One September Day
Years, they will come and go.
Sometimes the tears will flow.
Some of my memories will fade,
But I’ll always remember that one September day.
I used to reminisce
‘Cause I thought that love was bliss.
How did they know it would go astray?
It began, and it ended on one September day.
(Nina Simone, One September Day)
Reflecting on the last five years and all the events that have been front of concern, highlights how memories do fade. A global pandemic and economic collapse in early 2020, from which followed a strong early rebound that triggered an initial inflationary wave as too much money chased too few goods. This got compounded by an energy crisis as Russia triggered war on mainland Europe in 2022 and then it all got compounded even further by a wave of profit led inflation as corporations pushed prices ever higher. All in all, it took both the level of inflation and the level of interest rates to 40-year highs. That is not a ‘normal’ period.
Overlay that with some longer-term trends. The retreat from a globalised world, an ageing population, and an increasingly debt-laden world too. The increase of protectionism and populism in the political world, and that’s before we consider the fraught backdrop here in the UK. Brexit? ‘Oven-ready’ indeed! The collapse of Prime Ministers, of Chancellors and their budgets. All these events in just a short five years.
So, what of 2024? I would paint 2024 as being the starting year that the impact from all these events began to diminish. Granted, 2024 is not a year in which there have been giant steps forward, but one in which sounder foundations have been laid. Even the biggest waves from the strongest of storms, turn to ripples in the water in the end. Jerome Powell, Chair of the Federal Reserve, is certainly no Nina Simone, but with the path of interest rates finally on the turn during one September day after a period of tumult, a year that fades away may not be the worst of all outcomes, after all.
Interest rates: Buy one, get one free.
When the aforementioned Chair of the Federal Reserve, Jerome Powell, says “the time has come” to lower interest rates in a speech, which quickly gets followed by fellow Fed Board member, Christopher Powell, delivering a speech titled, “The Time has Come”, you don’t have to be the smartest reader of the tea leaves to get a sense that there may be rate cuts ahead. So, the announcement on the 18th of September, that the Fed has cut rates could only ‘surprise’ through the depth of the cut. Would it be a ‘steady as she goes’ reduction of 0.25%? Or would the Fed frontload the rate-cutting cycle with a heftier 0.5% cut, with an increasingly focused eye on a weakening jobs market, rather than inflation?
As it turns out, the Fed decided to plump for the larger cut of 0.5%, following earlier cuts by the ECB, the Bank of England and the Bank of Canada amongst others, as interest rate policy broadly turns from a headwind to a tailwind. Think of this as a ‘buy one, get one free policy’ decision from the Fed and recognition that they were too slow to begin the process of cutting rates in the face of a jobs market looking weaker than was thought to be the case. On that, the Bureau for Labor Statistics (BLS for short, and so I don’t have to misspell labour again) marked its own homework and revised its estimate of US employment lower by a hefty 818,000 jobs in August, sparking concerns that the jobs market was weaker than expected and negative momentum was building. Within this, there is an important shift. For the last few years, the focus of central banks, not just in the US, has been to curtail inflation. Inflation is no longer the chief concern. Jobs are. The Fed has a dual mandate, to keep inflation at target and to maintain full employment and whilst other central banks may not have the same formality, they all recognise the need to support the jobs market in a weakening point of the growth cycle.
We have written in the last two quarterlies how central banks need to be cutting rates just to keep their interest rate policy standing still. The more inflation falls, and the longer interest rates remain toward their peaks, the longer the period of pain being inflicted on households and the more unnecessary damage is heaped on an already weak economy as the pain of rising ‘real’ interest rates gets higher (the interest rate after allowing for inflation).
Fortunately, the Fed diary is conducive to rates being cut quite sharply. The meeting in September saw a 0.5% cut, and with meetings in November, December and January, even a steady-as-she-goes policy of cutting interest rates by 0.25% each meeting could see rates being cut in short order by over 1%.
With the inflation battle under control, the fight to save the jobs market and the economic recovery is now firmly on.
