With some trepidation I started the Investment Strategy at the beginning of last year, raising the hope that 2024 would deliver a more settled year and that, having been through a difficult last 12 months or so, the new year at least offered the chance for some new optimism. Sadly, the problems at Manchester United can’t be papered over by an FA Cup win and the malaise continues, but if I happened to have been writing about investment markets at the time, this guesstimate would look pretty good. Investors may not have been high fiving their way to Christmas parties this year, but sometimes making small steps forward is a necessity.
At least last year was more straightforward in comparison to recent years, providing a largely settled path through the year, which has an undeniable ‘sleep-at-night’ value all on its own. The exception was a summer banana skin in Japan, but even then we were all being distracted by the lack of any British Summer and the wonderful Olympics in Paris, rather than the Bank of Japan’s interest rate policy. Santa going AWOL in the lead up to Christmas by failing to deliver a year-end rally, shouldn’t leave us feeling too Grinch-like as we look forward to the year ahead, despite a December that left investors cold.
Interest Rates: Slow it down.
With the exception of the Bank of Japan, 2024 saw the beginning of interest rate cuts from major central banks, as the focus turned from tackling the inflation wave that hit during the post-pandemic period and the energy price spike that followed Russia’s invasion of Ukraine in 2022, to greater concerns about preserving the jobs market. Whilst the ECB and the Bank of England began cutting rates ahead of the Federal Reserve, September’s jumbo 0.5% cut in the United States meant that by year end both the ECB and the Fed had reduced interest rates by 1% during 2024, whilst the Bank of England cut by a more cautious 0.5%.
If there were such a thing as an ‘interest rate story’ for the year, then it is one which started with far too much enthusiasm and anticipation of a high number of cuts, to one of far greater apathy. Whilst we remain in an interest rate cutting cycle, the journey may be shorter than previously anticipated. This is particularly the case in the United States, where President-elect Trump’s policies (if implemented), could serve to keep inflation at a higher level and therefore make the US Federal Reserve more cautious in its approach.
Looking forward, the ‘story’ for interest rates in 2025 is one which sees a potential divergence in central bank policy across the globe. If the US extends tax cuts and implements tariffs and immigration controls, the Federal Reserve is likely to signal a slower, shallower path of easing in the coming year. In the UK, the Bank of England faces balancing Labour’s Budget that increased spending against rising taxes, which come with a damaging side-effect of lower consumer confidence and less willingness by companies to invest in growth, given the rise in both the National Living Wage plus those National Insurance increases. Meanwhile the European Central Bank, at least on paper, has an easier hand to play. Growth is low, confidence even lower and politics (in France & Germany) look a source of instability. The ‘landing zone’ for the ECB is surely quite a bit lower than here.
Bucking the trend lower, the Bank of Japan will ever so slowly continue raising interest rates. The Bank of Japan tripped over its own shoelaces last summer and fumbled its way to increasing their policy rate to 0.25%. Expect them to have dusted themselves off and go higher in 2025.
Inflation: Pretty Slowly.
Like chewing gum on your shoe, this inflation thing just won’t go away.
Inflation is, however, a far less troublesome foe than in recent years, settling into a slightly elevated holding pattern in 2024, which is likely to persist in the UK through this year. The aforementioned rise in employer NI costs and increase in National Living Wage, will keep wage costs elevated in the services sector, which remains by far the most significant part of the UK inflation picture.
Over in the US, whilst the theory behind some of President-elect Trump’s election policies would put upward pressure on inflation, there should be a healthy ‘let’s-wait-and-see’ discount between the theory and the reality, although implied within this sentence is the potential for surprise on both the upside and down!
China has been posting its rolling annual inflation data and each and every month since March 2023, the number has either been less than 1% or veering into outright deflation. Historically, building more and more property was the go-to remedy for Chinese governments to stimulate growth, but this lever has broken under the weight of excess supply, falling prices and poor demographics. A new remedy is needed but looks a long way short of being delivered.
