Investment Update – 28th February 2024

The UK Autumn Budget

Considering the final quarter of 2024, and the year as a whole, one theme stands out: the remarkable resilience of financial markets in the face of significant headwinds.  A widely anticipated market correction did not materialise, and instead, investors experienced a year of positive markets, particularly in US equities.

Global stock markets rose despite stubborn underlying inflation, growing tensions in China trade relations, and ongoing conflicts in Europe and the Middle East.  Markets embraced the result of the US election, a surprisingly strong Republican takeover of both Congress and the White House.  This potentially destabilising event was instead deemed an opportunity for deregulation and pro business policies.

Economic environment

The US economy has shown remarkable staying power, with GDP estimated to have expanded by 2.7% for the year. This robust growth, coupled with full employment and moderating inflation, indicates resilience.

However, the picture elsewhere was mixed. The UK economy, after a strong start to the year, faced mounting challenges, with growth stagnating in Q3 and showing only modest signs of recovery in the fourth quarter. The eurozone demonstrated greater resilience, while China grappled with property sector challenges and weak consumer spending.

Political Landscape: The Republican Sweep

The unexpected Republican victory in November’s US elections emerged as a significant market driver in the fourth quarter.  Early signals from the incoming administration were encouraging for markets, with Scott Bessent as Treasury Secretary being one of Trump’s relatively benign selections.  The early focus on a “3-3-3” agenda (targeting 3% GDP growth, a 3% budget deficit target (by 2028), and an additional 3 million barrels of oil per day) provided reassurance to investors.

Equity markets

The strong performance of the US market masks a story of market concentration. The “Magnificent Seven” technology companies – Alphabet (Google), Amazon, Apple, Meta (Facebook), Microsoft, and Nvidia – continued to dominate, accounting for more than 100% of the S&P 500’s gains in the fourth quarter, which means that the remaining 493 stocks collectively declined.  In contrast to previous tech-driven bull markets, such as the dot com bubble, this rally stands on firmer ground, with the leading companies generating operating margins of around 20% and demonstrating solid earnings and cash flows.  In the dot com bubble, the tech leaders were mostly different names (Intel, Cisco, IBM and Oracle), but Microsoft was one of them.  Microsoft was almost twice as expensive in the dot com boom as it is now. (on a forward price-earnings multiple).

Increasing concentration of the “Magnificent Seven” stocks in the S&P500

At the end of 2024, the Magnificent Seven accounted for more than a third of the S&P 500, and nearly a quarter of the MSCI World Index.

Looking ahead, although it is unlikely, it is possible that the Magnificent Seven will continue to dominate, leveraging their scale, profitability, and technological advantage.  Betting against this group thus far has not fared well.

Fixed Income: A Challenging Quarter

The bond market faced significant headwinds in the fourth quarter as investors adjusted their expectations for interest rates.  Despite the Federal Reserve implementing two 0.25% cuts in the quarter, their projections for 2025 remained more pessimistic about inflation than initially anticipated.  The yield on the benchmark 10 year Treasury bond ended the year at 4.57%, rising from 3.67% at the start of the quarter. In the UK, where the outlook is more challenging, 30 year gilts are yielding over 5%, reflecting market concern about fiscal sustainability.

Interest rates in major developed markets

Source: Bank of England Bank rate, Federal Reserve Fed Funds Target Rate,
Bank of Canada overnight policy rate, ECB deposit rate

Commodities

The commodities sector showed lacklustre performance overall.  Despite the ongoing conflicts in the Middle East and Russia, which might have caused supply disruptions and spikes in energy costs, crude oil prices experienced only modest increases.  Gold emerged as an exception, surging by 28% throughout 2024, with strong  buying from emerging market central banks as they sought to reduce their US dollar exposure. Strategic gold positions once again demonstrated their value in providing portfolio diversification.

Countries holding the most Gold (2024)

Source: Federal Reserve Bank of St Louis, International Monetary Fund, World Bank, World Gold Council

Currency Markets: The Mighty US dollar

Foreign exchange markets reflected America’s continued dominance in financial markets. The US dollar appreciated relative to most major currencies, supported by both impressive economic expansion (maintaining a 2.5% annual growth rate) and persistent investment inflows into American markets.

