Has morning broken or is it Groundhog Day?
And there we have it. In the blink of a metaphorical eye, another year has passed. I started the Investment Strategy at the beginning of last year with the headline “Hope springs eternal” and went on to say that I hoped the year ahead would be a more settled year for investors and that having been through a difficult past 12 months, at least the new year offered the chance for some new optimism.
Well, it’s Groundhog Day… again…
This year’s Strategy appears to start with a similarly forlorn phrase, prompting me to wonder: has anything changed at all? But each year has its own highlights: the Lionesses reaching the World Cup Final, witnessing the pomp and ceremony of a coronation, a second series of Vigil.
Two out of three ain’t bad, but a strong Santa rally in markets added a sweetener to last year’s sour market conditions.
The great hope for this year is that the last few weeks of 2023 have shown us the direction of travel for 2024. Financial markets ended last year strongly, with all asset classes reacting positively to a change in central bank tone, which has shifted away from a relentless focus in pushing interest rates ever higher.
The concern is, it’s the hope that kills you. Too many years of late have ultimately resulted in disappointment. The era of elevated inflation looks like it is in its last hurrah, and central banks are rowing back from their most hawkish of tones.
Each new year offers the chance for a clean slate; we can look forward to new adventures ahead and the opportunity to leave difficult things behind. We wish a very happy new year to you all!
Dis-in-flation-ista-baby
Inflation is slowing and slowing faster than anticipated. Inflation data in the US and in Europe continues to fall and the pace of its fall during 2023 is worthy of note.
In the US, January 2023 saw disinflationary pressure already well underway, but still elevated at 6.4%. By year’s end, inflation in the States had fallen to 3.1%. In Germany and France, recent inflation data has fallen faster than anticipated, helping overall Eurozone inflation to fall from a hefty 8.6% last January, to 2.4% in November.
It’s still falling fast, which could become problematic if the ECB continues to talk about a “difficult last mile”, when data suggests the “last mile” of inflation is being cantered through at pace.
In the UK, the Office for National Statistics offered a pre-Christmas gift by announcing UK inflation had fallen sharply to 3.9%, down from an eye-watering 10.1% in January.
Looking forward to the beginning of this year, the quarterly setting of gas and electricity prices will continue to throw a fly in the ointment as the pre-announced price increase kicked in on 1 January.
On the other hand, UK inflation data does not recognise the reality that the price you see in the supermarket isn’t necessarily the price you pay. Major supermarkets offer price reductions for those with loyalty cards as a way of buying, well, loyalty. With both Tesco’s Clubcard and Sainsbury’s Nectar schemes boasting around 20 million members each, shoppers have cottoned on to how to access lower prices, even if statisticians have not.
On inflation and in Arnie speak at least, 2024 is more likely to be more “Hasta la vista, baby”, rather than “I’ll be back”. What on earth are we going to talk about?
History books will show that central banks were dealt a tough hand dealing with the ramifications of the global economy shutting down in 2020 as the pandemic spread and its chaotic spluttering and spurting back into life.
The hand was undoubtedly made worse with Russia’s invasion of the sovereign Ukraine and the resulting surge in energy prices. History books will hopefully offer reflections on how future policy can be improved and prevent more situations of central banks being too slow on the way up, and too slow on the way down.
There are risks ahead, of course, but if central banks have now resolutely abandoned their hawkish tones, we may, just may, have avoided an even worse downturn that we were facing as central banks headed deep into policy error time.
The challenge to central banks will be to react to the changing inflation outlook in a timely manner. Inflation is falling faster than expected and, all the time interest rates are maintained at their current rate, the more restrictive policy becomes as real interest rates effectively tighten in the economy. Interest rates tend to go up in steps – 2024 could see them come down in an elevator.
What is the longer-term outlook for inflation now these inflationary forces have settled down? For our part, we remain of the view first espoused in this esteemed publication (ahem), back in 2022:
“Where the years after the global financial crisis were characterised by central banks being unable to hit their inflation mandates and employing policies to get inflation to lift off, the coming years are likely to see central banks more focused on trying to keep a lid on inflation, rather than trying to generate it.