Magnificent Seven: Riders in the Sky?
We have written in previous quarterlies about the strength of a small number of US, large companies, monikered the ‘Magnificent Seven’, whose share prices have driven the strength of both US and global equity markets. For a while now, passive investors have been enjoying the strong price appreciation of these companies shares, whilst gaining an increasing exposure to a relatively narrower number of shares. Whilst we have warned about this level of market concentration before, since the start of 2023 these stocks subsequently delivered a combined 107% return to their shareholders. Our timing in reducing exposure in Core portfolios has been off.
The chart below demonstrates the growth of these seven companies, as a percentage of the total US stock market – which back in 2012, accounted for around 10% of the US market. Today, that number is around 35%, which makes their combined market capitalisation around $12trn (which is the equivalent to the combined economic output of Germany, Japan and India put together!).
Source: Fidelity International Limited, July 2024
The below table, produced by my colleague Will, shows the percentage each Core and Passive portfolio (of equivalent risk profile) has in the Magnificent 7 and highlights the greater allocation in Passive portfolios. A huge boon in recent years, but one for awareness too, as investors continue to pay a high amount for the continuation of a trend that has been in place since the global financial crisis – namely the continued domination of US equities. That may well continue, but as valuations rise, if the laws of investment still ring true, the likelihood of future investment returns fall too.
Source: Morningstar, 31.08.2024. Table shows the percentage of HFMC Core & Passive portfolios of equivalent risk profile invested in Microsoft, Apple, Nvidia, Alphabet, Amazon, Meta & Tesla. Core portfolios include a mix of active and passive funds.EOE.
Growth and Inflation Numbers: As exciting as Nightsleeper?
Thanks, as ever, to our friends at Schroders for the latest consensus forecasts, which as of 23rd August 2024 were:
Source: Schroders Economic & Strategy Viewpoint, Q3 2024
Keen readers may look at the above table and allege this hasn’t been updated. Almost true!
Not since the opportunity to binge watch the entire series of Nightsleeper has there been as much excitement had, as highlighting slightly higher GDP growth expectations in the UK and slightly lower CPI as being the only fractional moves of note. For those both enjoying the new BBC series and excited at the prospect of a faster growing economy here in the UK – hold on to your hats! The consensus has moved UK growth up from 1% growth this year, to 1.25% growth in 2025. That’s the equivalent of a ‘blink and you’ll miss it’ change and not one that you, me or Tom Cobley will notice particularly when, in a few years’ time, all the GDP revisions have finally been made and we will have a different number anyway.
The global economic outlook looks more resilient than anticipated some quarters ago, but we are in a period of slowing economic growth and the health of the jobs market remains key to determining whether a ‘soft-landing’ is achieved, or a weak recession ensues. China remains weak as it continues to struggle resurrecting consumer demand and issues in its property sector remain. In late September, Chinese policymakers made a series of supportive measures to try and bolster their economy. First, a 0.2% rate cut, second a reduction of 0.5% in the required reserve ratio (a measure that potentially increases the amount of capital banks can lend into the economy), and third, measures to support the property market. Mortgage holders benefitted with lower a mortgage rate and potential property purchasers were helped with a lower downpayment amount needed to buy a property. A step in the right direction from Chinese policymakers, who will no doubt be thrilled with the prospect of a potential second Trump on the horizon.
Portfolio Outlook – The Masterplan
Too many investment pieces will have obvious Oasis tracks in them. So, whilst ‘The Masterplan’ may be slightly over-stating it, it was less ‘buy some of these, they’re going up’ than ‘Supersonic’ would have inferred, and less drab than ‘Whatever’ and definitely maybe more upbeat than ‘Slide Away’. I’m going to roll with it.
