August 2025
Both bonds and equities posted strong returns in August. A weak US jobs report, along with the 1 August tariff deadline meant markets got off to a jittery start. However, markets recovered by mid-month as resilient global activity, in-line inflation figures and strong second quarter corporate earnings all helped the S&P 500 post its fourth consecutive monthly gain. Federal Reserve (Fed) Chairman Jerome Powell’s dovish speech at Jackson Hole boosted investor confidence as the Fed said that the balance of risks to the US economy had shifted from inflation to the jobs market, strongly implying the Fed will cut rates at their next meeting in September.
But the US administration continues to make headlines, and in August, the Fed faced headwinds over concerns of its independence when President Donald Trump threatened to fire one of the Fed’s Board of Directors, which brought on fresh worries over inflation rising again. Short-dated US Treasuries had a strong month while longer-dated global bonds struggled. Rate cut expectations weighed on the dollar, which weakened against every other G10 currency over the month. The Dollar Index fell 2.2% in August.
Tariff deadline passes
The 1 August tariff deadline was the focus at the start of the month, with fresh tariffs being imposed on 7 August, including 50% tariffs on copper and raising Canada’s tariffs to 35% for non-USMCA (United States, Mexico, Canada trade-pact) goods. Mexico was granted a 90-day extension to try and reach a new trade deal. However, as the US reached trade deals with several of its largest trading partners, including the EU and Japan, the deadline was not as much of a cliff-edge for markets as some had previously feared.
Weak jobs report creates volatility…
It was a weak jobs report that weighed on equities at the start of the month, with the US economy adding 73,000 jobs in July, lower than economists’ expectations. The unemployment rate meanwhile rose slightly to 4.2%, up from 4.1% the month before, indicating that the US labour market was not as resilient as earlier in the year. Jobs gains from the previous two months were also revised down, with some arguing this showed signs of cracks in the labour market that could deteriorate once Trump’s economic plans take hold. The weak jobs report led Trump to make an unprecedented move and fire Erika McEntarfer, commissioner of the Bureau of Labor Statistics, which sparked accusations that Trump was politicising economic data.
…but markets recover as investors expect a Fed rate cut
But markets began to recover after the jobs report, particularly once investors became more confident the Fed would deliver a rate cut in September. The Consumer Price Index (CPI) – the Fed’s preferred inflation gauge – came in as expected, which gave confidence that there were no major signs tariffs had impacted inflation, even though core CPI – which excludes food and energy – grew the fastest in six months. At the annual conference in Jackson, Wyoming at month-end, Powell sent the strongest signal yet that the central bank is preparing to restart interest rate cuts, as he underscored the labour market’s vulnerabilities. “The balance of risks appears to be shifting,” Powell said on 22 August. With borrowing costs weighing on the economy, a softening labour market and inflation risks contained, “the shifting balance of risks may warrant adjusting our policy stance,” he said.
This helped push equities up in August, with the S&P 500 rising 2% and the Nasdaq up 1.7%. Gains extended beyond the US, with the STOXX 600 Index finishing the month up 1%, the FTSE 100 1.2% and Japan’s Topix 4.5%. Emerging markets also saw solid gains, with the Shanghai Composite surging 8.1% due to a combination of domestic fund flows, supportive government policies and an extended US/China tariff truce.
June 2025
The second quarter of 2025 has been a story of volatility, recovery and renewed optimism across global markets. After a strong start to the year, April brought a sharp correction, driven largely by the surprise implementation of new global trade tariffs and Trump’s self-declared ‘Liberation Day’. Equity markets pulled back significantly, with the S&P 500 dropping nearly 19% by mid-April, briefly testing bear market territory.
However, markets recovered quickly. The announcement of a 90-day pause in new tariff actions, along with stabilising economic data and more measured rhetoric, helped equities rebound meaningfully through May and June. By mid-May, the S&P 500 had returned to positive territory for the year, restoring confidence across both institutional and retail investors. While market leadership has again narrowed somewhat, returns have been broadly positive across most regions and sectors.
The standout performance came from large-cap US technology names. The Magnificent Seven delivered an impressive +21.5% return in Q2, marking a powerful rebound from April’s lows and reasserted itself after this relief rally. Global growth equities also rallied strongly, with the MSCI World Growth index up +17.7%, significantly outperforming the +5.4% gain in the MSCI World Value index.
US equities lead developed markets, with the MSCI USA index gaining +11.3%, driven by strong earnings in the tech and consumer sectors. The MSCI World index rose +11.5%, reflecting wider global participation. In Asia, MSCI Asia ex Japan advanced +8.5%, supported by strength in South Korea and India. Japan delivered gains of +7.6%, weighed down slightly by yen weakness and softer domestic activity, though we continue to believe that the improved corporate activity will benefit Japanese equities over the long term. Chinese equities were softer, rising +2.6%, as concerns linger over growth momentum.
Emerging markets continued to benefit from a more favourable macro backdrop, with MSCI EM returning +7.9%, supported by commodity-linked economies and a softer US dollar. European equities saw more muted returns following a strong first quarter, with MSCI Europe ex UK up +3.1% and MSCI UK up +2.4%, held back by slower growth data and political noise.
The US dollar softened slightly against a basket of major currencies, offering a tailwind to non-US equity markets and emerging economies. The Japanese yen remained under pressure, testing multi-year lows, which provided some support to Japanese exporters despite weighing on domestic sentiment.
Overall, Q2 has reinforced the importance of remaining globally diversified. While geopolitical risk and policy uncertainty persist, the breadth of this quarter’s recovery across regions and asset classes is a positive sign for investors heading into the second half of the year. Emerging Market (EM) debt, which is often denominated in US dollars, suffered due to weakness in the US dollar compounding poor performance as the dollar fell roughly 5.5%.
May 2025
Markets saw a significant recovery in May following extreme volatility in April caused by President Donald Trump’s tariff announcements. Equities performed strongly, as a robust set of first quarter corporate earnings in the US along with a shift towards tariff negotiation helped reverse many of the losses from April, pushing the S&P 500 to its biggest monthly gain in a year-and-a-half. European equities also performed strongly as fiscal support buoyed sentiment.
Tariff relief drives equity rebound
The rebound in May started with a positive US jobs report showing higher non-farm payrolls and a steady unemployment rate. This helped reassure investors that the US economy wasn’t facing an imminent slowdown.
In addition to the strong US jobs report, news of potential trade deals between countries began filtering through which helped lift equities. The US and the UK announced the framework of a deal on 8 May. Then on 12 May, it was announced the US and China would cut tariffs for 90 days, with the US paring back tariffs on Chinese imports to 30% from 145% and China reducing its levies on American goods to 10% from 125%. Equities rallied, pushing the S&P 500 up 6.3% in May. Hong Kong’s Hang Seng Index gained 5.9% while the Shanghai Composite rose 2.2%. The strong earnings season also buoyed equities, with some 97% of the S&P 500 companies reporting double-digit year-on-year earnings growth. Despite Trump’s unpredictable approach to tariffs and claims that European trade talks were not progressing, the Euro Stoxx 600 rose 5.1% in May.
There was a twist to the tariff saga towards the end of May, when the US Court of International Trade said the Trump administration did not have the authority to impose most of the tariffs that had been announced. However, a federal appeals court temporarily agreed to preserve many of Trump’s tariffs, pausing the earlier decision, so they remain in place for now.
After a tough first quarter for artificial intelligence (AI)-related technology stocks (i.e. the Magnificent 7), these companies rallied strongly in May following strong earnings. Contrary to market concerns that a US slowdown may result in these companies reducing their investment in AI, they showed no signs of slowing down.
In China, markets faced challenges due to renewed trade tensions with the US, as Trump accused China of violating a tariff truce. Despite these tensions, the MSCI China Index rose around 1% in sterling for the month, supported by government stimulus aimed at stabilising the economy. Japan’s equity markets meanwhile posted strong performance over the month, with the Nikkei 225 rising 5.3% as trade tensions eased between Japan and the US. The yen rallied, helping confidence in the region.
Central banks navigate trade tensions
The Federal Reserve (Fed) and Bank of England (BoE) both met in May, providing some insight into their thinking since Trump’s tariffs were announced on 2 April. Ongoing trade friction and uncertainty has increased, which could have a notable effect on prices and overall demand in the global economy.
The Fed held rates steady in May, sticking to a wait-and-see approach as officials prepare for Trump’s tariffs. At the meeting, Fed Chairman Jerome Powell maintained the Fed is not in a hurry to lower interest rates, stressing the Fed is “well positioned” to respond in a “timely way to potential economic developments”. He also noted how difficult forecasting has become. “It’s really not at all clear what it is we should do,” Powell said. “There’s so much uncertainty.”
The BoE meanwhile reduced rates to 4.25% on 8 May, carrying on with its 0.25% reduction every quarter since it began lowering rates last year. Although the latest cut was widely expected, the decision among policymakers was split, as concerns mount over how Trump’s tariffs will affect UK growth. Two out of the nine Monetary Policy Committee (MPC) members favoured a larger 0.50% cut, while two others voted to keep rates unchanged. Although potential shocks from the Labour government’s budgets and ongoing trade fragmentation could lead the BoE to speed up rate cuts, the wide range of views at the MPC’s most recent meeting tempers expectations of faster and deeper cuts. In the minutes from the meeting, Governor Andrew Bailey noted the bank does not have a “preset path for interest rates” and also underscored how global trade tensions “should not be overstated”.
Conclusion
Tariffs—and how they’re likely to affect businesses and consumers around the world—will continue to be a major theme. Although the US Court of International Trade said the Trump administration does not have the authority to impose tariffs, the reprieve granted to him by a federal appeals court means the tariffs are in place for now. Markets have trended upward, buoyed by Trump’s temporary pullback on tariffs until July, but risks remain. The outlook remains sensitive to further developments in trade negotiations, legal proceedings and fiscal policy. Mounting concerns over the US’s fiscal trajectory—exacerbated by credit rating downgrades and the prospect of extended tax cuts—continue to put pressure on sovereign debt markets. Central banks face an ongoing delicate balancing act.
May provided some relief from April but the path forward is unclear. Investors should be prepared for continued market volatility in the months ahead.
March 2025
In light of recent market volatility following Trump’s sweeping tariff announcements last week, aimed at reshaping trade relationships between the US and its global partners, I wanted to share my perspective.
The wider context
We entered 2025 with expectations of moderate growth and few concerns of a recession. With Trump’s tariffs taking markets by surprise, investors have dialled up the probability of a recession as well as higher inflation – also known as stagflation – should the tariffs remain in place. The potential economic impact of renewed trade tensions between China and the US – especially as China announced its own reciprocal tariffs on Friday – further unnerved markets Friday and Monday 7th. As a result, we have seen the S&P 500 in the US come off some 17%, with a further decline of 0.2% on Monday 7th. European, Japanese and Asian markets have all suffered similar declines. Even gold, perceived to be a safe haven, has sold off.
While it has been less than a week since markets commenced their steep decline, there are signs that we are witnessing indiscriminate selling where investors ‘sell what they can’ – or what we call in the industry ‘capitulation’. Some 75% of the S&P companies have hit 28-day lows, the small-cap Russell 2000 reached some four standard deviations from trend, gold is selling off in high volume, there are huge amounts of short ETF interest and some $100 billion of the SPDR (S&P Index) has been sold. These are all signs of investor panic which normally signals we are close to the bottom of the market. Bonds are moving to price in more rate cuts as result of the expected economic hit, resulting in shorter-dated bonds outperforming. Futures markets are pricing in 1.50 percentage points of rate cuts by June next year.
What happens next in the US depends on the eventual balance struck between an ongoing attempt to raise revenue to fund tax cuts and the readiness to negotiate in order to achieve strategic objectives relating to immigration, trade imbalances and defence spending. Treasury Secretary Scott Bessent has already urged other countries to not retaliate, encouraging them to view the rates about to be implemented are a ceiling that can possibly be lowered via effective negotiation. The risk, of course, is that trust (especially between allies), once lost, is often very difficult to rebuild.
The response so far
On Friday, we saw China retaliate with a range of measures, including:
▪ A 34% tariff on all imports from the US starting 10 April (matching the reciprocal tariffs that Trump placed on Chinese products on Wednesday evening).
▪ Regulatory moves such as restricting exports of seven rare earths and listing 11 American defence companies as ‘unreliable entities’.
This response is of a shape and magnitude which appears designed to make a clear point of strength without compromising the possibility of future agreement.
I recognise it is impossible to know at this stage how this plays out, but our current assumption is that this is the beginning and not the end of the playbook. Market volatility is likely to remain high and reactive to headlines. Furthermore, investors will be closely watching the earnings season that is about to start to get a sense of the outlook and how business spending will evolve.
Potential scenarios
There are possible scenarios where the impact of the announced trade tariffs on markets may lessen or even reverse:
1) De-escalation or policy reversal: We may see markets rebound if Trump (or his campaign) soften the tariff rhetoric, or delay implementation. This may come because of Trump backtracking (a bit) on the back of poor market reaction, or because Congress (Democrats and Republicans) forces him to alter his path.
2) Federal Reserve action: The Fed in the US could come to the market’s rescue through announcing aggressive interest rate cuts. This would happen if the Fed ignored the impact of tariffs on inflation and focused on signs pointing to a recession. It is unlikely they will go down this path just yet, as tariffs are expected to push inflation to around 4% (from current 2.5-to-3%) and sharp rate cuts would eliminate any hope of inflation falling back to their 2% target.
3) Congress passes tax cut bill ASAP: another positive for markets would be if Congress offsets the tariff increase by reducing taxes that come into effect immediately (within three months). While this is a credible option, there are several fiscal hardliners that need to be swayed first.
4) Europe and China stimulus: We have seen the first signs of this since Trump made his intentions regarding NATO clear. Fiscal stimulus, tax cuts, selective subsidies are all effective ways of counteracting Trump’s tariffs, rather than retaliating with reciprocal tariffs that could further damage sentiment.