“This will create a mindset shift in central banks. The primary tool at central bankers’ disposal has for years been rate cuts; going forward it is likely to be rate rises but all within the framework of interest rates staying low versus their historic norm…”
Float like a butterfly, sting like a bee?
What if Table Mountain doesn’t exist? One suspects this is a not-often asked question in the revered meeting rooms of central banks around the world but a question that probably should be asked in present circumstances.
Central bankers spent much of last year at pains to say interest rates would remain high and to talk up, as much as they could, the prospect for a prolonged stretch of interest rates remaining at their current levels while not dismissing the chance for further rate rises. They are “following the data”.
Thankfully, the rhetoric noticeably changed in December, as central banks all but confirmed that the rising interest rate cycle was over. Markets had already spent most of November pricing that in anyway, but who was leading who is a moot point.
Either way, the ending of the rate rising cycle and the anticipation of rate cuts to follow should prove a helpful backdrop for asset classes. The question mark for 2024 is how far and how fast interest rate cuts will come into play.
There is a caveat to all this enthusiasm about central banks and falling rates.
Higher interest rates achieve their objectives by taking the disposable income from consumers so that they have less in their pockets to be able to carry on spending. Reduced demand in an economy makes it a hard environment in which to push up prices, thereby curtailing price-led inflation.
Pushing up interest rates on credit cards, loans and mortgages is a blunt and pretty unsubtle tool, and its effectiveness has been lessened by the number of people who remain on fixed-interest mortgages secured in better times.
It also takes time for the impact of rising interest rates to feed through to the real economy and this is typically considered to be a period of around 18 months before the impact can be felt. This means much of the impact of the rate rises we have already had are yet to be felt in the wallets of consumers.
However, with the numbers of mortgage holders facing the prospect of rolling off their fixed rates onto a higher rate in the near future, the transmission “pain” of interest rate rises is going to become more real.
On the upside, if we broaden out our outlook on interest rates and focus on the longer term, we’ve recently navigated a regime shift in central bank policy and survived to tell the tale. The dramatic fall in interest rates at the onset of the financial crisis, which led to an era of very low and then ultra-low rates, has finally and firmly been slammed shut.
Source: Bank of England
Hi-Lo Silver Lining
There is another side to the interest rate story and that is the positive impact for those with cash savings.
The future drip, drip, drip effect of low interest rate mortgages being refinanced on to higher rates is being usurped by a more immediate and current benefit, which is the amount of interest that is being paid on cash!
While banks have been criticised for being slow to pass on the benefits of higher rates, consumers have been relatively savvy at taking cash off lower interest-bearing accounts and placing these savings on higher interest, fixed-term deposits.
According to the Bank of England, cash savers can take their immediate access cash paying just under 2% and move to fixed term deposits paying 5.27% and savers have been taking advantage of this. With interest rates peaking, it’s time to look at those best buy tables…
Source: Bank of England. (Interest paid on deposit accounts)
Outstanding Sight = existing cash, no notice/Outstanding Time = existing cash, notice required/New Time – new cash, notice required.
Source: Bank of England. (Breakdown of Household Deposits October 2023)
Buyback Britain
They have given up awarding the wooden spoon for “most unloved asset class” at the Asset Class of the Year Awards, because if ever there was an award for such a thing, UK equities would win the prize year in year out.
20 years ago or so, the large pools of capital that sat in UK company pension schemes would typically have held around 20-25% of their assets in UK equities.
Fast forward to today and that is down to around 5%. It isn’t just large pension schemes who have moved either; fund flows into the IA UK All Companies sector have been in negative territory every year since 2010 (with the exception of 2012 – an “it was the Olympics, life was good” blip?).
There are a number of reasons. Some have chosen to allocate to equity markets in line with the country weighting of global equity indices, where the latest data shows the UK stock market accounted for just 3.5% of the MSCI All Countries World Index! Others have just given up and moved elsewhere.
Either way, investors have largely given up on the UK. It turns out British companies on the other hand, have not. Listed UK companies are buying back shares faster than they have ever done before.
The UK looks in good value territory with the FTSE All Share trading as it is on approximately 10x forward earnings, alongside a yield if you combine dividends, share buybacks and special dividends of around 6%. At a sector level, as the charts from JPM Asset Management show, UK equities are trading at very significant discounts in virtually every sector compared to their US cousins.
