As we move towards the end of 2025 – another successful year for equities – speculation over an imminent market correction is intensifying. Whether a disconnect exists between valuations and the state of the ‘real economy’ is open to debate, but some have argued that concerns are borne out by the jobs market, both here and in the US, and its relationship with the trajectory of stock market indices.
Job vacancies are considered a forward-looking indicator, mirroring investment levels and aggregate demand through the wider economy. So it’s not difficult to appreciate why vacancy levels and stock market indices have generally shown a positive correlation, although the relationship isn’t etched in stone, and we have certainly witnessed recent periods of divergence.
The accompanying chart clearly points to a breakdown in the relationship between the US and UK jobs markets and their respective benchmark stock exchange indices. Vacancy rates have been in downtrend in both countries since the second quarter of 2022, the point at which the US Federal Reserve started to crank up interest rates. But it’s the extent of the divergence, rather than the breakdown itself, that should concern investors, particularly in relation to the S&P 500.
The US labour market has shown some recent positive signs, but the ‘real world’ situation is more difficult to gauge in the wake of the US government shutdown. It’s also worth recalling that job creation during the Biden era was disproportionately reliant on growth within the public sector and/or federal subsidies. Fed chair Jerome Powell also suggested earlier this month that the way that data is gathered may be overestimating the strength of the current labour market – one reason why the Fed cut rates again this month.
There are various theories as to why stock market indices and job market statistics have decoupled. But if you were to discount the tech cohort from the equation, the gap would narrow appreciably. Whether this amounts to a vulnerability is open to question, but it could be another indication, were it needed, that artificial intelligence (AI) investments do not directly or automatically translate into significant job creation. A sobering thought, even for those not engaged in the equities market.
The ‘treemap’ chart below shows that the UK has done as well as anywhere (outside of the US) in building its data storage capacity.
The fact that tech-related industrial production is far outpacing other sectors is both causal and symptomatic of the ongoing build-out across the sector. The US has witnessed exponential growth in the rollout in data centres over the past decade, with the rate of development accelerating due to the demands of big data, cloud computing, and the spread of AI technologies. Investment activities have already become the prime driver of growth in the US economy, a dynamic that hasn’t been lost on policymakers in the UK and elsewhere.
It’s widely appreciated that capital allocations in this space have driven valuations in US indices to the point where multiples for the tech cohort have become the major point of conjecture across the Atlantic – at least within investment circles. The fundamental question is whether the extent of AI investments – which started to grow rapidly in the early 2010s – are justified by a commensurate rise in corporate efficiencies and earnings.
It’s also widely appreciated that data centres require enormous amounts of energy to function, which should logically precipitate greater investment in power generation capacity. This presents something of a test for countries such as the UK which have prioritised investments in renewable (ie intermittent) energy sources. There is a demonstrable correlation between industrial energy costs and economic output, so government policy in this area has the potential to either constrain or stimulate the development of data storage capacity.
The UK has a solid reputation in relation to its sovereign debt, with only one technical default to its name, in 1934. And there were mitigating circumstances at the time. The default related to the country’s first world war debt obligations to the US which, unfortunately, were tied to Germany’s curtailed reparations payments. At that point, the UK national debt stood at 175 per cent, against the current rate of 102 per cent.
Yet the accompanying chart illustrates how debt markets have become increasingly sceptical about the UK government’s ability to put the public finances on a sounder footing. It should be pointed out that the premium on US medium-term debt throughout Donald Trump’s first term was wholly atypical in the modern era; US government debt (and the country’s ability to run a hefty current account deficit) has benefited from the US dollar’s safe haven status in recent decades.
Admittedly, the UK is not a fiscal outlier among advanced economies when measured by traditional debt and deficit metrics; yields on government debt have been in uptrend across the G7 economies. Following on from last year’s US elections, gilt yields rose in line with US Treasuries through to March 2025, but the risk profile on UK debt has subsequently deteriorated.
Although the bond market’s initial reaction to the autumn Budget in the UK was positive, it was a short-run affair. That’s partly because several tax-raising measures are scheduled for later in this parliament. It certainly doesn’t help that unemployment rates are on the rise, particularly in the youth jobs market. So, despite £26bn in targeted tax rises, the low-growth Budget is unlikely to put the UK on the path to fiscal sustainability.
Sentiment towards the UK hasn’t been helped by persistent inflation and mixed assumptions over the Bank of England’s base rate deliberations. It means that long-dated gilt yields have been rising more sharply than in other markets, and there is little improvement in sight. According to the Institute for Fiscal Studies, both net issuance by government (as a proportion of GDP) and the share of gilts held by the private sector are expected to remain above the historical average through to the end of the decade.
The worrying state of UK public finances has given way to an increasingly polarised debate on the best way to meet government debt and expenditure obligations. Proponents of supply-side reforms are pitched against those who believe that the surest way to boost economic growth is by stimulating aggregate demand through interventionist policies.
The narrative runs that an increasing number of ultra-wealthy taxpayers are moving out of the UK due to the phasing out of the non-domicile tax status, along with changes to capital gains and property taxes.
It is difficult to quantify the extent to which wealthy and highly mobile individuals are relocating abroad, as there is a dearth of reliable empirical evidence to back the proposition. But regardless of the extent to which it is playing out, it has reignited the debate over tax optimisation and the Laffer curve.
The Laffer curve describes a theoretical inverted U-shaped relationship between tax rates and the amount of tax revenue collected by the government. Somewhere along the curve the optimal rate exists, although it is not fixed given that it is sensitive to many variables. The overall tax burden is forecast to increase to around 38 per cent of GDP by 2030–31, placing the UK around the middle of the G7 countries on that basis. But the debate has increasingly centred on the willingness of top-rate taxpayers to take on the burden beyond a certain level.
The tables show that the aggregate income tax liabilities of the top 10 per cent of taxpayers in the UK fell on a proportional basis in 2022-23. The following three years, which are estimates by the government, suggest the fall is expected to continue. There are several possible reasons for this – the freezing of income tax thresholds, for example, means more people are being dragged into higher-rate bands and so paying a greater share of tax. It might also indicate that more of those high earners are expected to leave the country in the months ahead. That would also have negative consequences for indirect taxation receipts. Beyond the fiscal implications, the debate over optimised tax rates can have a bearing on investor behaviour, corporate profitability and inward investment levels.