Over the first half 2024, we have enjoyed what has felt like a normalisation in economic data and investment markets. Most economies have seen improving inflation readings and steady economic growth, indicating that the interest rate hikes of 2022/23 are doing their job without crashing the economy. The UK has recently reported that inflation is back to the BoE’s 2% target and markets have reacted positively to a centre left Labour majority. This should all increase the probability that interest rate hikes are behind us, with cuts on the horizon.
The peaceful glide path of 2024 so far, after what was quite a turbulent post Covid period for markets, has meant that almost all sectors have performed well. As we have discussed in previous commentaries, the combination of falling interest rates and robust economic growth should be very positive for stock markets as well as non-equity investments, such as infrastructure, Fixed Interest (corporate and government bonds) and real estate.
Whilst it is tempting to declare that inflation has been conquered, the data has more recently indicated a possible divergence between the outlook for different economies, with the stronger US economy looking less affected by higher interest rates than the UK and Europe. If this divergence continues, it is likely that interest rates will need to remain higher for longer in the US in order to keep inflation at bay, whereas economies that went into the rate hiking cycle in a weaker position may now have scope to start easing interest rates without incurring a re-emergence of inflation. If this happens, then it is quite possible to see a period of relative underperformance in US assets and further strength in the US Dollar, however, it is worth remembering that the US stock market contains a number of extremely high quality, global businesses that have been able to perform throughout market cycles, so write them off at one’s peril!
It is important to consider economic data and forecasts in our analysis and allocations to different asset classes, however, it is also important to remain long term in our thinking and not to be drawn into making short term bets on this changeable data. Economic indicators, headline grabbing news articles and political posturing will likely cause short term volatility and unexpected winners and losers over the months to come. We have seen this all too recently with the apparent decline in Biden’s cognitive abilities and uncertainty around his future in the Presidential elections – much still being speculated here, which inevitably feeds through to market volatility. A win for the Democrats (whether with Biden or another nominee) should be broadly neutral for markets and positive for international trade and peace. It is difficult to predict the impact of a Trump win on the stock market – inevitably higher tariffs and trade wars will impact companies that rely on trade negatively, possibly benefitting small and mid-cap US companies with predominantly domestic supply and demand. That said, perhaps the self-interest of a man who measures his success on US stock market returns and seems to give little notice of previous promises will take over and market friendly policies will follow. Either way, the uncertainty of a Trump president will certainly bring volatility.
There also remains significant tensions and uncertainty around how the terrible wars in Ukraine and Israel/Gaza will be resolved. This will probably cause volatility whilst the conflicts continue and as the world tries to understand how the outcome of the US election may affect them. This is another example where external politics in the US can have a much wider and more devastating impact globally than the domestic policies and outcomes that campaigns often focus on (or, sadly, in this case, the strength of one’s golf swing…).
As we have said in the past, our view is that interest rates will eventually start to come down, however, probably not to the very low levels seen for over a decade post Global Financial Crisis. If we are right, we are likely to remain in a very different investment landscape than we have been in – the pre-2022 years of growth stocks outperforming and steady well-capitalised businesses with low levels of borrowing lagging. We think that these growth stocks should enjoy some upside in a rate cutting environment (provided other economic fundamentals remain strong), but it is likely that more consistent returns will be found with higher quality companies.
Within equities, we remain positive on the UK. Returns have improved this year with the FTSE100 reaching new highs, however, valuations are still stubbornly below their European and American counterparts. This does not yet seem to have been acted upon by international investors, however, international corporates have begun to snap up bargains – notable recent high profile (albeit failed) bids include Currys and Anglo American, with a significant number of takeovers going on within the UK small and mid-cap market. It is reassuring to see this as confirmation of undervaluation and this is resulting in short term gains when takeovers do occur, however, we are hopeful that some momentum in returns for UK equities will encourage longer term international investors back into the market.
We also expect to see more value in holding the traditional diversifier from equities, Fixed Interest (corporate and government bonds). As you may remember, this is a sector we had been actively underweight for several years as negative real returns and little prospect of capital growth were not very attractive forms of diversification. Now that Central Banks are once again able to use interest rates as a monetary policy tool against possible recessions, holding Fixed Interest should provide reasonable downside protection, as it has done in the past. In the meantime, yields (the income the bond will pay you to hold it) are much improved, providing a good, diversified source of income for portfolios that can be reinvested if not needed.
As with equities, we remain conscious of where we invest within the Fixed Interest sector. We currently think that there is little benefit taking substantial risks in credit quality as high quality, investment grade bonds are offering almost comparable levels of to their non-investment grade peers. This means that you are not sufficiently rewarded for taking additional credit risk, so we aim to avoid that in portfolios where sensible.
The risk for long-term investors remains acting on uncomfortable, short-term volatility rather than sticking with the long-term plan. Provided there are no curveballs, we think that the combination of a more normal interest rate environment, robust economic growth and near target inflation rates, should result in a market that can provide good returns for your portfolio. The US election is still the main unknown, but we hope to gain more clarity throughout the summer. Nonetheless, if we do see a more volatile year ahead, the ability to invest broadly across equities, fixed interest and alternatives (infrastructure and real assets) at attractive prices should help us manage a portfolio that can provide consistent risk-adjusted returns from a diversified range of sectors and geographies.
This note is intended as a general market update and should not be regarded as specific advice or treated as a recommendation to invest in any particular fund or asset class. Stock market investments can fall as well as rise. If you would like to discuss the implications for your own portfolio, please do get in touch.