My belief in long-term equity market investing is unwavering. Each moment like this in markets has its own story and defining characteristics that makes it appear worse than the last. External shocks are expected and factored in when I’m assessing my clients’ willingness and ability to take risk. With a market now starting to look oversold and lots of bad news in the price I’m inclined to think opportunistically at this point, searching for dislocations using our framework of studying the fundamentals, valuations and technicals of the market.
How have portfolios held up
The nature of market moves over the past three trading sessions has left nowhere to hide, with all major sectors and regions suffering declines. Our equity allocation has held up relatively well which we know in the context of a drawdown in portfolio value is scant consolation. When investing primarily in funds, such sharp intraday moves make having a precise performance picture difficult, but our focus on being globally diversified and biased towards higher quality equities has certainly helped us smooth out some of the volatility. Our allocation to defensive global funds, such as Evenlode Global Income and Lazard Global Equity Franchise, has been characteristically resilient, in contrast to the more cyclical areas of the market.
One fear with the threat of tariffs, was that fixed income may not protect portfolios, as tariffs may lead to higher interest rate expectations to tame the ensuing inflation. Thankfully, fixed income markets have focussed on the threat to growth and therefore government bonds have done their traditional job of rallying in the face of an external shock. Medium and long-dated US Treasuries and UK gilts are up around 5% since the market started focusing on tariff risk mid-January. The alternatives component of the portfolios including Trojan and CG Absolute Return has been largely unchanged since the start of the month. I would expect this part of the portfolio to make money over the medium term, regardless of how things play out in international relations.
February 2025
European equities continue to thrive amid geopolitical turbulence in February.
At a glance:
- Europe rallies around Ukraine following a combative meeting between Presidents Trump and Zelensky.
- European stock markets have risen given increased defence spending pledges and an uncontentious German election outcome.
- The reversal of US big tech stocks has led to the outperformance of global stocks relative to US markets, coupled with geopolitical unrest.
The outperformance of global stock markets relative to US equities continued in February, as investors questioned whether US exceptionalism will last given increased global competition to develop artificial intelligence (AI) technologies and rhetoric stemming from the Trump administration. In the US, consumer and business confidence have diminished in recent months while inflation expectations remain elevated. Meanwhile, the German election outcome proved to be less divisive than predicted and the focus on European cooperation intensified following a contentious meeting at the White House between President Donald Trump and President Volodymyr Zelensky.
Equities
European equities have experienced strong performance so far this year and Germany’s DAX Index is not far from all-time highs, with defence and financial stocks leading the way. In February, the DAX gained 3.8%, while the STOXX Europe 600 Index rose 3.4% and the FTSE 100 nudged 2% higher.
US equities meanwhile continued to underperform other markets, with the S&P 500 falling 1.3% in February. The Magnificent 7 fell 8.7% in February to bring its year-to-date loss to 6.5%, astechnology stocks face headwinds. Tesla’s sharp decline in February was particularly noteworthy. After experiencing a meteoric rise following Trump’s inauguration, Tesla’s share price fell 27.6% in February as European car sales plunged. Nvidia meanwhile reported its fourth-quarter earnings, and although the chipmaker’s results broadly met analysts’ estimates, the stock still fell 8.5% on the day of its earnings due to concerns over gross profit margins and US tariffs. Nvidia has dropped 7% in the first two months of the year.
Fixed income
Bond yields were generally on a downward trend with 10-year Treasury yields falling from 4.5% to 4.2% in February, the lowest in recent months. US government debt outperformed other markets as recent data showed pockets of weakness in the US economy, prompting a re-assessment of Fed interest rate policy. Ten-year maturity gilts and German bunds showed little change over the month.
Central banks
The Bank of England (BoE) cut rates for the third time in six months, sticking to their 0.25% cut-per-quarter pace. The BoE halved their 2025 growth forecast as the British economy edges closer to stagflation but upgraded growth forecasts for 2026 and 2027 to 1.5%. It is likely inflation will reach 3.7% in the third quarter, spurred by high energy prices and less favourable base effects before gradually falling closer to target over the coming years.
Asia gains on tech optimism
Hong Kong stock markets have posted strong performance so far this year owing to continued excitement over technology stocks and undemanding valuations. Hong Kong’s Hang Seng Index rose 13.4% in February, bringing its year-to-date gains to 14.8%.
Japanese stock markets meanwhile have struggled, with the Topix falling 1% in USD terms (2.7% in local terms) in February, as the yen continues to strengthen.
December 2024
We approached 2024 with a degree of cautious optimism and it’s fair to say that overall returns have outstripped our expectations, especially when we look at the performance of US equities. That, in turn, leads us to ask whether some of those returns have been borrowed from the future. The rather frustrating answer is “maybe”, although we certainly have no desire to bet against further progress in 2025 and discuss this in more detail below.
2024 dawned to a chorus of speculation over the outcome of a number of elections scheduled to be held around the world which would involve more than half of the global population. Several of these were being defined as a test for democracy and there was also a fear that voters’ support for more extreme candidates could herald socio-economic disruption, reflecting a shift towards what might loosely be termed as “populism”. Although there were a couple of market-related wobbles, notably in India, where Prime Minister Modi’s BJP Party underperformed against expectations, the outcomes have been generally favourable for investors. One exception is France, where President Macron called a snap parliamentary election in the summer, the consequences of which are still rippling through the country.
The defining election of 2024 was the US Presidential election, which, again, threatened to bring chaos. However, whatever one’s opinion about the result, the fact that it was decisive helped to clear the air and to underpin a phenomenon that has become known as “American exceptionalism”. American companies dominate global equity indices and US equities have delivered the lion’s share of returns to global investors. The UK wealth management industry has gradually embraced a more global approach to equity investment, and this has enhanced returns, although there will always be a sense of frustration during such good times that the exposure was not even greater. Whilst the UK’s FTSE 100 Index delivered a total return (including dividends) of 9.6% in 2024, the US’s S&P 500 Index gained 25%.
The more technology focused index (NASDAQ Composite Index) was up 30%, while the Magnificent 7 group of leading technology shares (Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla) put on 67%. And if one had put all of one’s eggs into the basket labelled Nvidia (the pre-eminent provider of processors to power the Artificial Intelligence revolution), one could almost have tripled one’s money (+171%). Whilst the gains of such an investment would be sustainable over this period, it would expose the investor to an extremely high level of risk. Subsequently, that is not how we assemble portfolios, and the risks have to be spread across different asset classes and securities. This helps to spread the risk of poor returns in one area – An example of the other side of this risk can be demonstrated where at the beginning of the year that France’s booming Luxury Goods industry combined with cheap financial stocks and the prospect of interest rate cuts from the European Central Bank would be a tonic for that country’s stock market. Alas, the political turmoil and a downturn in demand from China’s well-heeled consumers meant that the CAC40 Index’s total return was exactly 0%.
In terms of our own government’s blunders, October saw the new Labour government deliver its first Budget, which has won few friends in the business community. Neither has it gone down well with households. Warnings of the need to fill the alleged £22bn “black hole” in the country’s finances bequeathed by the Conservatives had raised fears of tax increases, especially in relation to wealth and savings, which had reduced confidence. Perhaps because the Chancellor had anchored expectations to extremely negative outcomes, the relatively small rise in capital gains tax rates and the fact that pensions and ISAs were undisturbed provided some relief, although financial planning remains in high demand owing to changes to Inheritance Tax, in particular. But the real body blow was to businesses, especially to those in the retail, leisure and hospitality sectors. This was on account of an increase in the rate of private employers’ National Insurance Contributions and, more importantly, a reduction in the threshold for contributions being made, with the latter factor bringing a lot more lower paid workers into the net.
Trade bodies representing these sectors have suggested that the extra cost will have to be absorbed through some combination of higher prices, reduced profits, lower wage increases or lower employment, none of which are helpful to the economy. Many companies have also indicated that they will cut back investment plans.
With 2024 neatly wrapped, what is the outlook for 2025? Investment banks, as often seems to be the case, are generally herding towards a forecast of mid-to-high single digit returns for global equites and for bond investors to receive their yield and little else. As sensible as this sort of prediction might appear, it comes with the caveat that, for example, US equities have achieved a return in the 5-10% range only eight times in the last hundred years despite the long-term average being around 8%. It seems improbable that US equities can deliver a third consecutive year of returns higher than 20% with lower-than-average volatility. And despite their cheaper relative valuations, other markets will need to experience some sort of underlying cyclical recovery to lead global indices substantially higher.
UK GDP growth drifted lower in the second half of 2024 as consumers and businesses retreated into their shells, first in anticipation of Labour’s first budget of the new parliament and then in reaction to it. The Bank of England is loath to cut interest rates faster owing to sticky services inflation, a factor that has helped to take 30-year Gilt yields above 5% and to levels not previously seen in this millennium. UK equities continue to look relatively cheap on a global basis, but with the enduring caveat that the FTSE 100 is not sufficiently well stocked with the sorts of companies that attract higher valuations in a sluggish growth environment. Interestingly, small cap shares ex-Investment Trusts (+13.8% total return) outperformed their large cap peers (+9.6%) and we continue to see this as an area of potential further outperformance, especially should the Bank of England rediscover its appetite for rate cuts.
It was another difficult year for government bonds as inflation failed to retreat at the desired speed to deliver as many interest rate cuts as expected. Resilient US growth led to a negative total return of -1.6% in dollars for the Bloomberg Global Aggregate Bond Index (with the sterling hedged version managing a small gain of 3.1%). UK Gilts suffered a similar fate, although, the good news about higher bond yields is that it allows bonds to play a better role as a counterbalance against equity risk in the event of economic weakness or market disorder, as we witnessed in August 2024. All UK Gilts have delivered a total return of -3.1% over the last three months and -3.3% over the last year. Index-Linked Gilts returned -6.1% and -9% over the same respective periods. Emerging Market bonds produced a total return of +2.2% in sterling over the three months to end December (+14.6% over 12m). Global High Yield bonds delivered +0.8% (+8.1% over 12m) in sterling.
As another year passes, there seems to be little celebration of the fact that typical balanced portfolios delivered decent returns and well above what would have been achieved by holding cash. The world feels unstable and bad news is amplified by (social) media; and yet good companies continue to be able to generate growth and to compound their returns. 2024 provided an object lesson in sticking to one’s guns when following an investment process and not being deflected by the “noise” that can sometimes be overwhelming. It is inevitable that we will hit more bumps in the road in future, but we must always bear in mind that market volatility is the price that we pay for superior long-term returns. It would have been very easy to have been scared out of one’s equity investments on several occasions in the last few years, and yet here we sit with global equities within a few percent of their all-time highs.
November 2024
With so much going on in the world, the UK has been out of the spotlight following October’s Budget – although, domestically, there has been considerable dissatisfaction aired about the policies announced by Chancellor Reeves, not least the big increase in private employers’ National Insurance Contributions. Trade bodies representing retail, hospitality and other service-based industries are especially aggrieved, suggesting the extra cost will have to be absorbed through some combination of higher prices, reduced profits, lower wage increases or lower employment, none of which are helpful to the economy. Many companies have also indicated that they will cut back investment plans. The malaise that has taken over the UK since the election in July can be seen through the lens of Citigroup’s UK Economic Surprise Index, which measures economic data releases against the consensus of analysts’ expectations. The index level has fallen precipitously since August, from +66 to -45. If there is any consolation, it tends not to fall much further than this, other than in extreme circumstances such as the Global Financial Crisis or the Covid pandemic. The reticence of the Bank of England to continue to cut interest rates in the face of sticky service sector inflation is also something of a hindrance, and domestic equities could react positively to any signs that inflation is abating faster. This would be of specific benefit to small and midcap companies, where we continue to see good value, as it seems do corporate buyers, if we consider the pickup in M&A activity so far this year.
Global government bond markets initially continued to sell off in early November in response to Trump’s election victory, which was generally seen as having the potential to stoke inflation in the US. This came hot on the heels of the UK Budget, which also heightened domestic inflation fears. However, there was some reluctance to push yields towards last year’s highs as investors appreciated the returns on offer – around 4.5% for both the 10-year US Treasury and UK Gilt. There is also a concern that if interest rates remain around their current levels for too much longer then there is an increased risk of indebted companies and consumers finally capitulating. And so, as we saw in August, bonds have the potential to play their role as risk diversifying assets. Even so, for now, at least, traders are less bullish about the prospect of more aggressive immediate cuts in base rates, although that might be music to the ears of cash depositors. There are some sovereign markets where yields are testing or making new lows for this cycle, and the key ones are Germany and China. That is a reflection of weak underlying economies in both countries, and, in Germany’s case, in spite of political uncertainty and the Chancellor’s desire to increase government spending. The spread of corporate bond yields relative to government bonds remains close to the cycle lows and we would have to return to levels seen before the GFC if they are to tighten much further, which we believe to be improbable.
All UK Gilts have delivered a total return of -1.9% over the last three months and -2% over the last year. Index-Linked Gilts returned -0.9% and +1.1% over the same respective periods. Emerging Market bonds produced a total return of +2.7% in sterling over the three months to end November (+6.6% over 12m). Global High Yield bonds delivered +2.1% (+7.1% over 12m) in sterling.
As we approach the end of (another) trying year, there seems to be little celebration of the fact that typical balanced portfolios have delivered decent returns this year and well above what would have been achieved by holding cash. The world feels unstable, and bad news is amplified by (social) media and yet good companies continue to be able to generate growth and to compound their returns. This year has provided an object lesson in sticking to one’s guns when following an investment process and not being deflected by the “noise” that can sometimes be overwhelming. It is inevitable that we will hit more bumps in the road in future, but we must always bear in mind that market volatility is the price that we pay for superior long-term returns. It would have been very easy to have been scared out of one’s equity investments on several occasions in the last few years, and yet here we sit with global equities at all-time highs.
