1st December 2023
It was an eventful November, with inflationary pressures lowering, surpassing analysts’ expectations, and US GDP being revised up to 5.2%. It is widely accepted now that interest rates have peaked, and there could be reductions in the latter period of 2024. Stock markets have primarily been influenced by the global inflationary picture and the hope that central banks have tightened monetary conditions enough to bring inflation down to the target they are mandated to achieve.
In the UK, we saw inflation peak at 11.1% in October 2022, a 41-year high, before subsequently easing to 4.6% in the most recent reading. In Europe, Eurozone inflation sank to 2.4%, and in the US, it dropped to 3.24%. This has given stock markets some breathing space, and we witnessed equity markets broadly rising in November. The bigger question is which level inflation will stabilise at, and this is something we are watching closely.
It has also been interesting to observe what has happened to the Fixed Interest/Bond market. Broadly, this asset class has struggled because when interest rate expectations suggest continued increases, the capital value of the bond falls. However, now that it is accepted that interest rates have peaked and inflation is continuing to fall, it seems the most likely trajectory is that rates will gradually begin to decline, making this market more attractive. It is a topic we have extensively discussed within our internal Investment Committee, providing us with plenty to consider in terms of capital allocation.
The US economy is still powering on and defying all expectations. Last year, most analysts expected the world to be in a recession, but this has proven not to be the case. Investors are hopeful for the prospect of a Goldilocks scenario, envisioning a situation where inflation is tamed without triggering a recession. This is described in the investment world as a soft landing. This optimism follows recent data, which indicated a slight increase in the unemployment rate, sluggish job expansion, and wages returning to pre-Covid levels. A soft landing has only been achieved once in the last sixty years, but that does not mean it cannot happen again. The Federal Reserve is walking a narrow tightrope, but at present, it looks like they are navigating to the other side without causing significant economic disruption.
Thoughts are also moving towards 2024 and what is likely to be a year of politics. Almost certainly, we will see a UK election; some political commentators have even touted a Spring election. Additionally, there is the US presidential election in November 2024. Interestingly, since 1951, when looking at US presidential election years, there have only been three negative stock market years, with the rest being positive. Investors are hopeful that with inflation coming down and a new US president being elected, 2024 should be a good year for stock markets.
2023 has continued the recovery in risk assets following what appears to be the peak of inflationary pressure in the US and Europe, having come under pressure last year from higher inflation rates and recession fears whilst central banks began hiking interest rates. Value equities continue to offer more protection against downside threats compared with their growth peers, as they tend to benefit most from strong recoveries after recession and trade on lower earnings multiples. We are taking a more cautious approach to portfolio positioning for a possible recession.
We still like selective growth stocks where there remains true innovation and potential for change, especially recent trends in consumer behaviour that were accelerated by the pandemic but prefer value equities on the whole. We also continue to hold our overall equity weighting at neutral. Fixed income has started looking more attractive following last year’s bear market, with yields now at levels not seen in well over a decade. Bonds also remain an important diversifier in our portfolios. With inflation having seemingly peaked, we believe interest rates could begin to head lower as fears of a global recession pick up. Low duration bonds look the more appealing investment still given the level of inversion in the yield curve, along with selective investment grade credit which was hit hard during 2022.
Duration will become appealing again as market participants shift their primary concern away from inflation and towards growth fears, however we are cautious in our positioning here. We also hold an allocation to cash to offset some of this fixed income risk and dampen portfolio volatility. We have also been adding ‘alternative’ assets to the portfolios, which offer low-to-negative correlations to traditional asset classes (stocks and bonds) and give the potential to protect during times of significant market volatility, such as we are seeing at present.
The UK market is very value-tilted and despite this year’s positive relative performance is still highly attractive on a valuation-basis. The UK economy has also recovered well from the pandemic, though economic growth is faltering. The main driver of UK equity outperformance will be relative valuations.
There is good value to be found in European equities and the region is attractive given historic valuation differentials to the US, and financial companies stand to benefit with interest rates on the rise.
The US represents poorer value relative to the rest of the world due to the high proportion of tech companies that still command a multiple far in excess of the broader market, however it also has the best long-term earnings growth and some of the most outstanding quality companies, as well as the most innovative. In times of global stress, the US also tends to act as a safe haven investment, which props up markets. Overall, we are cautious on the US and so are positioned underweight in portfolios. We do believe the US will remain an attractive investment option in the long-term, but with some obvious headwinds making us more cautious for now.
We believe Japan to be an extremely poor environment for equity performance. The Japanese economy is predicted to grow at the slowest pace of all regions, in addition with a declining and ageing population, the prospect of future economic expansion looks unlikely. Thus, we expect poor relative equity performance from Japan. In the short-term, attractive valuations in the region may boost markets, but this will likely be short-lived.
Asia Pacific & Emerging Markets
Asia Pacific and Emerging Markets are predicted to see exceptionally strong GDP growth over the several years and with China’s reopening look set to outperform the broader global equity market. Thus, we are comfortable maintaining an overweight position. The more recent remarks from the Chinese government have been positive but must be taken with a pinch of salt. We currently like frontier markets as a more attractive investment option within the emerging markets universe. Typically, market move in cycles and EM vs US performance is no different. We have been in an extended period of US equity outperformance, and we now expect this trend to change in favour of EM stocks. The continued upwards trend in US equities is the narrowest in history, with just a select few large tech companies carrying the entire index higher. We do not expect this to continue in perpetuity.
The opinions expressed in this update are those of A&J Wealth Management Limited only, as at 30th November 2023, and are subject to change.
The content of this publication is for information purposes and should not be treated as a forecast, research, or advice to buy or sell any particular investment or to adopt any investment strategy. It does not provide personal advice based on an assessment of your own circumstances. Any views expressed are based on information received from a variety of sources which we believe to be reliable but are not guaranteed as to accuracy or completeness. Any expressions of opinion are subject to change without notice.
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