The iShares Physical Gold ETC held in the T. Bailey multi-asset funds closed August up 12.0% (in GBP terms). That is its strongest month since the correction began in June, even after giving back nearly 2% in the final week. It is held as a diversifier for periods when the fiscal and monetary stories pull in different directions - which seem to be becoming a regular feature.
Forty trillion and counting
"Don't fight the Fed" may be a well coined phrase, but ultimately the Fed does answer to the bond market. US gross federal debt was reported to have passed US$40 trillion in the third week of August, roughly double where it stood in 2017. The statutory debt ceiling sits at US$41.1 trillion, which, on current estimates, means it will need revisiting sometime between late winter and mid-summer next year.
The more immediate signal was in long-dated yields. The Treasury sold US$25 billion of thirty-year bonds on 13 August at above 5.2%, the highest yield at auction since 2001. By 18 August the thirty-year yield had pushed past 5.3% in secondary trading, its highest level since 2007. Similarly, UK, German and Japanese long yields all touched multi-year or multi-decade highs indicating a broader repricing of the term premium, the compensation investors demand for holding government debt over decades.
The US Treasury’s response has been a plan to double (at least) the size of its liquidity-support buybacks for ten-to-thirty-year securities, from US$2 billion to US$4 billion per operation. It worked for a few days as long yields fell on the announcement, but then climbed again as investors went back to worrying about the scale of ongoing issuance rather than the mechanics of one operation.
Federal interest outlays reached roughly US$970 billion in the last full fiscal year, more than the US defence budget, at 3.15% of GDP and more than double the level that prevailed through most of the 2000s and 2010s. Higher yields raise the government's debt-servicing costs and, in a self-fulfilling manner, add to the concerns that push yields higher still.
Within the T. Bailey Multi-Asset funds our government debt sits in the short to middle of the curve, not the twenty-to-thirty-year segment where the damage has been worst. The iShares $ Treasury Bond 7-10yr UCITS ETF (GBP hedged) returned 0.6% in August. Our short-dated UK gilt holding added 0.3%. Whilst higher yields may prove more attractive to investors, duration risk has not gone away and a term-premium repricing of this size, if it continues, will eventually reach every part of the curve, thus keeping our focus on shorter-duration debt.
AI's second phase: show us the revenue
Nvidia reported impressive second-quarter results towards the end of the month. Revenue reached US$96.2 billion, more than double the year before. Data-centre revenue rose 117% to US$89 billion and forward guidance for the current quarter came in ahead of expectations. The shares rose over 8% the next day, adding US$442 billion in market value in a single session, and the wider semiconductor complex moved with it.
That level of spending is certainly large enough to matter for the wider economy, and Kevin Warsh made that connection explicit in his Jackson Hole remarks. With US headline PCE inflation at 3.7% in July, core PCE at 3.3%, an investment boom pouring demand into energy, construction and skilled labour makes his job harder in the near term, whatever productivity gains AI eventually delivers.
Within the T. Bailey fund of funds’ portfolios, it was more notable how uneven the relief rally proved. The Polar Capital Artificial Intelligence Fund, still recovering from a 14.5% fall in July, returned only 0.9% in August taking its year-to-date return to 36.8%. Yet the parts of our portfolios exposed to Asian chip manufacturing, the memory and foundry names that supply the data-centre build, moved much further. The HSBC MSCI Emerging Markets ETF returned 5.0%. The Baillie Gifford Pacific Fund held within the T. Bailey Global Thematic Equity Fund returned 6.0%. In contrast, the Merlin Fidelis Emerging Markets Fund fell 2.1% even as the broader emerging-market sector rose.
Cybersecurity was a second beneficiary of the AI theme in August. The First Trust Nasdaq Cybersecurity ETF returned 9.6%, its best month of the year. August gave the sector plenty of reasons to stay in demand. The UK's AI Security Institute reported that safety testing of two frontier models had produced unsanctioned attempts to insert malicious code into public repositories. OpenAI paused work on an unreleased model after it could not rule out that the system had crossed a threshold for autonomous cyber-attack capability. US authorities disrupted a Chinese-linked hacking operation that had targeted the Justice Department, NASA and the Federal Reserve. Together these events explain why investors will keep paying up for the businesses that defend against cybersecurity threats.
