Whoa, we’re halfway there

Once upon a time, not so long ago
Tommy used to work on the docks, union’s been on strike
He’s down on his luck, it’s tough, so tough
Gina works the diner all day, working for her man
She brings home her pay, for love, mmm, for love
She says, “We’ve gotta hold on to what we’ve got
It doesn’t make a difference if we make it or not
We’ve got each other and that’s a lot for love
We’ll give it a shot.”

As the clock struck midnight this last New Year’s Eve, we found ourselves rattling through the first half of yet another decade with the speed and ferocity that Brendon McCullum and Ben Stokes would surely appreciate. As we reach half-time of this particular T20, the Twenty-Twenties, this is where we stand with cumulative and then annualised returns, all rebased to sterling for UK domiciled investors…

Source: FE Analytics

Bon Jovi’s ‘Livin’ on a Prayer’ reflected on the tough conditions of 1970’s America, lived through the lives of Tommy and Gina as they tried to make ends meet in the face of economic woe. Modern day Tommy and Gina’s have faced another tough start this decade. Only half-way through the 2020’s and we already live in the aftermath of a global pandemic, the highest inflation wave for 40 years and the sharpest interest rate rises too. Real wages have been under significant pressure, turning negative during the pandemic and then again during 2022 as energy prices spiked. There is war in Europe, a deeply unsettled middle east, combined with the backdrop of an increasingly fractured world order too – US reluctance to be the ‘global policeman’, but also the long-decline of global institutions, such as the United Nations, the G7. Throw on top, the usual cacophony of noise, a diva-load of drama, and plenty of reasons to be bearish. Oh, and yes, the union’s been on strike. Sorry, it’s January and that’s not very cheery is it. Must try harder.

For investors, when the smoke clears on the first half of the decade there are some pretty obvious takeaways:

• US equity returns have dominated equity performance numbers. For sterling investors, they have delivered at least double the average of everywhere else.
• Bonds have been down on their luck, posting negative returns, particularly government bond markets.
• Despite inflation rising sharply in 2022, index-linked gilts fared much worse than conventional Gilts. Whilst this appears counter-intuitive, ‘linkers’ have a much higher sensitivity to the movement in bond yields and rising yields equals falling prices.
• It’s been very tough out there to generate real, post-inflation, investment returns. We’re in recovery phase.
• Inflation has been uncomfortable at times and far in excess of what we’ve been used to this millennium.
• Cash investors have found a welcome surprise. Interest being paid (but only since 2022 onwards and now looking like it is on the decline).

Hidden in the numbers, and to an extent the reasons for them, are some changes that are potentially the most consequential since the Global Financial Crisis:

• Bond yields have gone up a lot (& prices fallen as a result)! Having collapsed during the financial crisis of 2007-2009 and then going even lower during the Covid pandemic, the inflation surge that following forced central banks to push interest rates higher, with a significantly negative impact of bond prices.
• Bye-bye negative yields. The curious sight of bonds delivering negative yields that saw investors willingly giving their money knowing they would get less back, peaked in the immediate post-Covid era with over $18 trillion worth of bonds offering up a negative yield. One for the history books to ponder.
• Governments have been very willing spenders. Crucially in time of crisis, but habitually even when not.
• The unions have been on strike as wages suffered their most sustained real-terms decline this millennium.
• Equity valuations in the US are at multi-decade highs against the UK, European and Chinese markets and this decade has only seen the relative premium of US equities versus UK, European and Chinese markets only get wider, and then wider still.
• The big sector ‘winners’ remain Technology funds, the top ten biggest companies taking an ever more dominant share of the US stock market, accounting for over c33% of the S&P 500 by end of December 2024.

These trends have been going on for so long that investors have become de-sensitised to them and maybe now see them as a permanent state of affairs. If I had a pound for every time I’ve heard people say, ‘value investing is dead’ and ‘only ever buy growth stocks’ then I’d be able to buy out the entire share capital of Amazon lock, stock and (next day delivery) barrel. Well, an annual Amazon Prime subscription, more likely.
But it does at times make sense to try and look at the bigger picture, so let’s look at the total returns (capital growth plus reinvested dividends) from the previous two decades for comparison:

Source: FE Analytics

If we’d written this piece back in 2010, you’d be reading that:

• It was a very poor decade for developed market equity returns.
• The big winners were Emerging Market and Asian funds.
• The big losers were the US, Japan with negative returns.
• Value (commodities) outperformed Growth (technology).
• Bonds produced above-average returns.
• Inflation was very muted.
• Returns from Cash not too bad…until 2008.

So, what changed? If I were to paint a picture of markets over the past 15 years, the image would feature a mantelpiece flanked by two robust bookends. The first bookend marks the Global Financial Crisis, while the second, added more recently, represents the interest rate hikes beginning in 2022 and concluding mid-2023. Either side of these bookends lies a “normalised” interest rate environment, while between them sits an era defined by ultra-low interest rates and abundant central bank liquidity.

A question to ponder is, is it possible that this unique period of ultra-low rates has likely allowed market dislocations to become embedded and less visible? We maintain that valuation remains a crucial element of investment decisions. Consequently, we have gradually moved away from areas displaying what we feel are elevated valuations, favouring assets with relatively attractive valuations and consistent income generation. We have also highlighted fixed income in recent investment quarterlies; an asset that it is once again a viable source of investor returns.

Portfolio adjustments reflect this view, with an increased allocation to fixed income assets, particularly government bonds, where we have diluted US Treasuries and increased UK Gilts. Additionally, we have expanded holdings in global infrastructure, drawn to the sector’s regulated nature and strong income focus. For more risk-tolerant portfolios, while valuations in large US companies remain challenging, smaller and mid-sized firms appear more reasonably valued and we have increased exposure to UK and US smaller companies too.