The UK doesn’t need to be back with a bang, it just needs to become less hated. And, whisper it quietly, but the numbers of those who are at least talking about European and UK equities as attractively valued is on the rise. A reverse in the fortunes for UK assets would be a helpful tailwind for portfolios.
Source: J.P.Morgan Asset Management. Guide to the Markets
Growth and inflation numbers
Thanks, as ever, to our friends at Schroders for the latest consensus forecasts, which as at November 2023 are:
Source: Schroders Talking Point, November 2023
There isn’t too much in these estimates to blow away the January blues, as the outlook for many economies is looking like weak, anaemic growth emerging as the primary concern against a backdrop of fast falling inflation, which will continue to recede through this year.
While at a headline level US growth does not shout out as strong, it is at least a relative winner against a barely moving forward UK & Eurozone.
The US may well avoid recession, the UK and Europe will face more of a challenge. The headline writers may well go to town about recession if/when it arrives, but the practical difference in the daily lives of all of us between slightly negative or slightly positive GDP growth is not worth the ink spilt.
That China is not roaring either means overall global growth is forecast to be weak. China’s contribution to the global growth numbers are still important, but have been far less impactful since the onset of the “Covid years”, than those that came before it.
As China adjusts to a structurally lower growth economy, this ongoing transition from the world’s global manufacturer to a domestically focused service economy presents risks and challenges both internally and to external investors. A bigger fiscal response is going to be needed to deal with the imbalances in its economy and to meet growth targets.
Portfolio Outlook – Buying straw hats in winter
While the outlook for economies looks and remains challenging, Main Street and Wall Street don’t walk in lock-step as financial markets are discounting mechanisms after all.
We are positioning portfolios for an environment that recognises that some value has been created through all this tumult. Cash isn’t the only asset class that looks good value today.
Fixed income markets rallied strongly at the end of the year in anticipation of interest rate cuts during 2024. Fixed income is looking attractively positioned – a decent starting yield and with the potential for capital gains if/when rate cuts arrive. We are looking for 2024 to deliver solid returns from the asset class. We continue to use a selection of investment grade corporate and strategic bond funds and in most portfolios added to government bonds early last quarter.
Equity markets are more sensitive to an economic slowdown, which remains at the forefront of our minds. 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. Areas such as mega-cap US equities now look on a very rich premium.
The UK and Japan are looking cheap versus history but require a catalyst to unlock that value: so, too, smaller companies, which we feel offer an opportunity for higher risk/reward investors.
We wrote about the changes being made to Core, Passive and Offshore portfolios in the last valuation commentary and these were completed in the period overlapping quarter end.
During this quarter, we completed a review on the Positive Impact Portfolios. We continued the theme implemented in the other portfolios, namely increasing both the overall fixed income component, and tilting it to benefit from rising prices associated with falling yields.
We did this by reducing or removing (depending on risk profile), BNY Mellon Sustainable Real Return, a conservative multi-asset fund, where we felt directly allocating to fixed income would deliver stronger returns.
Conclusion – Hope springs eternal (v2)
Rising markets in the last few weeks of 2023, may well end up having taken some of the wind from the sails for the start of this year, but the difficult market conditions over the last few years have laid the groundwork for better years ahead.
Cash is at last paying a high interest for the first time in over a decade, which is apparent from the windows of every (remaining) bank on the high street. Value is not exclusive to cash though, as it has emerged in fixed income and across selected equity markets too.
It is foolhardy to be unaware of the risks, but short-sighted not to be aware of the opportunities. There will be periods of consolidation alongside setbacks before there are some more concrete signs of a genuine economic recovery, which may not appear until later this year.
The strong returns at the end of last year may well inhibit a strong start this year, but also highlight the capacity for markets (and prices) to move quickly in short order. Staying invested in a risk appropriate portfolio is the standard, but important, rallying cry.
The inelegant phrase “muddle through” continues to apply to both the global economy and financial markets, which is uncomfortable intellectually and emotionally for investors. The foundations of future performance are being laid for long-term investors and having the patience to allow this value to emerge, while picking up interest and dividends in the interim, remains the strategy of the day.
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.
Featured image: “[174/365] Terminator in Disguise” by pasukaru76 is marked with CC0 1.0.