Across the Atlantic, the British pound proved surprisingly resilient, ranking as the second strongest major currency of 2024, even as the business community reacted negatively to government fiscal measures.

Looking Ahead: Opportunities and Challenges for 2025

As we progress into 2025, several key themes dominate:

US Economic Strength: The Federal Reserve’s aggressive interest rate hikes over the past two years have yet to deliver the slowdown many economists anticipated, with US consumers remaining resilient.  This is partly due to the structure of US mortgage debt, with over 90% of loans locked in at fixed rates.  In turn this suggests that rates may need to remain ‘higher for longer’ to achieve the Federal Reserve’s inflation targets.

Political Risk Management: While markets have responded positively to the initial signals from the incoming administration, potential tensions around trade policy, immigration, and regulatory reform remain.  The implementation of these policies will require careful monitoring, particularly regarding their impact on inflation and international cooperation.

Trump’s proposed tariffs on imports threaten to raise costs for US manufacturers and consumers alike.  Immigration restrictions, meanwhile, risk worsening labour shortages in critical industries.  Both policies are potentially inflationary.

However, even expectations of inflation are heavily politicised.  Where Republicans believe Trump’s policies will lower inflation, Democrats have no confidence whatsoever:

Political polarisation on inflation rate expectations

Source: University of Michigan, Bloomberg

Global Divergence: The gap between US and international market performance remains significant.  Europe faces a combination of political gridlock and subdued business confidence, although a possible ceasefire in Ukraine could boost optimism.

The Chinese economy faces challenges across multiple fronts: vast stretches of vacant or incomplete housing developments, local authorities buckling under massive debt loads, and surging industrial output fuelling an export boom that’s heightening global trade tensions.

UK’s Struggle for Growth: Britain’s economy showed momentum in early 2024, with expansion in the first six months.  However, this initial vigour faded as growth flatlined in the third quarter, followed by predictions of only tepid improvement for the year end. The nation appears to have come full circle: a struggling economy, underperforming equities, and a government facing plummeting popularity.  Investor confidence remains low and this is reflected in the stock market:

 UK stocks are valued at an historic low compared to US stocks.

Source: Barclays Research

Market Concentration:  The exceptional level of market concentration in technology stocks presents both opportunities and risks.  While these companies continue to deliver strong earnings growth, their dominance in market indices makes diversification more important than ever.

Investment Implications

For global investors the following investment themes prevail:

Equities: Despite the strong equity market performance, it makes sense to maintain a strategic overweight to global equities, with benchmark exposure to US markets and technology sector leaders. However, this position should be complemented with selected opportunities in quality companies in markets and sectors that have lagged the recent rally.  Determining the future winners of AI and digitalisation will remain a challenge, but opportunities across industries and markets will present themselves over time.

Fixed Income: The interest rate environment suggests a cautious approach to bond investment. High quality bonds continue to offer attractive yields and important diversification, counterbalancing equity market risk.

Alternative Investments: It remains sensible to maintain a strategic allocation to gold and other alternative investments that can provide portfolio diversification benefits and inflation protection

Regular Rebalancing: Given the significant divergence in performance across different market segments, regular portfolio rebalancing becomes even more important to manage risk exposure.

Conclusion

As we progress in 2025, the investment landscape presents a delicate balance of opportunities and risks. While “American exceptionalism” is the dominant theme, propelled by technological innovation and resilient consumer demand, political risks and market concentration demand careful attention.

Europe faces a combination of political gridlock and subdued business confidence, and the UK’s economic headwinds prevail.

China’s economy remains precariously balanced, as policymakers attempt to navigate a path through mounting debt, a troubled property sector, and industrial overcapacity.

The key to navigating this environment will be maintaining a disciplined, long-term approach while remaining alert to evolving risks and opportunities. For UK investors, this means building globally diversified portfolios that can benefit from US market leadership while maintaining exposure to other markets and asset classes that offer attractive long term value.

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