August 2024
Before moving on to developments that have occurred over the last two weeks, recent months have seen more central banks opt for rate cuts. Most notably, the European Central Bank (ECB) cut rates by 0.25% to 3.75%, whilst the Bank of England cut rates by 0.25% to 5%. At the current time, the Federal Reserve has not yet decided to follow suit, with Chairman Powell and colleagues instead opting to signal they may well cut in September. The market currently believes this is all but a certainty, with 4 hikes from the Fed priced in by year end, with a further 4 cuts by this time next year:
Looking back on a remarkable few weeks in markets, sentiment started deteriorating when we had a weak ISM manufacturing print in the US. Not only was the print weaker than expected, but the employment subcomponent was the weakest since the pandemic and pointed towards further job losses. This was compounded by the release of the nonfarm payrolls last Friday afternoon, where job increases were softer than expected. Consequently, the unemployment rate moved to 4.3% from 4.1%, triggering the so called ‘Sahm’ rule – a recession rule based on the rise in the unemployment rate by a magnitude of 0.5% over a 12-month period. The efficacy of this rule has been in question this cycle as the rise in the unemployment rate has been driven to a large degree by increases in the labour force. Nevertheless, there has been increasing evidence that wage pressures are cooling and are now commensurate with the Fed’s 2% inflation target.
Against this backdrop, Government bonds rallied sharply, with 10-year Treasury yields moving below 3.7% (from over 4% at the end of July). Gilts too followed suit with 10-year Gilts yielding 3.75% at one point. Whilst these have retraced somewhat, the upcoming Fed meeting at Jackson Hole proves to be an extremely interesting event, with market participants eagerly awaiting any information surrounding the path for interest rates in the US.
We also saw huge volatility in US Technology and Japanese stocks, with the Yen ‘carry trade’ seemingly unwinding. This is where some market participants borrow in JPY, which is subject to low interest rates, and invest in overseas assets (where if borrowing in local currency would be subject to higher rates of interest). Whilst the JPY is depreciating against other currencies, investors following this strategy benefit from low interest rates in Japan but also rising price of overseas assets in JPY. However, last week the Bank of Japan raised interest rates and noted the possibility of further rate increases going forward. This, combined with the weaker employment data in the US causing an increased chance of US rate cuts meant that the differential between the two rates had narrowed somewhat, thus the carry trade was less profitable. This caused certain investors to sell their assets, buy back JPY and pay back JPY debts, putting upward pressure on the JPY. Somewhat of a vicious circle. The end result was an incredibly volatile period for Japanese stocks, falling by record amounts in one day, before staging a recovery the next. Additionally, given a proportion of the borrowed JPY was invested in US tech names, the unravelling of the trade put downward pressure on those names as many holders became forced sellers.
Whilst we have no crystal ball to look forward in markets, this has been a very useful reminder around staying calm and rational during periods of market stress. As this was written during the midst of the sell-off, we saw very little material weakening of economic conditions during that period, and as such are not surprised to see markets recover their losses. Additionally, the period provided a helpful ‘proof of concept’ for many active funds whose valuation discipline meant they had a far lower exposure to those tech names that had driven the lion’s share of performance. Additionally, fixed income & alternatives both acted to lessen the blows from the market volatility, and as such well-constructed portfolios performed as expected.
June 2024
As we pass the halfway mark of the year, a moment that lends itself to a review of market-related developments during the first six months of 2024, one word seems to come to mind: “unresolved”. Many of the things on investors’ worry list at the start of the year have not been removed. These range from the outlook for inflation and interest rates, to possible results from several important elections. On the geopolitical front, we seem to be no closer to a cessation of hostilities in Ukraine or the Middle East.
And yet, as we seem to have noted relatively frequently over the years, investors have been well looked after by markets. Equities have built on the recovery that started during the final months of 2023, and although bonds have yet to sparkle, they seem at least to have found an equilibrium. While the gains in global equity markets have been relatively concentrated into a small group of (mainly) leading technology companies, we are not unduly concerned that those gains are unsustainable and certainly push back on arguments to suggest that we are in a bubble similar to the one that developed at the turn of the millennium. As we entered the year, one of the strongest expectations was that central banks would soon be in a position to start cutting interest rates as inflation continued to recede from its highs. Interest rate futures were pricing in the first cuts for March, but here we are in July and neither the US Federal Reserve nor the Bank of England has acted. There have been some small reductions made by, for example, the European Central Bank (-0.25%) and the Swiss National Bank (-0.5%), but certainly not to the extent that was anticipated. The main reason for the lack of action is that inflation has failed to drop quite as fast as the authorities would have liked. Positively, this reflects resilient economic activity; more negatively it also reflects tight labour markets and some lingering effects of past supply chain bottlenecks. This delay notwithstanding, we maintain our opinion that inflation will continue to trend lower, although not necessarily to settle at the very benign levels that were prevalent in the decade before the Covid pandemic. Global trade tension, climate change, the green energy transition, demographics, increased levels of spending on defence and the appeal of “populist” politicians conspire to make inflation a greater threat than we have been used to for many years. And central bankers seem to be acutely aware of this, refusing to take for granted that they have it beaten. That being the case, we also believe that future interest rate cuts are a question of “when”, not “if”.
As for the politics, it has long been our opinion that the UK election would be something of a non-event from a financial market perspective, and so it has proved. The strong showing of the pound this year is testament to the lack of investor concern. The first round of voting in France’s election was deemed to have reduced the risk of the worst two possible outcomes, those being a majority victory for either the far right National Rally party or the left-wing New Popular Front coalition. The current view is that the second round will lead to a “hung” parliament, with limited ability for any party to deliver on their promised policies. President Macron will continue to preside over international and defence policy. But the world is now on notice for a potentially more radical president in 2027.
The returns from the FTSE 100 have not been as strong, but a total return of almost 8% is not to be sniffed at, especially as the UK stock market is not home to any global technology leaders. As always, a reasonable chunk of the market’s return has been from dividend income, with the annual dividend yield running at around 4%. Around a quarter of the index’s points gains have been generated by the pharmaceutical company Astra Zeneca (+18%), a world class company in its industry despite not having any exposure to the appetite suppressing drugs that have taken the world by storm. Much less is made of the concentration of the FTSE 100’s returns, where 99% of the 430 points accumulated this year can be attributed to just six companies, with the others being Shell, HSBC, Unilever, Rolls Royce and RELX, of which only RELX can be said to be enjoying a boost from its association with the AI story (it has vast amounts of proprietary data which it can interrogate for the benefit of its customers, especially in the legal profession). That list certainly displays far less industry concentration risk. At the other end of the size scale, we have been encouraged by a recovery in smaller companies, with the total return of the FTSE Small Cap Index (ex-Investment Trusts) being marginally greater than 8%. There has been some recognition of value in the form of increased merger and acquisition activity as well increasing optimism about the benefits of a more stable political environment should Labour prevail in the election as expected.
Government bond markets, having rallied strongly towards the end of 2023 in anticipation of the interest rate cuts that never came, have, unsurprisingly, struggled to find new direction this year. Economic growth and inflation are not weak enough to persuade central banks to cut, but neither are they so strong as to raise the prospect of further increases. And while the threat of persistently high fiscal deficits in many countries lurks in the background, investors do not yet appear ready to demand higher yields to compensate. Even so, we believe that current yields offer a reasonable return for those seeking insurance from potential economic weakness, and that central banks would be quicker to cut interest rates in the face of a threat of recession than is currently priced into forward curves, and so government bonds are worthy of inclusion in balanced portfolios.
We entered the year with greater optimism than in either 2022 or 2023, encouraged by our opinion that inflation would continue to trend lower and that the prospect of an interest rate cutting cycle was ahead. Whilst our best hopes for inflation and interest rates have not (yet) been met, growth has been resilient and equities have prospered. We also noted the packed global election calendar, observing that investors tend to become a bit more cautious ahead of the result being clear, but that the threat of a major upset which might badly affect financial markets was limited. So far, so good, even taking into account the surprise election in France. We are not inclined to change our opinions at the halfway stage. A seasonal pause for breath is possible over the summer, and we know that more thinly traded markets are vulnerable to surprises, but we retain our faith in the ability of the companies we choose to invest in to continue to compound returns way beyond just the next few months.
May 2024
Despite that fact that many major stock market indices remain very close to all-time highs, it is remarkable how little euphoria is generally evident amongst investors. Client conversations often focus on what could go wrong rather than on what might go right. Financial media are well stocked with commentary focused on potential negative outcomes. It is widely accepted that negative news generates more readership than positive news, and we can also refer to Prospect Theory, which states that fear of loss is a far greater influence on (the majority of) humans than the promise of gains, especially when those gains are subject to a volatile path.
It is not difficult to believe that the events of recent years have left many feeling vulnerable. The Global Financial Crisis (GFC) of 2008 threatened to topple the whole financial system; the Covid pandemic was literally life-threatening; since then we have seen the threat to Europe’s Eastern border raised by Russia’s invasion of Ukraine, not to mention the further threat of the use of tactical nuclear weapons; most recently there has been an escalation of hostilities in the Middle East; and ahead of us lies a potential invasion of Taiwan by China – a racing certainty according to various military figures, although one could be suspicious of their motives in predicting such an event.
And yet, remarkably positive things keep happening, not least in the field of technology. The speed with which generative artificial intelligence (AI) has captured the public imagination is unprecedented, at least in terms of how many people have tried some of the products on offer. Admittedly, we are in the very early stages of wider adoption, and we would also suggest that asking ChatGPT to write a song about a Prime Minister launching an election campaign to the tune of “Singing in the Rain”, while amusing, is hardly going to increase productivity.
“The Next Financial Crisis” is the sort of headline that invariably attracts readers. It has been long argued that a repeat of 2008 is improbable. Regulation is much tighter than it was then, and banks are much better capitalised too. Yes, there have been accidents such as the bankruptcy of Silicon Valley Bank in March 2023, but a wider impact was immediately averted by the relevant authorities stepping in to provide liquidity. The swift resolution of the problems at Credit Suisse soon after was another case in point. Banks in the US, UK and Europe are currently very profitable, and rather than using those profits to create loans of a dubious nature, they are more inclined to be returning them to shareholders in the form of dividends and share buybacks.
Another area that is being monitored is Private Credit. This is, effectively, the loans that are made to companies by non-bank entities, which can range from private equity and hedge funds to insurance companies and pension funds. It is sometimes referred to as “shadow banking”, which probably sounds a bit more ominous than it needs to. The concern is that it is less well-regulated than bank lending (if at all), and so lenders might be taking on too much risk. However, the lenders would tend not to be as leveraged as banks and so less vulnerable to losses. Supporters of private credit note that many of the loans are made to businesses where the lenders are already owners of the equity and therefore have a good understanding of and relationship with the business. For many, such lending will be part of a wide and diversified range of investments and therefore less likely to undermine a whole portfolio. We have little doubt that there will be some headline-generating failures and attendant losses, but we have yet to see evidence to convince us that these will be a precursor to a wider systemic failure.
As alluded to earlier, geopolitical risk is also widely cited as a factor of current concern. We note an interesting debate on the subject that was kicked off recently by an op-ed in the Financial Times written by a strategist from Citigroup. His contention, supported by work from researchers at the Federal Reserve Board, was that investors tend to overreact to negative geopolitical news, building in “worst case scenarios” and elevating risk premia beyond a fair level. He noted that despite the cited measure of geopolitical risk being elevated currently, it is not much higher than the average going back to 1900 – admittedly a period that encompasses two World Wars. The most recent peak coincided with the 9/11 attacks on the US.
One problem with analysing geopolitical risk is that it is very wide ranging. Elections and referendums, for example, might create big local headlines but have less global influence, with, perhaps, the US Presidential and Congressional elections being an exception which proves that rule – and, of course, those lie just a few months away. Wars, these days, tend to be more localised, but, as we witnessed with the invasion of Ukraine, can play havoc with supply chains. Indeed, the biggest factor in this case was arguably Europe’s voluntary shift away from buying natural gas from Russia, which was still capable of producing plenty of it. Any future sanctions that might involve China could leave the West short of critical components, and if Taiwan was directly involved, a parlous shortage of semiconductor chips. No wonder so many western countries are racing to build fabrication plants.
In response to the FT article, there were several letters written to the editor expressing concern that the writer had been too dismissive of geopolitical risk. Unsurprisingly, perhaps, one came from the Head of Macro Policy Research at a large US asset manager and another from the Head of Geopolitics at a European asset manager. They were both eloquent and argued passionately for building geopolitical analysis into portfolio management, but neither offered a solution. And that’s the problem. One can write long essays and build scary presentations about all the dreadful things that might happen, but how does one actually invest, especially when it comes to dealing with “tail risks”, or low probability events that could have a big impact? If one constructs a portfolio that is predicated upon disastrous events, it is very difficult to benefit from the good things that will happen, and it would have been very easy to adopt that mindset for the last fifteen years or so when equity markets have performed very well. Even a meaningful drawdown today would not make up for years of bunker mentality.
Practically, we have to maintain balance in portfolios. Government bonds, which at least now offer a reasonable yield, are the classic defensive option in times of stress, but we also note that they are prone to risk from high fiscal deficits and the threat of persistent inflation. Indeed, many of the geopolitical risks that we identify carry the threat of higher and more volatile inflation in future (and one can add climate change and the green energy transition to the mix). We have identified US dollar cash and Gold as the asset classes which tend to perform best as “safe havens” across a range of risks. We can also invest in very specific Structured Products to hedge against an adverse movement in an individual commodity, such as oil, for example. At a company level it is possible to invest in shares of those that might benefit from conflict, maybe with exposure to defence spending (now viewed as more acceptable owing to the benefits of preserving peaceful and democratic societies) or cyber security. The build-out of renewable energy and distribution assets also offers opportunities. However, it will be very difficult to generate reasonable returns without taking the view that a lot of the worst case scenarios will remain just that – scenarios.
Last month we mentioned the role of large cap stocks leading the FTSE 100 to a new record high. It made further new highs in May as the UK seems to be experiencing a period of rehabilitation in global investors’ minds. Part of the thesis is that a new Labour government would bring some much-needed stability to UK policymaking, attracting an increase in investment into the UK. Certainly, there is no sign of concern from markets about an imminent change of government, with sterling, the usual barometer of political sentiment, rising towards the top end of its post-Brexit trading range. Then there is also the fact that UK equities appear to offer good value against those of other regions, even allowing for a less attractive market composition. We are also starting to see this renewed optimism reflected in the performance of UK small cap shares, which have done better than their large cap peers so far this year, with a marked pick up in relative performance in recent weeks as the pound strengthened further.
