Market Talk: Global markets 'more correlated than ever' to the US | REUTERS

Key Concepts

• US Government Shutdown: A situation where the US federal government ceases to operate due to a failure to pass appropriations bills.
• AI-Related Stocks: Stocks of companies involved in the development or application of artificial intelligence.
• Government Bond Yields: The return an investor realizes on a bond, influenced by factors like interest rates and market sentiment.
• Risk-On Sentiment: An investment attitude characterized by a willingness to take on more risk for potentially higher returns.
• US Tariffs: Taxes imposed by the US government on imported goods, intended to protect domestic industries.
• Profitability: The ability of a company to generate earnings.
• P&L (Profit and Loss): A financial statement that summarizes the revenues, costs, and expenses incurred during a period.
• Earning Season: A period when publicly traded companies release their financial results.
• Magnificent 7: A group of seven large-cap US technology companies that have significantly influenced market performance.
• Correlation: A statistical measure that describes the extent to which two variables change together.
• Fed Rate Cutting Cycle: A period when the US Federal Reserve lowers its benchmark interest rate.
• Emerging Markets: Countries with developing economies that are experiencing rapid growth.
• Fat Neutral Rate: The theoretical interest rate that neither stimulates nor cools the economy.

Market Reaction to US Government Shutdown and AI Stock Valuations

Markets began the week positively, buoyed by the prospect of an end to the US government shutdown. The US Senate passed a deal to fund the government until the end of January, marking the end of the longest shutdown in US history. This development provided a boost to markets that had experienced volatility the previous week due to concerns about the justification of AI-related stock valuations.

Michael Brown, Global Investment Strategist at Franklin Templeton, commented on the historical impact of US shutdowns. He stated that historically, these shutdowns have had minimal impact on markets and the broader economy. Brown believes this shutdown, despite its length, will likely follow a similar pattern, with markets showing a degree of recovery post-shutdown, which is currently being observed.

Economic Data and Federal Reserve Policy

The government shutdown has led to a lack of economic data, creating a situation where market participants are "flying blind." A significant influx of economic data is expected in the coming weeks, requiring economists to catch up and assess the current state of the US economy. Indications suggest that US economic growth remains robust.

Regarding the Federal Reserve's policy, Brown noted that the situation is "finely balanced." He highlighted that the anticipated inflation following the imposition of tariffs has not materialized, and it does not appear likely to occur. Consequently, the current interest rate is deemed unnecessary, leading to a debate about the long-term real base rate and the "fat neutral rate."

Impact of US Tariffs on European Companies

A survey by Business Europe indicated that European companies anticipate a greater impact from US tariffs in the upcoming year compared to the current year. Brown agrees with this assessment, citing reports from companies in the current quarter that have shown the negative effects of tariffs on their profitability. He observed that corporations are currently absorbing these tariff costs rather than passing them on to customers. While some might argue this suggests future price increases, Brown suggests that companies are currently taking the hit on their Profit and Loss (P&L) statements. The evidence, from a US perspective, suggests that tariffs are proving effective.

Earning Season and European Market Outlook

The earning season has yielded mixed results. While many European companies have upgraded forecasts, these upgrades are often for the second half of 2026, suggesting uncertainty in the nearer future. Brown acknowledged that both Europe and the US have reported decent numbers this quarter, which should improve the backdrop for earnings into 2026. He expressed surprise at the reluctance of European analysts to raise their numbers, especially given the known impact of tariffs and currency strength. Brown believes this reluctance presents an opportunity, suggesting there is untapped value in the European market.

US Exceptionalism and Global Market Correlation

Despite discussions about the end of "US exceptionalism," global equity markets continue to be influenced by the performance of the "Magnificent 7" in the US. Brown's research, looking at correlations since 2008, reveals that global equity markets have become more correlated to the United States, not less. This is counterintuitive, given the growth of the Magnificent 7, which is a unique US phenomenon.

Implications of a Fed Rate Cutting Cycle

In the context of a Fed rate cutting cycle, markets are expected to react quickly to these US rate cuts. Historically, emerging markets have performed best during periods of a series of US rate cuts. Therefore, despite increased correlation, this trend is seen as beneficial for global markets, including the United States.

Conclusion

The markets are showing resilience, with the potential end of the US government shutdown providing a positive catalyst. While economic data remains scarce due to the shutdown, current indications point to strong US growth. The impact of US tariffs is being felt by corporations, and the earning season, particularly in Europe, presents potential investment opportunities due to analyst conservatism. The strong correlation between global markets and the US, driven by the performance of major US tech stocks, means that US monetary policy, such as rate cuts, will have a significant positive impact on emerging markets.