1st February 2024
2024 saw a mixed start to stock markets as investors attempted to ascertain when central banks would begin to cut interest rates this year. The resilience of the US economy, despite higher interest rates, has given the Federal Reserve a real conundrum. The worry is that a premature rate cut could mean that inflation comes back to haunt the economy and therefore cause pressures on interest rates to increase again. Everything is data-dependent, and it will be interesting to see the next set of inflation figures with the hope that the inflationary trend is still downwards.
The Bank of England has acknowledged that there has been fast progress in getting inflation down, and this has been supported by analysts who expect the Consumer Price Index to fall to around 2% (the Bank of England’s target) in the second quarter of this year. Although Bank of England Governor Andrew Bailey suggested there will be no rate cuts anytime soon, economists expect the first rate cut to come in June. This has been supported by services price and food and wage growth, which has been declining. Interest rate cuts will help to support the economy with the hope of avoiding a recession in the UK.
Many economists predicted a recession in the US and the world economy, albeit they have suggested that this would be mild and it would not cause large economic disruption. The US has defied expectations and grew at an annualised rate of 3.3% at the end of 2023. These figures confirmed the US as the fastest-growing advanced economy in 2023, and this was in a higher interest rate environment. This data, combined with inflation falling, does suggest that the Federal Reserve has engineered what is referred to as a ‘soft landing.’ This is where a central bank manages to lower inflation via monetary policy (i.e., interest rate increases) but avoids a recession. Joe Biden has taken credit for this positive economic data, and he will be using it as political ammunition in the run-up to the US Election.
The US election will be an important factor for stock markets to take into consideration this year. The election is in November, and it seems almost certain that Joe Biden will be campaigning against his previous political opponent, Donald Trump. Ron DeSantis suspended his Republican presidential bid and endorsed Trump. Nikki Haley is still battling Trump in the nominating contest, and these have not finished yet, but the momentum is behind Trump. Campaigning will really begin to ramp up as we get into Spring and Summer, and we will be following this closely.
One factor that could derail the downward trend of inflation is the ongoing unrest in the Middle East. The Houthis are a militant political and religious organisation that advocates for the rights of Yemen’s Shia Muslim minority, known as the Zaidis. They are part of the resistance against Israel and have been attacking commercial ships in the Red Sea. Prominent shipping firms have ceased navigation through the Red Sea, a crucial pathway typically utilised for nearly 15% of global maritime trade, opting instead for a significantly longer route around the southern tip of Africa. This will delay shipments and could cause potential price increases. However, at present, this conflict is not expected to cause huge global economic disruption.
Finally, China has announced a series of measures to support their economy and stock market. The Chinese stock market has been under serious pressure because of China’s real estate sector and concerns around a slowing economy. China’s exports also fell last year. Chinese Premier Li Qiang called for ‘forceful and effective measures’ in the form of a stock market package worth £222bn using offshore accounts of state firms to buy Chinese shares. In addition, China has cut the amount of reserves banks need to keep on their books to encourage them to invest and to bolster the economy. These measures have helped to boost stock market prices, and foreign investment has increased. This has benefited the holdings A&J has in Asia.
2023 continued the recovery in risk assets following what appeared to be the peak of inflationary pressure in global economies and also the peak of interest rates with a now likely downward trajectory. Value equities offered more protection against downside threats compared with their growth peers, as they tended to benefit most from strong recoveries after recession and trade on lower earnings multiples.
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 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.
Duration has become appealing again as market participants shift their primary concern away from inflation and towards growth fears. 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 positive relative performance it 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. We have increased our US exposure as 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.
The opinions expressed in this update are those of A&J Wealth Management Limited only, as at 1st February 2024, and are subject to change.
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