Aggregate Emerging Market equity indices remain a long way off their 2021 highs, mainly thanks to the poor performance of China. That disguises the strong performance of India and, to a lesser extent, Mexico, both of which have just completed leadership elections. Projected strong wins for the ruling parties in both countries have been greeted in different ways. The BJP’s victory in India sets up “more of the same” policy from Prime Minister Modi, which is expected to be friendly to business. The landslide win for new President Claudia Sheinbaum in Mexico, on the other hand, has raised fears of more radical policies and a possible abandonment of her predecessor’s relatively conservative fiscal approach. Mexico at least retains an enviable position as a strong trading partner with its neighbour to the north, although concerns that China is using Mexico as a “back door” for exports into the US could come to the fore if Donald Trump wins November’s US Presidential election.
Bond markets continue to struggle to establish a new trend, caught between the hope for interest rate cuts and the reality of resilient growth and inflation that refuses to fall as fast as investors and central bankers would like. If one were to peg the yield of 10-year government bonds to long-term nominal GDP growth expectations (which is a reasonable benchmark), then they currently appear to be around fair value. It would probably take a resurgence of inflation or more concrete concerns about the size of fiscal deficits to push yields sharply higher, while lower yields would more likely be the result of economic weakness. The Bloomberg Global Aggregate Index of investment grade bonds is -3.3% year-to-date (total return in USD), while the sterling hedged version is -0.85%. The current UK 10-year Gilt has generated a total return of -3.2%.
Investing requires some degree of optimism about the long-term prospects for economic growth and innovation and it can often be hard to retain such a mindset in the face of a continuous barrage of negative headlines from the media. We would be the first to acknowledge that portfolio returns will not be achieved without the odd setback; indeed, we would be suspicious of any investor claiming never to suffer any losses. Many investors are most comfortable with a balanced portfolio of bonds, equities and other diversifying assets which help to smooth the bumps out of the ride, although the components of that suspension system are always subtly changing according to the terrain. It remains our goal to provide the right mix of assets to provide the best risk-adjusted outcomes according to investors’ appetite for risk and volatility.
April 2024
A well-worn phrase, apparently derived from a German proverb, that gets wheeled out after a strong run in the stock market or in specific stocks and sectors is that “trees do not grow to the sky”. It probably helps to know whether you have planted a giant redwood or a bonsai before estimating how tall it can grow. It doesn’t take much Googling to find all sorts of references to investment analysts and fund managers warning of the dangers inherent in rising prices in the past, but in many cases their caution has not aged well, especially where it concerned the leading technology companies which today dominate the global indices.
Nevertheless, even the healthiest trees sometimes need a bit of a trim, and during April markets were subjected to a lopping following what had been one of the strongest and most persistent rallies seen for many years. Global equities suffered their first monthly reversal since October 2023, falling 3.2% (Total Return in US dollars), while the dominant S&P 500 Index in the US lost just over 4%. Notably, though, the UK’s FTSE 100 Index gained 2.7%, an outcome that we shall investigate in more depth in the country sections below.
As we often reiterate, the main driving forces behind equity performance in the long term are liquidity (largely interest rates and bond yields, but also other central bank actions) and earnings growth expectations. We could also cite investor sentiment and positioning in the short term. We shall see in a moment that earnings appear to be relatively stable. It was interest rate expectations that upset the apple cart last month.
Of course, interest rate expectations do not move in a vacuum. They are driven by the outlook for economic growth and inflation, in particular. While at the beginning of this year inflation was generally expected to be on a steady glidepath back towards central banks’ 2% target, it is proving to be somewhat stickier. US Consumer Price Index readings, covering the first three months of 2024, have all come in higher than expected. And while there are idiosyncratic factors possibly at play, including higher motor insurance premiums, rising asset management fees (thanks, ironically, to rising stock markets) and the outsized contribution from housing rent (actual and Owner Equivalent), the trend has been persistent enough to become unnerving.
The situation is not as worrisome in the UK, especially as the latest drop in household energy bills will feed through to the headline calculations in April, but there is some concern about service inflation, which is still running at 6.1%. Some of this is attributable to a tight labour market, leading to a similar level of wage growth. There are all sorts of explanations put forward for the paucity of workers, ranging from poor investment in education and training to the inevitable finger-pointing at Brexit, but the fact that 2.8 million people are on some kind of long-term sick leave is viewed as a primary cause. This has been noted by the government, which is trying to manage the situation, but there would appear to be no quick and easy fix. And whereas increased levels of immigration could be seen as a possible practical solution, that is not politically acceptable at the moment in the UK, the US or in many European countries.
Thus we have seen an increase this year in the future rate of inflation implied by the relative prices of conventional and index-linked government securities (known as the breakeven rate, which is the average expected inflation rate over the referenced period). The 2-year breakeven in the UK has risen from 3.2% to 4%, for example, with the 10-year rate up from 3.46% to 3.77%. Even allowing for the fact that these markets can be somewhat illiquid and therefore subject to exaggerated price movements, the trend is undeniably higher. If there is some good news, it is that we are nowhere near the peak 10-year breakeven rate of 4.63% hit in August 2022 at the height of the inflation scare.
The US 10-year breakeven has also risen, from 2.16% to 2.41%. This does not really constitute an unmooring of longer-term inflation expectations, which is positive, but we will need to keep a close eye on it, allowing for the fact that the US Treasury Inflation-Protected Securities (TIPS) market is less evolved and less liquid than the UK Index-Linked market.
It is our central view that this was a once-in-a-generation reset from an unsustainable low, and so we are not expecting a rerun. However, investors are worrying about other things. The current major concern, if not inflation itself, is the creditworthiness of many western governments, not least that of the United States. The bond market scare that took the 10-year Treasury yield up to 4.99% last October, with the real yield hitting 2.51%, reflected that concern before nerves were calmed, primarily thanks to some nifty footwork by US Treasury Secretary (and former Federal Reserve chair) Janet Yellen who fiddled with the composition of government debt issuance by increasing the issuance of more market-friendly short-term Treasury Bills. We cannot rule out another such scare, but the latest announcements regarding this year’s federal funding requirements appear to have been well received by markets. Maybe the next crunch will come once we know who gets to sit in the Oval Office next year. The US Presidential election will take place on 6 November and neither candidate seems willing to exercise fiscal restraint. While Biden will aspire to carry on spending, Trump would opt for tax cuts. A lot will hinge on the outcome of the Congressional elections, as Congress will have the ability to apply some restraint.
Circling back to where we started, then, equity markets are largely toiling against the headwind of higher (real) bond yields at the moment. Expectations for interest rate cuts have also been pushed out thanks to the sticky inflation, but at least some of that appears to be down to better-than-expected growth, and so corporate earnings remain resilient in aggregate.
We would not be at all surprised to see markets remain around current levels for a while as they navigate all of these crosscurrents, and, in many ways, it would be healthy to consolidate the strong gains made through the end of March. A deeper reversal might require a more negative catalyst, such as a US recession (which has largely been priced out of the reckoning) or a major geopolitical event (which, by its nature, will be difficult to predict exactly, especially regarding timing).
The earnings season data for the UK tends to be aggregated with the rest of Europe, at least in terms of what we see. Even so, we can report some decent wins in terms of market reaction. Leading the way in terms of FTSE 100 during April was Astra Zeneca, which contributed 78 of the 212 points gained. The company firmly beat both sales and earnings forecasts, whilst also delivering positive news on its drug discovery pipeline. HSBC (62 points) was another heavy-hitting winner, beating estimates thanks to strong net interest income (courtesy of higher interest rates) and fee generation. It also surprised positively by announcing a $3bn share buyback programme, a billion dollars higher than forecast. Banks are fearsomely strong generators of cash when the environment is favourable. If they are not required to bolster their capital position and are not growing loan books aggressively (which few banks are at the moment), then they can reward shareholders with buybacks and dividends. The best performance in terms of share price appreciation in April came from the mining group Anglo American. Its shares rose 37% on news of an approach from BHP Group (whose primary listing is now in Australia). It has not yet made a formal offer and its approach is somewhat unusual in that it wants Anglos to spin off various South African subsidiary companies first, but this move is illustrative of the value that might be tapped from UK shares.
As covered earlier in this commentary, bond markets have reversed many of the gains they made during the final two months of 2023, although yields have not reached the same levels. As long as inflation remains sticky and government deficits remain high, it will take a major economic setback to push yields back down a long way again.
While we maintain a reasonably upbeat opinion about the longer term prospects for riskier assets including equities, owing to the fact that we continue to believe that the next move in interest rates will be lower and that a second big wave of inflation is not on the cards, it is probable that we will have to display a little patience. It helps at such times to take a much longer term view. The recently deceased author and psychologist Daniel Kahneman proposed that one of the greatest barriers to saving was an individual’s inability to project forward twenty years or more and to imagine the circumstances they would be in, their financial needs and what they needed to start doing about that today. Popular health author and broadcaster Peter Attia makes the same point about our need to start training physically today to become the sort of person we will need to be to deal with old age. And so we will end this month’s commentary with a Chinese proverb on the subject of trees: “The best time to plant a tree was twenty years ago… The second best time is now”.
March 2024
The end of the first quarter invites a retrospective of what has unfolded in the world and markets so far this year. In many ways the period has been notable for what has not happened: perhaps most significantly, the fact that none of the major western central banks cut interest rates (Switzerland’s was an idiosyncratic exception). Sadly, there has been no progress towards more peaceful outcomes in either Ukraine or the Middle East. On the political front, in the UK we are still waiting for the date of a General Election to be announced, while in the United States, incumbent and former Presidents Joe Biden and Donald Trump remain the shoo-in candidates for their respective parties in November’s election.
The retention of this status quo worked out well for balanced portfolio investors, as riskier assets such as equities and corporate bonds continued the ascent that they had begun in the last two months of 2023. Government bonds had a slightly harder time of it. The key reason for this is that growth has turned out to be more resilient than anticipated, especially in the United States. Indeed, the US recession that was widely expected to materialise in 2023 appears not to be going to happen in 2024 either. And while both the UK and Germany have suffered consecutive quarters of shrinking GDP, thus entering technical recessions, the downturns in both countries have been marginal and growth seems to have already resumed.
Equity markets were the stars of the show during the first quarter, with several registering new all-time highs. While some investors fear such territory to be unsustainable, the breaking of new ground often tends to herald a shift to a higher level, and this was certainly the case for US equities, where almost 40% of the trading days during the period resulted in a new closing peak. A key driver of sentiment in the US was, once again, enthusiasm about the adoption of generative artificial intelligence (AI), but there were also signs of a healthier broadening of participation in the bull market. The trends were similar in Europe, although the UK FTSE 100 remains frustratingly short of its February 2023 high.
Another feature has been the ascent of Gold to new all-time highs. During the quarter, it appreciated by 8.1% in dollar terms, and by 8.6% in sterling. Since last October’s lows, it has risen by 22.4% (17.9% in sterling). These are huge moves for such an asset and have to be examined for the messages they are sending, because demand for Gold usually reflects investors’ meaningful fears about something else. While Gold is often viewed quite simply as a hedge against inflation we believe that there is more to it than that. We note the increased buying of Gold by non-western central banks in the aftermath of Russia’s invasion of Ukraine and the freezing of Russia’s dollar-based assets. Many countries around the world, while not necessarily being hostile to the US, have seen some merit in diversifying their reserves away from dollars owing to concerns about the direction of US policy (the fact that Gold’s price is generally quoted in dollars is not a factor – it’s the value in the local currency that counts
The FTSE 100, as previously mentioned, has been unable to close at a new high despite being viewed by many as one of the world’s cheapest markets. However, whereas highly rated US Technology shares dominate the S&P 500, around a third of the UK’s market capitalisation is made up of Energy, Mining and Banks, sectors which struggle to command price/earnings ratios in double digits. The second best large-cap performer so far this year is paper and packaging company D.S. Smith (+29%), which has found itself on the receiving end of competing bids from rivals Mondi and International Paper Co. This sort of action does reflect the cheapness of UK assets, at least in the eyes of international corporate buyers. There have been similar competing bids from overseas for transportation company Wincanton and for telecoms equipment company Spirent Communications, with substantial premiums being paid to the undisturbed prices – more than 100% in the case of Wincanton and 86% for Spirent. The value of take-overs announced in the first quarter of the year surpassed the whole of 2023. It is rather sad to see the value of UK Plc being recognised in this way rather than by more enthusiastic buying of shares in the open market by active investors, but at least it is providing a rewarding exit for those who have clung on to companies they believed in despite a long period of lacklustre performance.
There are tentative signs that China’s economy is beginning to respond to the stimulus that has been applied to it, but, following an equity market rally in February, there has been little in the way of a follow through. American investors, in particular, are reticent about increasing their weightings in China owing to the geopolitical tension. As the US election looms, an anti-China stance is one of the few things that unifies Congress. Beyond China, the strength of the US economy is a mixed blessing for EMs. While strong activity boosts trade, delays to US rate cuts have strengthened the dollar, which, as usual, has provided a headwind to EM equities. We continue to be impressed with the way that most of the EM regions have negotiated the pandemic and subsequent inflationary cycle. They did not incur as much debt as many western governments when responding to the Covid pandemic and they were much quicker to respond to the threat of inflation with interest rate increases, thus allowing them the potential to cut when appropriate. Although we are having to be a bit more patient than intended, we still believe that the eventual turn in the US interest rate cycle will provide a healthy tailwind for EM equities.
February 2024
February saw a continuation of the positive trend for equities. Government bonds found the going harder as Consumer Price Indices generally showed inflation to be a bit too sticky for comfort. This led to a repricing of the timing of the first interest rate cuts of the cycle, with an almost unanimous expectation of a March cut by the US Federal Reserve being pushed out to June, and the UK and Europe heading in the same direction. Even so, any immediate risk of a derating of equities has been offset by the prospect of stronger and more sustainable growth, with several research houses abandoning their US recession calls for 2024.