2024 – The runners and riders
As with any year, 2024 delivered some highs and lows. From being belatedly and surprisingly hooked by The Traitors to alarmed at a revival in ‘Murder on the Dancefloor’ in equal measure, each year brings its own ups and downs. Since 2020, investors have certainly been buffeted by more big macro events than they care to imagine, so for 2024 to deliver a relatively smoother path was welcome. As shown in the chart below, headline valuations haven’t moved too far, except for the S&P 500 which has got more expensive as investors have been generally prepared to pay an ever-higher amount for the earnings of US companies, particularly those largest US tech companies. So, another strong year for US equities, with 2023 and 2024 becoming the first time the S&P 500 has delivered +20% returns in back-to-back years this millennium.
Of course, ideally a significant proportion of returns that drive equity markets higher will come from earnings and dividends and less down to multiple expansion, which is inevitably more sentiment and momentum driven than the others. The good news is that corporate earnings improved through 2024 in comparison to 2023 in most countries. Factset, a US financial data company, is estimating calendar year earnings for the S&P 500 to have been 9.5% in 2024, but this is significantly split between the large US tech giants, such as Nvidia, Amazon, Alphabet and Meta, who alongside the other ‘Magnificent 7’ companies are forecast to deliver earnings growth of 33% in 2024. Meanwhile, the other 493 companies in the index are expected to have earnings growth of just 4% for 2024. For what it’s worth, Factset are reporting analysts expect earnings growth of 15% in 2025, but even this needs some caveats given the propensity for analyst optimism, but the forecast broadening out of earnings growth away from those mega-caps would be welcome.
At a sector level, it is no surprise to see the technology sector leading the charge. In US dollar terms, the MSCI Information & Technology and Communication Services sector, which returned over 50% to investors in 2023, delivered a not-too-shabby 33% in 2024 too.
This has contributed to pushing overall US equity market valuations higher across various metrics and starting valuations play a crucial role in determining long-term future returns. Whilst the era of US equity market dominance since the global financial crisis (GFC) between 2007-2009 has been one to behold, high starting valuations and investor expectations today, need to come with the realistic expectation of more contained returns going forward. Part of the very reason why returns since the financial crisis have been so strong is because valuations were so attractive at their lows in the GFC. The first decade of this millennium were a period of relative weakness for US equities as they unwound the excessive valuation that had built up from the dot-com era and then we fell into the global financial crisis. The ‘noughties’ were a lost decade for US equity investors – ‘old’ news for investors more struck with the allure of newer emerging markets and the rise of the BRIC’s (Brazil, Russia, India & China). By the end of 2010 the S&P 500 had delivered negative absolute returns, but in the meantime had become cheap (and an outright bargain during the depths of the financial crisis), with valuations flagging a better return lay ahead.
Growth and Inflation Numbers: Slim Pickings
Thanks, as ever, to our friends at Schroders for the latest consensus forecasts, which as of 25th November 2024 were:
| GDP (%) 2024 | GDP (%) 2025 | CPI (%) 2024 | CPI (%) 2025 | |
|---|---|---|---|---|
| Global Economy | 2.7 | 2.5 | 3.1 | 3.1 |
| China | 4.8 | 4.5 | 0.5 | 0.4 |
| Emerging Markets | 4.3 | 3.9 | 3.6 | 3.7 |
| US | 2.7 | 1.9 | 3.0 | 2.9 |
| EU | 0.8 | 1.1 | 2.4 | 2.4 |
| UK | 1.0 | 1.3 | 2.6 | 2.6 |
Source: Schroders Economic & Strategy Viewpoint, Q4 2024 (Data to 25.11.2024)
Globally the outlook looks like one of slow growth, but hiding in this is stronger growth in the US; (improving from a very low base) growth in the UK and Europe; with China struggling relative to its pre-pandemic trend as it continues to struggle resurrecting consumer demand and grasping hold of significant structural issues in its economy.
