A new year, same old story? Yes and no.
While inflation has remained the key theme for financial markets during the valuation period (covering the three months, 5 January 2024 – 5 April 2024), markets have largely brushed-aside the pairing with aggressive interest rate cuts.
Instead, markets are embracing the view that the global economy can keep growing at the same time as inflation keeps falling.
This is because economic data over the past three months has been like a comforting bowl of Goldilocks’ porridge, in that it hasn’t been too hot or too cold, or as the US economist and Nobel Laureate, Paul Krugman put it, we have a global economy that is “hot” where you want it to be hot, with GDP growth and strong employment, and “cold” where you want it to be cold, with disinflation.
In fact, economies around the world have defied expectations of a sharp slowdown and are instead demonstrating remarkable economic resilience, while at the same time inflation readings have markedly slowed.
Inflation has, as we have been forecasting, gone from being ‘always and everywhere’ (as Milton Friedman famously claimed), to almost no-more and nowhere. For example, in the UK, CPI inflation has cooled to 3.4% from 10.4% over the past 12 months – and is likely to fall below the Bank of England’s 2% target in the coming months. It is a similar picture, albeit slightly less dramatic, in the US and Eurozone with readings of 3.2% and 2.6%, down from 6.0% and 8.5% respectively.
This all suggests to us that while one of the most aggressive monetary cycles we have ever seen is definitely (and thankfully) over, central bank policymakers are unlikely to want to cut interest rates as rapidly as we initially expected.
However, for financial markets what matters is the direction of travel and those interest rate cuts that we have been forecasting are coming, just at a slightly slower pace than we previously predicted – and even though interest rates are unlikely to be cut aggressively in the coming months, the current economic growth bodes well for global financial markets.
As for what is keeping us awake at night: the geopolitical situation remains very tense, especially following the Israeli attack on Iran’s embassy in Syria. Whilst we certainly don’t want to appear nonchalant, thankfully this has had only a limited impact on financial markets. For example, the price of a barrel of Brent oil has only edged up by just over $10 a barrel during the valuation period. While this higher oil price may flow through into inflation readings over the coming months, we believe it is unlikely to rise significantly more as the market remains well-supplied.
In summary, it doesn’t matter how we slice and dice the quarterly review, it has been a positive period for global financial markets. For example, the FTSE 100 has risen 2.88% during the period, while the US Dow Jones has climbed 3.84%, and the Stoxx Europe 600 ended the period 6.33% higher – and one wonders how many bottles of champagne were cracked open in Japan during the period, as the Nikkei finally closed at a new all-time high for the first time since the end of 1989!
Income Element
As central bank tightening has thankfully ended, the peak for corporate bond yields has been reached – and with the prospect of the global economy on course for a ‘soft landing’ (in other words where economic growth is slowed to help reduce inflation without triggering a recession – just like when an aircraft touches the runway in a nice gradual and smooth way), fixed income markets can breathe a sigh of relief.
Furthermore, with inflation continuing to slow, corporate bond yields will undoubtedly fall and prices (which move inversely to the yield), will rise as interest rates eventually get cut.
Consequently, our strategy of holding a diversified spread of secure companies with investment-grade credit ratings and stable income until their maturity continues to look sensible.
Long-Term Growth Element
Although expectations of interest rate cuts have been scaled back, global equity market performance during the valuation period has been positive, as confidence has grown in the ‘soft-landing’ narrative.
This confidence is rooted in an array of economic data that has showcased slowing inflation and a global economy that has remained resilient (and, in particular, that of the US, the world’s largest economy), thanks to a healthy employment market, which in turn has underpinned consumer spending.
Looking ahead, there is plenty of scope for further equity markets gains given the combination of a soft landing, the prospect of looser monetary policy and more economic stimulus from China.
During the valuation period our analysis coupled with a strategic shift (driven by factors like acquisition sustainability, US market exposure, regulatory changes, consumer spending and AI), led us to make several changes to the UK holdings: Entain, Halma, Reckitt Benckiser, St James’s Place, Vodafone and WPP, were all exited, while holdings were reduced in M&G and Sage. New positions were established in the retailer, Next and Smith & Nephew (a producer of hip and knee implants), and we added to existing weightings in the likes of BT, Compass, Diageo, Flutter and RELX.
During the period, although we adjusted the weightings of many of your individual Asian and Emerging Markets funds, we remain positive (and therefore overweight) in these two regions (which means they have a higher weighting than the benchmark), due to positive demographics and a growing middle-class population.
For clients with Ethical portfolios, the performance over the valuation period has unfortunately been disappointing. Ethical funds tend to own growth companies (in other words, those that have a lot of profit potential in the future) – and as expectations of interest rate cuts have been scaled back it has made these companies less attractive (as higher-for-longer interest rates reduces the discounted value of those future profits).
Investment Management Team