Whilst the US prospers, the UK fell into a technical recession in the last quarter of 2023, although only by the slimmest of margins, with seemingly little negative momentum. The balance was tipped the wrong way by the latest junior doctors’ strike. We recall that during the pandemic, monthly GDP data was influenced by vaccination numbers, a reminder that healthcare accounts for around 11% of the UK’s economic activity. Some of the economic data for January, such as mortgage approvals, showed evidence of a recovery. Continental Europe as a whole is in a “zombie” state – not growing but not in a technical recession either.
There is little doubt that the dominant investment factor is the US economy, and especially the inflation component. If GDP can continue to expand while inflation steadily declines, then we could congratulate the authorities on pulling off an unexpected “immaculate disinflation” (at least if we are willing to ignore the fiscal cost). Should the expansion falter, much will then depend upon the path of inflation and how fast the Fed might be able to cut rates. Too fast growth and sticky inflation would bring the risk of higher interest rates and bond yields, setting up the potential for a re-run of 2022.
The usual litany of (geo)political risks is in evidence, although none of them are escalating sufficiently to throw financial markets off course. There is no strong reason to expect the course of events concerning Russia/Ukraine or China/Taiwan to change dramatically, although these both represent high impact risk. We continue to believe that the UK election is not a big market-sensitive event, but the US election could be. However, there are still too many uncertainties to make it a key factor in our tactical asset allocation today (even running to the possibility that neither Biden nor Trump will be on the final ballot).
While many stock markets around the world are being propelled to new highs by strong tailwinds, the UK is stuck in the doldrums, displaying a small negative return so far in 2024. Although there are a few notable gainers in the FTSE 100, led by aerospace company Rolls Royce (+26%), none have the critical mass to lead the overall index forward. Big sectors including Energy and Mining are weighed down by poor commodity price action, while Consumer Staple stocks are deemed to have neither sufficient growth appeal nor the potential for cyclical recovery. The country waits for a General Election date to be set against the background of there being no fiscal policy headroom, while at the same time the Bank of England appears happy to sit on its hands in terms of monetary policy, and so there is no catalyst for change.
The relatively lacklustre start to the year in sovereign bond markets has given way to a period of greater calm. Global bond indices remain down for the year, but, to some degree, that reflects a touch of over-enthusiasm towards the end of last year. We continue to believe that the readjustment of bond yields to more “normalised” levels is now largely complete and that bonds offer a more attractive “safety net” once more in the event of economic weakness. High Yield credit spreads have fallen to their lowest level of the current cycle, suggesting limited stress. UK Gilts have delivered a total return of +2% over the last three months and +1.1% over the last year. Index-Linked Gilts returned +1.9% and -2.2% over the same respective periods. Emerging Market bonds produced a total return of +6.3% in sterling over the three months to end February (+8.5% over 12m). Global High Yield bonds delivered +4.2% (+11.2% over 12m) in sterling.
We entered the year with cautious optimism ahead of the expected turn in the interest rate cycle, and equity markets have extended their gains from the end of 2023. We continue to note a wide dispersion between the best and worst performers, with instant and severe retribution being handed out to companies which underperform expectations. While there are hints of speculative behaviour emerging, there is nothing yet to suggest the extremes of late 2021 or the heights of the TMT boom (Telecoms, Media and Technology) in 2000. Even so, we also note plenty of post hoc rationalisation for the good performance as well as rising targets for equity indices and a flurry of “this time it is different” notes on the subject of valuation. Such factors mean that we maintain a very high quality barrier for our investment selections.
January 2024
There was almost bound to be a New Year hangover following the very strong performance of both bond and equity markets towards the end of 2023, and it’s fair to say that markets took a while to wake up. After equity leadership broadened out in November and December, it was more concentrated again in January, led by the Magnificent 7 (or, for now, the Magnificent 6). Europe’s Technology leaders (ASML and SAP) joined the party too, and another one of last year’s winners, appetite-suppressing drug manufacturer Novo Nordisk, has continued to power ahead. The best performer in the FTSE 100 is betting company Flutter, but for unwelcome reasons. It has decided to move its primary share listing to New York, where it feels its virtues will be better recognised. On current evidence, that’s hard to argue with.
The market is focused on interest rates and as noted last month, the market’s current obsession still lies with interest rates. When will central banks start to cut them? And how fast and how far will they be cut thereafter? The question we posed to start the year was “will central banks cut rates because they can (owing to inflation falling back towards target) or because they have to (activity slows, threatening a recession)? So far, and by far the preferred outcome for investors, it’s very much the former case. The pace of increase in consumer price indices has slowed markedly and it looks as though headline CPI rates will reach the 2% target in the first half of this year in many countries. Core inflation (which excludes the more volatile components of energy and food) is slowing less rapidly, though, which means that central bankers, while generally acknowledging that further rate increases are off the table, are not quite ready to fire the starting gun on the rate-cutting cycle. Additionally, they remain haunted by the experience of the 1970s, when a premature declaration of victory over inflation contributed to a second surge in the latter half of the decade. And then there is the also the fact that economic growth has been a lot more resilient than expected. The Bank of England called for a five-quarter UK recession starting in early 2023 and it never arrived, although growth has been anaemic. The almost unanimous consensus opinion that the US would enter a recession in 2023 has also been proved emphatically wrong. US GDP grew by 4.9% (quarter-on-quarter annualised) in the third quarter of 2023 and by 3.3% in the fourth, buoyed primarily by domestic consumption. The Atlanta Fed’s GDPNow tracker currently projects growth of 4.2% in the current quarter. This all means that there is no hurry to cut rates and in January’s meetings, the heads of the US, UK and European Central banks all pushed back on the idea of early reductions. Futures markets have extended the horizon from March to June.
Last month we referred to the persistent selling of London-listed shares by UK-based institutions which has been blamed, at least in part, for the ongoing de-rating of the market and its sluggish performance. There was an interesting publication from Ondra Partners, an independent financial advisory firm, which put more flesh on the bones. Here are some of the more interesting observations. UK Pension Funds and Insurance companies have been the main source of capital flight. Since 1990, their ownership of the UK share market has fallen from 55% to around 5% thanks to a more conservative approach to matching current assets with long-term liabilities which was largely driven by regulation. The good news is that there is pretty much nothing left to sell. Higher Defined Contribution scheme liabilities (arithmetically driven by falling bond yields) have also forced companies to top up their pension funds to the tune of £250bn over the last decade. That’s been handy for the government in terms of demand for bonds but is money that has been diverted from more productive uses in the real economy. In a similar vein, 75% of the generous dividends being paid by UK Plc are today leaving the country and being pocketed by non-UK investors. These trends have helped to exacerbate a negative self-reinforcing spiral of decreasing liquidity and less issuance of primary capital (i.e. new share issues tend to go elsewhere). Furthermore, several big UK companies, especially those with substantial revenues in the US, have de-listed from London and headed to New York. There has also been a big shift in Mergers & Acquisitions activity. Whereas UK companies were net buyers of overseas assets before 2005 (admittedly not always with sparkling results), there has only been one year since when that has been the case, with UK Plc effectively up for sale to the highest bidder. Worryingly, the investment horizon for the UK market has shortened considerably, with much of that attributable to its composition (especially very little Technology). Ondra calculates that whereas in 2006 around 62% of the FTSE 100’s market capitalisation could be attributed to earnings expected to be generated more than ten years hence, that has now fallen to 35%. No doubt that helped in 2022, when the UK market was almost alone in registering a positive total return, but it bodes less well in a world of more stable bond markets. It’s possible that structurally higher global inflation could be of relative benefit to UK equities, but that comes into the category entitled “be careful what you wish for”.
Global bonds, as measured by the Bloomberg Global Aggregate Dollar Index of investment grade bonds, have had a lacklustre start to 2024 following the storming recovery of late 2023. That seems to be a function of some understandable short-term profit-taking in the face of generally resilient economic data. It has also coincided with a pushing out of the horizon for the start of the central bank interest rate cutting cycle as well as niggling concerns about the amount of government bond issuance that will be required to fund still historically large fiscal deficits.
We still believe that the readjustment of bond yields to more “normalised” levels is now largely complete and that bonds offer a more attractive “safety net” once more in the event of economic weakness. UK Gilts have delivered a total return of +6.1% over the last three months and -1.1% over the last year.
Index-Linked Gilts returned +4.9% and -7.2% over the same respective periods. Emerging Market sovereign bonds produced a total return of +6.4% in sterling over the three months to end January (+4.8% over 12m). Global High Yield bonds delivered +8.6% (+8.7% over 12m) in sterling.
Our cautious optimism about the outlook for 2024, driven by the expected turn in the interest rate cycle, has been borne out so far, but it is very early days still. We have seen enough already to suggest that returns as viewed through the lens of average index performance are not going to be evenly distributed across their constituents, with rewards accruing to companies that can demonstrate resilient or even increased growth potential. The compounding of growth over the longer term remains a key criterion for our equity investment choices. However, we see the potential for tactical outperformance from more cyclical and/or leveraged entities as the interest rate cycle turns. Many of these opportunities can be found amongst the mid and small caps, where we see value potential.
December 2023
As recently as October, it felt as though any review of 2023 was going to make grim reading. Sovereign markets were in turmoil, equity markets were at their lowest point of the year, and geopolitical concerns were once again in the ascendant as hostilities escalated in the Middle East. However, and as is often the case in financial markets, the mood was darkest before the dawn, and portfolios delivered strong gains over the final weeks of the year. While seasonality played its part in the rally, the primary fuel was a shift in the outlook for interest rates in 2024, with traders bringing forward the expected date of the first reductions as well as pricing in deeper interest rate cuts.
We shall examine the interest rate and economic outlook in more detail later, but first we should cast our minds back to some of the key events of 2023. It’s hard to believe now that a year ago the broad consensus was that the United States’ economy would fall into a recession and that China’s was on the threshold of a rapid recovery. The fortunes of the world’s two biggest economies turned out quite the opposite of what was expected, with the US proving incredibly resilient and China remaining sluggish. A poll of economists by Bloomberg still puts the probability of a US recession in 2024 at around 50/50, with the lagged effects of past interest rate increases being balanced by the expected cuts. In China, the unwinding of an epic real estate bubble still casts a long shadow over the wider economy. Hopes for meaningful stimulus measures abound, although the government remains reluctant to oblige. Rarely does the fate of such a huge driver of the global economy rest so squarely on the whim of one individual, China’s President Xi.
March 2023 provided the first real test for investors. Rising interest rates and bond yields were widely expected to break something eventually, but which was the weakest link? It turned out to be a regional US bank called Silicon Valley Bank (SVB), closely followed by two others, Signature and First Republic. In the case of SVB as interest rates rose, the value of its investments went down, which presented no real problem until depositors cottoned on to the fact and started asking for their money back. A classic “run on the bank” developed, but with a modern twist. Mobile and internet banking enabled depositors to request their funds at the touch of a screen, and the weight of potential outflows mounted rapidly, sending SVB into bankruptcy within days.
The next major turning point for markets was a more positive one. It was the first quarter report from US semiconductor chipmaker Nvidia. Not only were its profits well ahead of forecasts, but its outlook was even more ebullient thanks to the expected demand for chips to power Generative Artificial Intelligence (AI). AI is expected to be the catalyst for the next big technology revolution thanks to its ability to deliver efficiency in the workplace as well its more creative capabilities. This was reflected in the exceptional performance of a handful of US technology leaders (dubbed the Magnificent 7) including cloud/internet stalwarts such as Microsoft, Amazon and Alphabet (parent of Google), as well as Nvidia itself.
The big move in markets during the third quarter was downward, with a relentless rise in government bond yields driving most risk assets lower. The peak-to-trough move from the end of July to late October was a fall of 11% for the MSCI All-Countries World Equity Index. Government bond yields hit highs not seen in almost two decades. The main cause of this was a growing belief that central banks would maintain a “higher for longer” interest rate policy in the face of resilient growth and sticky inflation.
In early 2024 the key points to bear in mind are these. Inflation, if not necessarily conquered, is trending lower, and the supply problems associated with the pandemic are largely behind us. This means that the peak of the interest rate cycle is very probably also behind us and that central banks have the capacity to respond to economic weakness with easier monetary policy if required. Economic growth and corporate profitability have held up better than expected but remain vulnerable to the lagging effects of past interest rate increases. More than half of the world’s population is scheduled to be deciding the fate of its leaders this year, with the US election deemed to be the most important. Investors have in the past shown a tendency to be more circumspect until the results are clear.
Thus we enter 2024 with a familiar feeling of uncertainty. As we noted in the last commentary, the big question is this: will central banks cut interest rates because they can (lower inflation) or because they have to (weaker economies)? The first reason would be preferable, while the second makes for a bumpier ride. However, we would emphasise that we are still discussing potential interest rate cuts in both scenarios, and they usually end up providing the fuel for better investment outcomes.
The markets’ rally during November and December provided a clear example of the benefits of staying the course when investing for the longer term. Lacklustre returns until that point were tempting many to throw in the towel and to opt for the greater certainty of cash deposits. But once sentiment turns for the better, decent returns are often generated rapidly, and that was certainly the case this time. Indeed, more than a year’s worth of the interest available on a cash deposit was delivered in about nine weeks, even by a reasonably conservative balanced portfolio. Unlike the steady drip of interest that one receives on cash, returns from riskier financial assets tend to be more lumpy, but it is this volatility that pays the entry fee for higher returns in the longer term. No doubt our patience will be tested again in 2024, but we continue to have faith in the ability of the companies we invest in to compound returns for shareholders.
October 2023
There has been no real change to the driving forces behind markets since the summer. The main weight hanging over equities has been the rising cost of capital, which in turn is a function of higher bond yields. The primary force behind higher bond yields has been the strength of the US economy, combined with increased bond issuance by the US government to cover a ballooning fiscal deficit. The consistent message from the Federal Reserve (Fed) is that interest rates will remain “higher for longer”, and this has resulted in a steepening of the yield curve, meaning that longer term interest rates are no longer much lower than short-term rates.