Before we all don a hairshirt and throw that last mince pie in the fast and abstinence bucket, even with an economic backdrop that looks frugal at a headline level, we shouldn’t let ourselves get too downbeat. Yes, the British can no longer boast about being world-beaters in many areas, but for doom-mongering, we still rock. In Blighty, one permanent truth holds sway. Things were always better in the past and headlines dominated by the cost-of-living crisis and a broken system reinforce this. So, how about this? UK household savings ratios are well above the levels they were in vast swathes of the 1960’s, ‘70’s, ‘80’s, ‘90’s and most of this millennium. Whilst consumer confidence is not strong, it has strongly recovered from its 2022 lows, since when household debt has also been strongly falling too. True, the benefits of these savings are not equally shared and there are areas of obvious weakness, for instance, the Department of Work and Pensions estimate 2.8m people are economically inactive due to long-term health, which is a huge contrast to the US and the Eurozone. But, and it is a “but”, imagine how things could change if confidence returned, some savings were spent and some waiting lists were unblocked. What did Dolly sing? Tumble out of bed and stumble to the kitchen. Pour myself a cup of ambition…
Source: UK Economic Accounts from the Office of National Statistics
Portfolio Outlook – Moving forward
Fixed income yields rose into the end of 2024, after a topsy-turvy kind of year which saw the US ten-year rise and fall and then rise back to near-year-high’s by year end. The glass half full amongst you, will see another chance to snap up attractive yields with a helpful backdrop of central banks cutting rates. The glass half empty, however, will caution about fiscal overspends, particularly in the US, and fewer rate cuts than expected being a headwind for capital returns.
Elevated government deficits in various economies present genuine concerns around the sustainability of long-term debt servicing costs. Corporate credit spreads (the extra yield you can receive for holding corporate bonds over government bonds) look firmly valued too, but overall corporate health looks acceptable. For fixed income, we remain more in the glass half full camp for now and anticipate solid returns this year. Whilst we share the concerns of those who sit in the ‘glass half empty’ camp and worry about fiscal discipline over their cornflakes in the morning, 2025 is likely (no promises) to see a trimming back of some interest rate risk in client portfolios.
There are some highly cash generative companies in areas such as mega-cap US equities, trading at a rich valuation, but with strong forecast earnings growth. Equity market valuation differences abound. In developed markets, the US trades at a premium versus most, whereas the UK looks cheap, whilst in emerging markets, China looks troubled but cheap, whilst India & Taiwan look expensive. We added to US smaller companies in higher risk/reward portfolios – too early in hindsight – and this has been a headwind during 2024.
Still moving forward, but…
As investment managers, we see many areas which make us optimistic about where we are starting 2025, but are either humble enough or have learnt the hard way that pontificating too heavily about the future is littered with trap doors with nasty things behind them.
The economic backdrop looks solid and that’s rarely a bad starting point. Consumers look well positioned in the developed world too, with wages growing in real terms and household debt on a downward path. In the UK, household cash levels and savings rates remain elevated versus their pre-pandemic norm. But, we remain in a multi-year period of slow economic growth.
In markets, fixed income assets look well positioned to take back their rightful position in portfolios. Namely, an asset class that can deliver steady income and provide some defensive ballast to the inevitable buffeting equity markets go through each and every year. But, there’s a danger that central banks don’t cut interest rates as hoped and politicians spend their way to perdition.
Meanwhile, equity markets are divided. Certain segments feature highly successful, cash-generating businesses but have expensive valuations, while others offer clear value that remains unrealised but still a lack of a catalyst to unlock it. Over the long-term, it makes sense to hold a measure of both, hence our policy of having well diversified portfolios and not trying to time mean-reversion in markets.
There is always room for one more but…
But…what happens in the political world has become increasingly influential to markets too. Over the last decade or so, the rise of populism and self-indulgence in the political world has taken us to junctions, in which one way or the other resulted in widely divergent possible outcomes. These undermine our certainty, misplaced or not, about the direction on how the world is panning out. Markets are holding their breath that the political world doesn’t deliver more wild swings ahead, but that is probably not a given and therefore remains a source of risk.
As ever, from all of us in the investment team, Will, Emma, Becky, Kim, Hayley and me, we thank you for continuing to place your trust with us in managing your portfolio and we wish you all the very best for the year ahead.
