers. Amazon, Alphabet, Apple and Microsoft all jumped sharply on Wednesday. 

So why are hyperscalers rallying on the back of enhanced AI risks? If the Democrats do succeed in slowing down data centre development, and in some cases crushing plans to build new ones, this will naturally bring down the rate of capex spent by the hyperscalers, who have been spending like crazy on AI in recent years. This will help them to preserve cash and rebuild their free cash flow positions, which for the likes of Alphabet and Amazon is negative right now.  

So, a Democratic win could be beneficial for the bottom line of the major hyperscalers. 

Can the Democrats help the longed-for broadening out of the stock market? 

The Democratic win in the Midterms and greater scrutiny of the costs associated with the AI trade in recent months means that chip stocks now trade at a discount to the S&P 500. However, this is not enticing buyers because other sectors of the market are also cheap. Overall, the S&P 500’s price to earnings ratio is below its long term averages at 18.

Not only are US stocks looking cheap, even if they are only a few percent off their all-time highs, but the market rally is also broadening out. 

Will the oil price stay below $100 per barrel? 

While the focus is on the AI trade and the stock market rally, commodities is where the election could have a longer term impact. The price of Brent crude oil is back below $100 per barrel, and is at its lowest level since the end of August. There has been no sign of escalation in the Middle East and Trump has, so far, not escalated the war with Iran. Reports suggest that diplomatic efforts are ongoing to come to an agreement, and we expect to hear more about this on Friday.

Supply issues are also weighing on the oil price this week. The UAE said that it is considering a third oil export pipeline, which would avoid the Strait of Hormuz. The plans have not been finalized, but it is good news, and suggests that Middle Eastern oil producers are building resilience to the challenges facing the region. It also means that if the war rumbles on for the next two years, then oil supplies might not be affected. 

What to expect on Thursday 

Overall, the market’s focus will return to fundamentals including strong growth and decent earnings. A lower oil price for the long term could also boost sentiment, and will keep downward pressure on bonds. We do not think that the BOE will say anything today that could spook UK asset prices, however, if their economic forecasts suggest that today’s rate hike is a one off, we could see GBP/USD move back towards $1.34.