If rates are rising because of higher inflation, that can often be an opportune time to buy cyclical companies benefitting from strong economic activity. If it is a rise in “real rates”, a result of the extra return demanded by investors to compensate for a variety of potential risks, then the environment for all financial assets tends to become tougher. It is a rise in real rates that has propelled bond yields higher in the last few months; hence the weakness in equities, including, finally, some of the high-flying US technology giants. The ultimate cure for higher rates will be economic weakness. We are experiencing more of that in the UK and Europe, but it is the US that holds sway over global asset prices. There remains a huge range of forecast expectations for the US economy. One predicted is an imminent US recession; the other that growth would continue for at least another year. Their arguments were equally plausible. We have been in the “imminent” camp for a while and remain there, acutely aware that the cycle has taken longer to play out than we expected. We are far from alone. The recession “waiting room” has standing room only. Even so, given the lingering effects of pandemic-related distortions, ranging from supply chains to working patterns and from government handouts to spending sprees funded by “excess saving”, we have not had sufficient conviction to adopt an extremely defensive stance. To revive a phrase we were using a year ago to describe our attitude, we remain “cautious, not fearful”.
The major development during October was the attack on Israel by Hamas operatives, resulting in a tragic loss of life. Almost a month on from that incursion, markets remain almost surprisingly calm. An initial upward spike in the oil price has been fully reversed as the situation has not expanded further into the Middle East.
The greatest concern was that Iran would be drawn into the hostilities, given its support for both Hamas and Hezbollah and its longstanding animosity towards Israel. Iran produces around 3% of global oil output, but, more importantly, has effective control over the passage of oil tankers through the Strait of Hormuz. These account for closer to 20% of global supply, meaning that any closure of the Strait would be catastrophic for the global economy. There is little doubt that the superpowers recognise the risks and appear to be intent on imposing some sort of restraint upon the various adversaries, but the risk of escalation is definitely not zero. Bearing that in mind, another traditional hedge against rising geopolitical risk, gold, performed well during October, even reaching an all-time high when priced in sterling. Gold has distinguished itself by breaking its historical correlation pattern.
The UK can only dream of such growth. 1% economic expansion over the course of a whole year, let alone a single quarter, would be welcomed today. In the 12 months to the end of August, which is the latest data we have, the economy expanded by 0.8%. Unlike in the US, where the great majority of mortgages are taken out at a rate fixed for 30 years, in the UK most are fixed for two or five years. This means that the refinancing “fuse” is much shorter. Around 100,000 households per month are facing a sharp increase in payments, and this will continue for some time yet as past deals expire. Transaction levels in the housing market have collapsed, with mortgage approvals at their lowest level since 2011 (ex-Covid). Inflation remains much more persistent in the UK than in other countries, a trend that has been apparent for several years. It is often blamed upon a lack of productivity growth, for which there are many potential reasons, with a lack of investment combined with (government) policy uncertainty being widely cited. At least part of the current inflation will unwind quite quickly when we see data for October owing to the latest reduction in the energy price cap. When he delivers his Autumn Statement, it is quite possible that Chancellor Jeremy Hunt will be able to claim that inflation has halved under his and Prime Minster Sunak’s watch, but it will probably still start with a five. One shoe that has not dropped is employment. The unemployment rate has ticked up from 3.8% to 4%, but that is as much on account of new prospective workers joining the labour force as people losing their jobs. The consensus growth forecast for 2024 is a measly 0.4%, which, if nothing else, suggests that the Bank of England will be hard pressed to raise the base rate any further than its current 5.25%.
All emerging market roads still tend to lead to China. Every scrap of economic data from the country has the capacity to produce large swings in commodity prices, especially. China’s leadership is desperately trying to leave this old model of growth behind, partly out of necessity owing to the huge amounts of debt attached to it. The unwinding of years of speculative residential construction is weighing heavily on current activity as developers attempt to deal with their liabilities. This has already led to several defaults with more to come. The government would prefer growth to be driven by more sustainable consumption, but China’s citizens appear unwilling to break a strong savings habit, especially given weak housing and stock markets and the traumatic experience of Covid lockdowns. China did report surprisingly strong year-on-year GDP growth of 5.2% in the third quarter, although there is always a degree of suspicion about the trustworthiness of such figures. The latest purchasing manager surveys, hovering around or below the crucial 50 mark that separates expansion from contraction, suggest a much weaker experience. The latest move by President Xi was to announce additional fiscal support to the tune of $137bn to be raised through the issuance of sovereign debt. That represented an unusual mid-year shift in the budgeted deficit from the targeted 3% of GDP to 3.8%. This demonstrates further intent to draw a line under recent economic underperformance, but still falls short of creating a strong lift-off. Lower interest rates are an option, especially with consumer price inflation non-existent, but lower interest rates would squeeze the banks’ profits, and they are key to providing credit to the economy (as well as soaking up the bad debts of real estate developers).
Investors have become used to economic and stock market cycles coming to an abrupt end defined by a major event, such as the financial crisis or the pandemic. The cycle was then almost equally as quickly resuscitated by central banks applying monetary defibrillators. This time, the central banks are deliberately withholding the ‘current’ with a view to making sure that inflation is contained, and so everything is taking a lot longer to play out. We continue to project that our next major tactical asset allocation shift will be to increase the equity risk weighting. This could be as a result of markets declining sharply in the face of tightening financial conditions and thus offering better value; or it could be because the outlook for economic growth, inflation and interest rates align in investors’ favour. At a time when many investors are tempted to turn their backs on traditional balanced portfolios, we are keen to emphasise that such a course of action could be poorly timed.
September 2023
This year in financial markets has been all about potential “landings” for various economies. Will they be “soft” or “hard”, meaning either a shallow or deeper recession? Or might there be no landing at all, with growth remaining in positive territory? Eight months into the year, economists are still unable to reach a consensus, making for a choppier market in August as investors reacted to data releases.
Part of the problem in reaching an overarching conclusion is that different economies are moving at different speeds. Additionally, within those economies, the various subcomponents are unsynchronised. The most widely observed divergence is between the demand for goods and services. Broadly speaking, many goods producers were beneficiaries of the pandemic when consumers stocked up on more durable items as nests were feathered in response to lockdowns, while social activity was curtailed. Now, the reverse is happening, with “revenge spending” on holidays and experiences prevalent and households running down “excess savings” accumulated during lockdowns.
The picture is further clouded by the lingering effects of supply chain disruptions and labour market shortages. In the case of the former, the rush to refill inventories has resulted in too much stock in some wholesale and retail channels. This can lead to discounted sales as well as a hiatus in demand at the manufacturing source. The stress is visible in global trade data. The shipping giant Maersk forecasts that container demand in 2023 will fall by between 1% and 4% relative to 2022. China’s monthly trade data is also revealing. In July, the value of its exports was down 14.5% from a year earlier, while its imports fell 12.4%.
As we have written about previously, generative Artificial Intelligence remains a powerful growth theme. Leading chip-designer Nvidia confirmed strong demand for its products with its results. As for the longer-term costs and benefits, it remains difficult to be precise. On the one hand, estimates of potential job losses run into the millions as computers take on more menial office tasks. On the other, Goldman Sachs projects that the median company in the Russell 1000 Index will eventually enjoy a 19% benefit to its earnings per share as a result of gains in labour productivity.
Much as that might sound like a boon for investors, it also raises the spectre of increased social and wealth inequality, factors that have been at least partially to blame for the chaotic and divisive political scene that has developed in recent years. Politicians and regulators have a challenging few years ahead of them to ensure that the benefits of this new technology are equitably distributed.
Residential Housing is not an asset class that we invest in. However, we know that it is of great importance to our clients, for whom the primary residence is often their single most valuable asset.
The value of residential housing in the UK amounts to around £9 trillion, or close to four times the size of the economy measured in terms of Gross Domestic Product, and so has a big impact on how wealthy the population is feeling. It used to be higher. The latest figures from Nationwide suggest that the average house price has fallen by more than 5% over the last year and by a little more from the cycle’s peak. Given the experience of the early 1990s and the fallout from the financial crisis, concerns about another crash in house prices are ever-present. Recent analysis from Deutsche Bank and Longview Economics attempts to lay such fears to rest. Despite worries about rising mortgage rates, they see this having a much greater effect on those seeking to get on the housing ladder than on existing owners, given that just over half of current owner-occupiers are mortgage free. Of greater concern would be a large and rapid rise in unemployment, although neither sees that as being a probable outcome. Moreover, the government has made it clear that it expects banks to provide a degree of forbearance should defaults start to rise. Even so, don’t expect another boom, either. We have enjoyed a 40-year trend decline in funding costs that is unlikely to be repeated, and that coincided with an era of financial deregulation. Mortgage debt is around 70% of GDP today, compared with just 10% at the beginning of the 1980s and house price to income ratios remain elevated.
We continue to experience some frustration with markets. Our long-held opinion that the sharp rise in interest rates over the last year or so will lead to a broader economic slowdown is taking longer to be borne out than we (and many others) expected. We have witnessed a degree of capitulation amongst some in the industry as they have shifted from being bearish to more bullish. Whether this turns out to be a justified volte face or an ill-judged folding of the cards remains to be seen. Our analysis of the economic cycle still holds us back from becoming more relaxed about the outcome.
Even so, we continue to emphasise that neither is this a time for “tin hats”. It is becoming clear that we are very close to the peak of the current interest rate cycle. Much of the valuation damage resulting from a higher discount rate has been done; we just need to gain more conviction as to where the corporate earnings cycle might land.
We have maintained for a while that we expect to be projecting a more optimistic view at some point during 2023 (or early 2024), and that remains the case.
August 2023
This year in financial markets has been all about potential “landings” for various economies. Will they be “soft” or “hard”, meaning either a shallow or deeper recession? Or might there be no landing at all, with growth remaining in positive territory? Eight months into the year, economists are still unable to reach a consensus, making for a choppier market in August as investors reacted to data releases.
Part of the problem in reaching an overarching conclusion is that different economies are moving at different speeds. Additionally, within those economies, the various subcomponents are unsynchronised. The most widely observed divergence is between the demand for goods and services. Broadly speaking, many goods producers were beneficiaries of the pandemic when consumers stocked up on more durable items as nests were feathered in response to lockdowns, while social activity was curtailed. Now, the reverse is happening, with “revenge spending” on holidays and experiences prevalent and households running down “excess savings” accumulated during lockdowns.
If we were to observe a pair of contrasting fortunes, it would be between the world’s two largest economies, those of the US and China. Suffice to say at this point that China is struggling to regain altitude owing to a combination of retrenchment in its overleveraged real estate sector and a lack of consumer confidence following the heavy-handed imposition of lockdowns that resulted from the country’s strict zero-Covid policy.
Meanwhile, the US economy is much stronger. The Atlanta Federal Reserve publishes a running estimate of GDP growth for the current quarter based upon the latest economic data. It calls this GDPNow. It is currently predicting growth for the current quarter to be running at an almost unbelievable 5.6% over the last quarter. Even if we allow for the fact that this is an annualised figure – and so actual growth of 1% would print at 4% – it is a long way from the recession that the vast majority was predicting at the start of the year. Corporate earnings reported for the second quarter remained resilient. There were areas of weakness, notably in the Resource sectors, where lower commodity prices reduced profits from 2022’s bonanza levels, but large consumer staples companies continued to display strong pricing power and the all-important (to sentiment) Technology sector displayed no signs of weakness.
As we have written about previously, generative Artificial Intelligence remains a powerful growth theme. As for the longer-term costs and benefits, it remains difficult to be precise. On the one hand, estimates of potential job losses run into the millions as computers take on more menial office tasks. On the other, Goldman Sachs projects that the median company in the Russell 1000 Index will eventually enjoy a 19% benefit to its earnings per share as a result of gains in labour productivity. Much as that might sound like a boon for investors, it also raises the spectre of increased social and wealth inequality, factors that have been at least partially to blame for the chaotic and divisive political scene that has developed in recent years. Politicians and regulators have a challenging few years ahead of them to ensure that the benefits of this new technology are equitably distributed.
Looking to housing, latest figures from Nationwide suggest that the average house price has fallen by more than 5% over the last year and by a little more from the cycle’s peak. Given the experience of the early 1990s and the fallout from the financial crisis, concerns about another crash in house prices are ever-present. Recent analysis from Deutsche Bank and Longview Economics attempts to lay such fears to rest. Despite worries about rising mortgage rates, they see this having a much greater effect on those seeking to get on the housing ladder than on existing owners, given that just over half of current owner-occupiers are mortgage free. Of greater concern would be a large and rapid rise in unemployment, although neither sees that as being a probable outcome. Moreover, the government has made it clear that it expects banks to provide a degree of forbearance should defaults start to rise. Even so, don’t expect another boom, either. We have enjoyed a 40-year trend decline in funding costs that is unlikely to be repeated, and that coincided with an era of financial deregulation. Mortgage debt is around 70% of GDP today, compared with just 10% at the beginning of the 1980s and house price to income ratios remain elevated.
We continue to experience some frustration with markets. Our long-held opinion that the sharp rise in interest rates over the last year or so will lead to a broader economic slowdown is taking longer to be borne out than we (and many others) expected. Our analysis of the economic cycle still holds us back from becoming more relaxed about the outcome.
Even so, we continue to emphasise that neither is this a time for “tin hats”. It is becoming clear that we are very close to the peak of the current interest rate cycle. Much of the valuation damage resulting from a higher discount rate has been done; we just need to gain more conviction as to where the corporate earnings cycle might land.
We have maintained for a while that we expect to be projecting a more optimistic view at some point during 2023 (or early 2024), and that remains the case.
July 2023
Although the summer holiday season is upon us, there has been little evidence of a summer lull developing in financial markets. The second quarter results season is in full swing, and policymakers and investors alike are scrutinising every piece of economic data for clues as to the path of inflation and what it might mean for monetary policy and growth expectations. The result has been another constructive month for credit and equity markets, although government bonds continue to struggle to generate positive returns. In the context of a balanced portfolio, 2023 continues to be a more pleasant experience than 2022, even if there is a lingering degree of scepticism about the sustainability of equity market gains.