Fixed income yields have rallied strongly in recent months that has curtailed some of their headline attractiveness, but fixed income remains a far more helpful asset than in the lean years that we had prior to 2022. Solely from a yield perspective, fixed income is less attractive today than it has been, but still maintains yields at a level to warrant attention, particularly as the interest levels on cash begin to weaken. Corporate credit spreads (the difference in yield between government bonds and corporate bonds of the same maturity and a measure of the attractiveness of corporate credit over government debt) look firmly valued too. Spreads look relatively tight across the fixed income world and there’s a risk that they widen should the economic outlook weaken or concerns about corporate health elevate.
There is now a strong, positive backdrop of supportive central bank policy in place, that is likely to be in place for many quarters to come. We are therefore expecting solid returns over cash from fixed income, with the potential for portfolio diversification benefits too. In Core portfolios, we continue to use a selection of investment grade corporate and strategic bond funds, having added to government bonds earlier in the year. We made further adjustments in Core portfolios in July following a manager departure in one of the strategic bond funds we favoured.
We have had two years of very narrow equity markets; energy in 2022 and mega-cap US tech in 2023 delivering an oversized amount of the total return from equity markets. The latter has, for the most part, continued into 2024. There are some highly cash generative companies in areas such as mega-cap US equities, but they also trade at a rich premium. Whilst equity markets remain more sensitive to an economic slowdown, valuations vary broadly across different countries. In developed markets, the US trades at a premium versus most, whereas the UK looks cheap. A trigger to precipitate a fall in the valuation of US equities, or a catalyst to trigger an appreciation in the value of UK assets, may not come to pass. Our argument, that valuation matters in the long run as one of the starting principles of investing, sounds thin when ‘everyone knows’ what goes up all the time. That’s until something changes anyway.
Over in emerging markets, China looks troubled but cheap, whilst India & Taiwan look expensive. We are a little wary on China, despite recent policy interventions and stock market bounce. It’s cheap and it’s cheap for a reason, as history points to countries that are undergoing an unwind in their housing sector, to be long-term recovery stories. Taiwanese stock market valuation looks expensive too. Digging beneath this, with MSCI Taiwan being made up of almost 80% in the information technology sector, and the top ten reading like a ‘who’s who?’ of semi-conductor companies, you can see the reason for the high valuation!
Valuation dispersion exists not only between countries, but within them and there is a growing gulf in the gap of large companies versus their smaller company counterparts. The addition of smaller companies in portfolios looks premature for now, but one that with a dose of patience, we remain happy to hold and expectant for stronger long-term returns. We maintain a watchful eye in the meantime.
Conclusion – I want a little sugar in my bowl.
Investing this year has felt a little, “two steps forward, one step back”. Progress has been made, but it has felt like running through soft sand at times – hard work, with the occasional sharp pebble to make you wince. This is quite a step forward from last year, when it felt like “one step forward, four steps back”. Small wins, but to finish with another Nina Simone song, “I want a little sugar in my bowl”, where she sings and reflects on the prospect for more energised investment returns in future years…we’re right with you Nina.
The investment world has a habit of taking pretty meaningless words and through the act of obfuscation, conferring on them a deep level of perceived insight and intuition. “Constructive” is a case in point. As such, we feel ‘constructive’ about the outlook. For our part, we define this as seeing a slowing economic backdrop heading our way, but with central banks broadly cutting interest rates and with plenty more cuts to come, this helps to remove one of the big headwinds of recent years. Alongside that the jobs market is relatively well-behaved (though not immune), and should that continue to be the case, if we do tip into a recession, a jobs-filled recession is a less to be feared beast.
In portfolios, we remain optimistic that the higher level of interest that is now available in fixed income will give a strong and stable income stream, which is an excellent starting point for future investment returns. We look to maintain current equity weightings as this is the asset class that is going to be the foundation stone and driving force of future portfolio performance.
2024 feels like a year when some torrid earlier years get consigned to the memory, rather than having to be lived through. If 2024 does turn out to be a year where markets consolidate themselves, then we will happily accept that if it lays the groundwork for a better five years ahead, than the five we have just gone through.
As ever, from all of us in the investment team, Emma, Will, Becky, Kim, Hayley and me, we thank you for continuing to place your trust with us in managing your portfolio.