Global equity gains this year have been built on two primary foundations. The first is that economic growth in all major economies (with the exception of China) has proven to be more resilient than was expected. Although the UK and Europe continue to flirt with recessions, a reduction in energy and food prices combined with the protracted recovery in the post-pandemic services economy has boosted consumption. Remember that the Bank of England was forecasting a five-quarter long period of economic contraction at the end of 2022, while at the same time there were real fears that Europe would run out of natural gas in the face of supply constraints associated with the war in Ukraine.
The US brushed aside a technical recession as long ago as the first half of 2022, although it was never officially tagged as one by the National Bureau of Economic Research, the body which adjudicates on such matters. The latest reading of US GDP for the second quarter of 2023 displayed no signs of weakness, showing growth of 2.4% on an annualised basis over the previous quarter. Consumption continues to be bolstered by the drawing down of “excess” savings accumulated during the pandemic.
The second key factor that has driven markets higher this year is the dawn of the age of Artificial Intelligence (AI). The release and fast adoption of intuitive, interactive applications such as ChatGPT triggered the first wave of enthusiasm. This was magnified by a positive earnings release and outlook statement from Nvidia, the leading designer of the chips required to power AI-based offerings. The positive sentiment then spread to other companies deemed to be key players in the industry, including Technology behemoths such as Microsoft, Alphabet (Google), Meta (Facebook) and Apple.
While market gains in the first half of the year were dominated by this very small group of (mainly US) beneficiaries of the prospective AI boom, we have witnessed a broadening of leadership during July. This partially reflects the belief that the US will not (yet) fall into recession, but there is also an element of catch-up being played, as investors who missed out on the gains in the earlier part of the year (but who cannot stomach paying up for the winners) find solace in the laggards.
Meanwhile, central banks continue to juggle growth and inflation as the key determinants of monetary policy. The good news is that inflation appears to have peaked in most regions, especially at the headline level. However, there remains much uncertainty about how long it will take to return to central banks’ 2% target and whether it will take some damage to the labour market to achieve that target.
The main drivers of markets have not changed much this year, but it is fair to say that sentiment has improved dramatically, as evidenced by a positive re-rating for equities whilst earnings expectations have been little changed. This has elicited an increase in targets for equity indices at the half-year stage from several investment banks and fund management houses.
June 2023
The half-way point of the year is a natural moment to reflect on what has taken place so far and to consider what we can look forward to in the next six months. With the benefit of hindsight, it is abundantly clear that, bearing the scars of 2022, strategists and investors as a group were too cautious at the beginning of 2023.
At the turn of the year, there was widespread expectation that recessions would develop in the US, the UK and Europe. Activity has surprised to the upside in the two former cases, although parts of Europe have been hampered more by a global slowdown in the manufacturing industry.
Corporate treasurers have termed out a lot of their debt, meaning that they will continue to benefit from lower interest payments until those loans mature. A lot will then depend upon the new rate. There are similar dynamics at play in many housing markets around the world. Fixed-rate mortgages are cushioning the immediate blow of higher rates, as we detailed in last month’s commentary. In the UK, the majority of fixed rate mortgages are in the two-to-five-year range, meaning that there is a much shorter fuse on the “mortgage timebomb”.
For some, memories of the house price crash of the early 1990s are being rekindled, although back then, the UK was locked into the European Exchange Rate Mechanism where sterling was tied to the German Deutschmark, even while Germany was raising interest rates to deal with its own post-unification inflation problem.
Central bankers will remain key players over the months ahead. It is clear that they have struggled to interpret the economic signals generated during the last couple of years, and much scrutiny is being placed on their methodologies. Even so, it is possible to have a modicum of sympathy for their plight given the disruption caused by the pandemic.
It is clear that different parts of the global economy are moving at very different speeds. The manufacturing economy appears to be in a recession as it battles the bullwhip effect of inventory management. The services economy is much stronger and even booming in parts. Ryanair has just announced that it carried a record number of passengers in June.
Additionally, there is a US boom in the construction of new manufacturing facilities (despite the global manufacturing recession). This is being driven by fiscal incentives from the Biden administration to shorten and strengthen supply chains, to reduce the dependence on China, especially, and to accelerate the green energy transition. This effectively means that the government is pressing down on the economic accelerator while the Federal Reserve is hard on the brakes and helps to explain some of the persistence of higher core inflation.
Worth mentioning is the latest hot investment topic of generative Artificial Intelligence (AI). The excitement started to build in late 2022 with the release of Chat GPT, the first publicly available interactive and intuitive iteration of AI. This latest iteration of AI is a potential game-changer in terms of productivity. However, it is far from clear exactly how the benefits and losses will be distributed. The launch of Chat GPT has been likened to that of the iPhone, in that it provides everyday utility in an easily accessible form. It’s a product breakthrough as much as an advance in technology. Famously, the iPhone was the source of great disruption to the taxi industry (think Uber), and, more recently, the ability to withdraw deposits from a bank by tapping a phone contributed to the swift demise of Silicon Valley Bank. Such outcomes were not predicted when Steve Jobs unveiled his new device.
In summary, forward-looking indicators continues to suggest that tougher times are ahead for the global economy and that central banks will persist with tight monetary policy either until they are convinced that inflation is permanently contained or there is a nasty financial accident. Such a sharp repricing of the cost of capital as seen in the last year will ultimately have more widespread negative consequences, although any recession will be relatively shallow owing to the fact that neither consumers nor companies are excessively stretched, as they were, for example, in the lead up to the financial crisis.
May 2023
To characterise the investing year so far, one could say that it has been a period during which several things that could have happened have not (yet), and that some potentially nasty accidents have been avoided.
What are the things that have not happened? At the beginning of the year, economists were almost unanimous in their forecasts for a recession in the US, UK, and Europe. Even the Bank of England expected the UK to be mired in a recession for the whole of 2023. And yet, five months later, the “most anticipated recession in history” has not arrived. Only Germany, of the major countries, has recorded two consecutive quarters of negative growth.
How could the consensus have been so wrong? One mitigating factor in the UK and Europe was the weather. Winter turned out to be pleasantly warm relative to long-term averages and expectations. This reduced the demand on energy for heating and punctured the price of natural gas that had been squeezed up aggressively in response to supply reductions from Ukraine and Russia. Higher energy prices can be viewed as the equivalent of a tax on consumers, and so the reductions effectively delivered a timely “tax cut”.
The concept of post-Covid “revenge spending” was postulated back in the depths of lockdowns, when the idea of a new “roaring twenties” did the rounds. Buoyed by the extra savings that were accumulated during lockdowns and by rising wages, consumers are almost single-handedly keeping economies afloat. But the nature of spending has shifted, meaning that we are witnessing a two-speed economy. Demand for services and experiences (denied during Covid) is strong; demand for goods (which boomed) is soggy – with the sogginess exacerbated by weak housing markets, which are having to cope with much higher interest rates for new mortgages.
The strength of consumer demand in what remain tight labour markets (thanks to many workers having exited for good during the pandemic, and a considerable number on long-term sick leave) has led to something else not happening: a swift reduction in the rate of inflation. While headline consumer price indices in all regions have retreated from their peaks, that retreat has not been fast enough to satisfy central banks, who continue to aim for 2% inflation.
As a result of this, another thing that has not turned out as expected is the path of interest rates. Based on the expectations priced into futures markets at the start of the year, the UK base rate should have been topping out now at around 4.7%. Instead, traders are expecting the peak to be around 5.35% later this year. In the US, the peak expectation in January was for around 5%. There is “only” an extra 0.25% priced in here, but of greater importance, perhaps, is that the forecasted rapid rate reductions in the second half of the year are no longer on the radar. The European Central Bank was always viewed as a laggard in implementing tighter policy, and here the expected peak rate has moved even less, from 3.5% to 3.6%. But there is definitely a feeling that rates will now be “higher for longer”.
The good news is that the application of tighter monetary policy means that longer term inflation expectations have not become unanchored. The not so good news is that the world is having to learn to live with higher interest rates and a higher cost of capital. Monetary policy is often described as acting with “long and variable lags”. Just because the effects of tightening have not been fully felt yet, it does not mean they will not be in the future. The far greater use of fixed-rate mortgages these days slows down the transmission of monetary policy to some degree. While it has quickly slowed demand for new mortgages, holders of existing mortgages face a less immediate increase in debt servicing costs.
As for the nasty accidents avoided, they are a banking crisis and a US debt default. We have covered the demise of several banks triggered by the fall of Silicon Valley Bank in early March in previous commentaries. Suffice to say that fears of an all-out banking crisis were exaggerated. But the seeds of the bankruptcies were sown in the higher interest rate environment, and they are symptomatic of the corrosive effects of higher rates. If rates are to remain “higher for longer”, then we would expect more evidence of corrosion to be revealed.
Germany drifted into a recession in the first quarter of 2023, weighed down by a tough domestic property market and a global manufacturing slowdown. But eurozone unemployment in April hit a new record low for the euro era extending back to 1998 and May’s inflation data for several of the large countries (and, by extension, the eurozone as a whole) was lower than forecast. This looks more like a soft patch than a major slowdown.
We continue to operate in “patient” mode. We trust that the preceding commentary helped to illustrate the unusually difficult nature of the current investing environment. But we continue to believe that the current cycle of uncertainty will be resolved over the next few months and look forward to being able to convey a more optimistic outlook in the months ahead.
January 2023
- Inflation and central banks remain firmly centre stage as global interest rates rise at speed
- Chancellor of the UK delivered a controversial mini-budget
- War in Ukraine continues, with Ukraine taking back territory
- Fears of a global recession grow
When the markets closed on 30th December in New York, the S&P 500 wrapped up what was the seventh worst performing year for the index in the last 95. In recent history, the -19.4% yearly performance (in US dollar terms) was only surpassed by the bursting of the Dot-Com Bubble and the near-systemic collapse of global financial markets in 2008 (source: Factset). Inflation – primarily caused by constraints in energy, supply chains and labour – caused much of the sell off for investors in 2022 as the equity market’s relative attractiveness compared to government bonds and cash declined, impacting valuations. Whilst equities across much of the globe sold off sharply, investors suffered as badly (if not worse) in the fixed income market – ordinarily a ‘safer’ asset class. Contrary to the rest of the year, markets generally rallied and the US dollar weakened in the fourth quarter.
Throughout the quarter, and year, there has been a primary focus on the discourse and actions of central banks. Most equity market sell offs are about economic growth but this one has been clearly about inflation and interest rates. It has also been characterised by a lack of panic – the repricing of assets has been painful but mostly orderly.
Encouragingly, year-on-year inflation, decreased from 8.2% to 7.1% between October and December in the US, with 6.7% forecast in January 2023 (source: Factset). Similarly, a dip in inflation between October and November in the Eurozone and the UK gave hope that inflation may have peaked. After four months of 0.75% rate increases, the Federal Reserve (Fed) stepped down to a 0.50% increase in December whilst lowering GDP growth expectations in 2023 to 0.5%. Chair Powell noted that the Fed still had “ways to go” but also that certain contributors to inflation were rolling over. With the suggestion of a 0.25% rise in February and now multi-month stability in expectations about where interest rates will end up, markets have greater clarity about how to value assets, something which was lacking in the first half of last year.
In the Eurozone and the UK, central banks are not only dealing with inflation but also with economies perilously close to a recession. In November, the Bank of England said that the economy was probably in recession. Whilst economic growth rebounded in October from a September decline, the British economy is likely to post a second quarter of economic contraction, meeting the definition of a recession. After the US 50bps hike, Christine Lagarde re-iterated her point that rate hikes and quantitative tightening will continue whilst also upgrading the inflation forecast. Despite this gloomy outlook, it is worth remembering some of the very grave autumnal warnings about blackouts and an outright collapse in Eurozone economic growth. Helped by imports of liquified natural gas, high levels of gas in storage, and a mild winter, Eurozone economic indicators, whilst weak, have surprised to the upside over the winter.
The Bank of Japan (BoJ)’s announcement of a change in policy on yield curve controls added to market volatility. Previous BoJ policy was to have yields at 0.00% for 10-year Japanese government bonds with a +/-0.25% tolerance. In December this was raised to 0.50%, raising expectations from investors that ultra-loose monetary policy was ending. Yields rose sharply for global government bonds as Japanese government bonds became (modestly) more attractive.
With a change in leadership there has been something of a normalisation in British politics. The so called ‘moron risk premium’ of higher borrowing costs, driven by concerns about inflationary fiscal policy and a vicious cycle of liquidations from the liability-driven investing (LDI) of UK pension funds, has been replaced by Rishi Sunak’s ‘boring dividend’. Throughout 2022, UK equities largely held up despite the political and economic turbulence. Indeed, the FTSE 100 was one of very few indices to be up on the year. A good deal of this is attributed to a dislocation between the FTSE 100 and the British economy as the index has a large exposure to those least susceptible to inflationary pressures (e.g., mining and energy) as well as large foreign earnings, which benefited from sterling depreciation.
Developments regarding China’s COVID-19 policy eclipsed all others for the Asia-Pacific region in the fourth quarter. China’s zero- COVID-19 policy has had a material impact on both global supply and demand over the past two years. The country is now moving towards an approach that is more familiar with those outside of China – a reluctant co-existence with COVID-19. Going forward, supply chain pressure should improve as factories are no longer forced to close. The opening up of the country to international visitors as well as the free movement within China should also boost demand. Investors reacted positively to this news with the Hang Seng up 14.9% and SSE up 2.1% in local currency (source:Factset).
Performance attribution for the quarter
In June, Joe Biden voiced that “inflation is the bane of our existence”. The dynamic between people and prices has extended out to equities. Central banks have responded to surging prices through monetary tightening, namely raising interest rates. According to Bloomberg the value of global equities declined by $25 trillion. News flow is one input into market performance, the other is expectations and the adage that markets are ‘darkest before the dawn’ played out in the last quarter. A rally in equities in October and November allowed the quarter to be generally positive, despite giving back some of the gains in December.
The FANG+ index (comprising the ten most traded tech giants) was down 5.2% in Q4, ending the year -40.0%4. Some of 2022’s notable underperformers include Tesla -65.0% and Meta -64.2% (all in US dollar terms)5. These companies are generally regarded as growth stocks – they rely on a story for rationalising a higher share price for their ability to further grow revenues above their cost of capital. As the global economy has slowed and the cost of borrowing has risen, investors de-risked their assets in favour of those with more reliable earnings. This theme was also seen in Q4 where the tech heavy Nasdaq ended the year in negative territory, unable to lock in some of the positive returns achieved in the November. This filtered through into MS US Advantage and our other tech-focused holdings.
After their worst three quarters in modern times, fixed income markets settled in the fourth quarter. On the government side, greater clarity about the future path of interest rate hikes stabilised yields. This was driven by consecutive months of inflation coming in lighter than expectations, driven by broad based improvements. The Federal Reserve (Fed) has now stepped down from their 75 basis points (bps) rate rises to 25bps and they seem set on 5.25% as their terminal rate to be reached over the next few months (4.50% currently).
◄► Fixed interest
Over the last year, the Jupiter and Allianz strategic bond managers have been adding to duration within their fund in the face of a deteriorating economic environment. Whilst we are not necessarily opposed to this view and generally happy to let our active bond managers move take directional bets, we feel it is prudent to manage duration risk, particularly in the lower risk models where there is a higher proportion of fixed income within the portfolios and volatility within markets remains high. We have therefore reduced exposure to strategic bond managers and have allocated to the Vontobel Sustainable Short Term Bond Fund.
The Vontobel fund is a sustainable, long only bond fund which is simple to understand and aims to keep volatility low (less than 3%). Not only does the strategy screen out securities negatively, but it also applies a positive screen to select bonds that have high ESG scores. This feeds into the low risk thesis, of trying to find high quality holdings with limited downside risk. The fund has a duration of c. 1.5 and focuses on IG and BBB credit, taking a highly selective approach to screen for high quality bonds.
▼ UK equity
Despite an improvement in both sterling and the UK bond market following Rishi Sunak’s appointment as Prime Minister and Jeremy Hunt’s most recent budget announcement, economic conditions in the UK remain more challenging than in other equity markets. UK insolvencies have risen notably over the last year and despite some short term support, consumers remain under pressure with spending levels dampened.
We therefore continue to look elsewhere for new opportunities, prioritising American or Asian equities and have not allocated further to UK fund managers. Instead, we have sold out of the Threadneedle UK Equity Income Fund across the models.
◄► Overseas Equity
This quarter we have also sought to add further value exposure to the models by introducing a new fund – the Beutel Goodman US Value Fund. The fund is a concentrated portfolio of 25-35 companies trading at a significant discount to business value. The fund owns high quality yet undervalued companies, which the managers believe will achieve superior risk-adjusted returns. Our analysis has supported this, finding the fund to have delivered positive risk-adjusted returns over a long period of time and through various cycles. Sector and stock weightings are purely an outcome of conviction in the quality and value proposition of the stock, not any macroeconomic overlays or tactical positioning. The team have developed a rigorous process over the years, which seeks to mitigate behavioural biases through reviews of stocks that have met target prices. This is a true value strategy in that they target over two thirds of their total returns will come from price re-ratings.
Much like the Lazard Global Equity Franchise Fund that was added last quarter, the Beutel fund also does not focus on traditional value plays such as energy, financials or utilities, instead focusing across sectors on high quality companies that have large economic moats, stable histories and a high degree of earnings predictability, but are seen as undervalued and currently out of favour. We therefore feel the thesis of the fund ties in well to our own core beliefs and that as investors become more focused on the strong fundamentals of quality companies once again, fund managers that also focus on this will benefit greatly.
As we have done across the portfolios, we have also sought to reduce our biases in the higher risk models, in particular by reducing our exposure to those more richly valued parts of the portfolios, and by adding wider Japanese exposure. The Fidelity Japan Index Fund gives us exposure to parts of the market that we would otherwise not usually access via our fund managers such as Japanese industrials. Currently, both the yen and the wider Japanese equities market are very undervalued- Japanese stocks are currently trading at a 25% discount to their US peers, while the yen is still the cheapest currency in the G7. Even if we begin to see a strengthening yen impact Japan’s largest exporters, we still expect the relative undervaluation to offset any of these negative impacts. In comparison to the environment of rising rates across Europe and the US, the Bank of Japan has resisted following in their footsteps and rates remain low due to the minimal risks of the country experiencing a long term inflation problem, ensuring there is ample monetary support for businesses. Alongside this, when contrasted to the ongoing war in Europe or the recent volatility in Chinese markets, Japanese stocks can be viewed as relatively safer assets, with the addition usefully balancing out some of our more growth-focused or high beta positions elsewhere in the portfolios.
Lastly, in the higher risk models we have top sliced some of our active managers, reallocating to low cost, passive alternatives. Whilst we continue to favour our high quality active managers, adding market exposure through low cost alternatives will dampen some of the style exposure within the portfolio whilst simultaneously reducing cost.
◄► Absolute return
With the exception of a small increase in the allocation to the CG Absolute Return Fund in some of the models, there have been no further changes this quarter. Our active alternative funds continue to offer diversification benefits and robust, stable returns in periods of economic uncertainty.
◄► Cash
Cash levels have been maintained across the models this quarter.
Looking ahead
In the economy the inflation picture should continue to improve, but at what cost? With interest rates increasing so far and so fast it is likely that this will have an impact on economic growth in 2023. Portfolio wise, we continue to like to combine a core of holdings in quality companies at reasonable valuations, with themes and ideas that should work well over the coming twelve months. With rate hikes priced in and inflation improving, fixed income should stop bleeding in 2023. The added kicker being that from a portfolio construction perspective, fixed income is now very useful.
LGT Wealth Management UK LLP
December 2022
Economy contracts as snow hits
- UK GDP shrinks over three-month period
- Industrial action continues to cause disruption throughout December
- We remain selective when investing in the UK and maintain a global and diversified approach to investing
There has been a mixture of good news and bad news in the UK recently, depending on the lens you look through. Good news – the economy grew in October. Bad news – this is only because the previous month was weak due to national mourning of our late Queen. Good news – a snow day in December, a lovely pre-Christmas surprise. Bad news – with energy prices already sky-high, this is forcing people to contend with the huge cost of turning on the heating. Then comes more bad news – countless strikes that will disrupt the festive period. Additionally, the Bank of England is set to hike interest rates again later this week in an attempt to curb inflation.
GDP – up or down?
This week, the headlines painted a rosy picture – ‘UK rebounds by more than expected in October’. This refers to the month-on-month GDP figure increasing 0.5% between September and October. Although, in September there was the extra bank holiday for the Queen’s funeral. Dig a little deeper and in actual fact UK GDP shrank over the three-month period, signposting the start of an expected prolonged recession
CPI and interest rate decisions
In other important data this week, following the positive US inflation print on Tuesday, we have UK CPI and another expected 0.5% interest rate hike from the Monetary Policy Committee. The Bank of England’s main aim is to rein in the runaway inflation, but they will not want to send the economy into a deeper recession. A fine balancing act.
Snow falls, heating soars
December has brought about a wave of freezing temperatures. A layer of snow on Monday felt Christmassy and festive at its best, but at its worst caused major disruption across the UK. The major impact, however, will be the impact on households. Household bills, in particular energy, have been rising all year and a cold Winter is only going to compound intensifying pressure on the purse strings. Less disposable income will weigh on discretionary spending and thus slow the economy further.
Industrial action takes a hold of the country
Four weeks of rail strikes started yesterday, with a reduced service still running, but disruption planned at various points until the second week of January. Postal workers have been striking for a few weeks now and nurses’ strikes commence this week. Teachers in England and Wales may follow suit of their counterparts in Scotland. University staff walked out on three days in November. Driving examiners are another to add to the string of walkouts planned over the next month. Baggage handlers at airports are also trying to secure pay increases that keep up with rising prices.
According to the Office for National Statistics, 417,000 working days were lost to strikes in October, the highest since November 2011 but is expected to rise significantly in December. For some perspective, nearly 12 million working days were lost in 1979 amid the ‘winter of discontent’. Industrial action of this breadth puts increased pressure on the UK government and Rishi Sunak, who, so far, has lasted 50 days in Number 10. A relatively unscathed period once put into context of his predecessor’s 45-day tenure. The very fact Mr Sunak has had to schedule two emergency Cobra meetings this week really highlights the gravity of the task in hand. Rising inflation has led the Unions to demand for wages to increase in real terms. If inflation continues to remain elevated throughout 2023, the unrest and disruption is likely to get worse.
Breakdown of strikes planned throughout December (source Bloomberg)
Our UK exposure
The UK is facing a number of headwinds and looking solely at the economy, 2023 will be tough. At LGT Wealth Management we have long been selective when investing in the UK. There are numerous quality companies found on these shores. However, for the most part, their earnings are earned abroad. There are some gems to be found in the small to mid-cap range but because of this darkening macro-economic outlook, we have been reducing our domestically focused UK exposure. It remains imperative to invest into those companies with resilient earnings, experienced management teams and strong business models with the ability to pass on higher input costs. Many of these quality companies are found in the UK equity funds we own, especially Lindsell Train UK, however, it does highlight the importance of having a global and diversified approach to investing.
LGT Wealth Management
November 2022
In the markets this has been a huge week, albeit, the outcomes were fully expected. Both the US Federal Reserve (Fed) and the Bank of England raised interest rates by 0.75% on Wednesday and Thursday respectively. US rates are now 3.75%-4% (they use a range system) and UK rates are 3% exactly. The press headlines are obviously dominated by articles covering such historic increases and the big struggles ahead for developed economies.
In reality, we have known for some time that a recession is on the horizon but the difficulty is determining how severe and protracted it will be. Jerome Powell and the Fed openly admit that they have no idea exactly when the recession will happen in the US but expect the lags associated with monetary policy (raising rates) to eventually impact consumers. The stock markets are a discounting mechanism (always 9-12 months ahead of reality) and hence we have seen substantial draw-downs in US Indices, with both the flagship S&P 500 and Nasdaq Indices down -22% and -34% respectively this year. This tells us the markets have priced in a chunk of the bad news already. Whether markets fall any further in the short-term or can recover from these levels will be dependent on the data and how high interest rates eventually rise to combat inflation. What we do know is that markets tend to turn while economies are in recession as they are always looking 9-12 months into the future.
Looking at the UK more specifically it has been a humbling period for the Government and Bank of England. The appointment of Rishi Sunak appears to have restored some credibility within the markets but we have heard constant whispering of a global risk premium being attached to UK assets. The Gilt markets have calmed down substantially since the mini-budget, which has reduced the cost of future borrowing for the UK Government. This is essential to demonstrate to international bodies, such as the IMF, that interest costs on our debt can be serviced and that the budget deficit will be managed.
Rishi has also announced that there will be some form of windfall tax on the big energy companies, given the likes of BP and Shell have generated record profits from oil and gas trading. These two companies alone now represent 14.5% of the FTSE 100 and have protected the Index from the sharp falls seen across most European markets this year. In fact, the wider picture has been massively hidden from view. The majority of sectors such as housebuilders, travel and leisure and retail have fallen in the region of -30% to -40% and the FTSE 250 Index is down -22.5% in 2022. This reflects the significant challenges facing the vast majority of British businesses and the anticipated recession here in the UK, as consumers battle mounting cost pressures.
Turning to the Euro-zone and the situation is a similar story where they are battling higher inflation (record of 11%) and falling output. Despite manufacturing remaining weak there are still concerns about equipment shortages, and the ECB is expected to prioritise the inflation threat and target interest rates of 3% (currently 1.5%). Meanwhile, in Asia, we have finally seen some positive news-flow with Hong Kong relaxing many of its Covid restrictions for the first time in 2 years, including lengthy periods of quarantine for inbound visitors. The region has suffered enormously from its rigid Covid rules with third quarter GDP growth falling -4.5% year on year, and the Hang Seng Index falling to its lowest level since April 2009. However, the region’s grand reopening party and commitment to a new path appears to have sparked some enthusiasm for equities. The Hang Seng Index has rallied +10% over the past few days with the tech sector leading the charge. This provides some respite for Funds such as Morgan Stanley Asia Opportunities and Allianz China, which form part of our exposure to the region. In summary, the outlook remains challenging.
Following the central bank announcements, investors will be focused on company earnings in the short-term. We have seen a mixed bag so far with the majority of big tech companies (except Apple) missing their guidance. Despite this, flows into the sector remain steady with over $3bn of inflows into the exchange traded fund (ETF) that tracks the Nasdaq 100 during October. In fact, last month marked a 7-month high for US equity inflows in general, with over $63bn making its way into the respective ETFs. Looking ahead, there are still some great opportunities in the fixed income markets. Whilst longer-term fixed-term cash deposit rates have fallen back, short-dated Investment Grade corporate bonds are still offering ‘annualised’ returns around the 5-6% mark.
LGT Wealth Management
Abacus Money Management Ltd
Office Hours
Mon to Fri: 9am to 5pm
Location
14 Miller Court, Severn Drive, Tewkesbury, GL20 8DN
Contact
01684 778360 info@abacusmml.co.uk
Abacus Money Management Ltd is authorised and regulated by the Financial Conduct Authority under registration number 610239
The guidance and/or advice contained within this website is subject to the UK regulatory regime and is therefore primarily targeted at consumers based in the UK.
The Financial Ombudsman Service is available to sort out individual complaints that clients and financial services businesses are unable to resolve themselves. To contact the Financial Ombudsman Service please visit www.financial-ombudsman.org.uk Please be aware that by clicking onto this link you are leaving the Abacus Money Management website, Abacus Money Management Ltd is not responsible for the accuracy of the information contained within the linked site accessible from this page.
Abacus Money Management Ltd is a Private Limited Company registered in the UK, Company Number 06755206