Investment Update – 1st August 2024

Market Overview

The second quarter of 2024 saw global markets continue their positive momentum from earlier in the year, albeit with some moderation. Major equity indices made modest gains, with the MSCI World index up 2.8% for the quarter. This performance came against a backdrop of resilient economic growth, moderating inflation, and a cautious approach from central banks regarding interest rate cuts.

Economic Environment
Global economic activity showed resilience throughout the quarter, with growth forecasts being upgraded for several major economies. The US grew by 1.3% in the first quarter, demonstrating a slowdown from the exceptional pace seen in the latter half of 2023 but still maintaining solid growth. The Eurozone expanded by 0.3%, while the United Kingdom’s GDP growth for the first quarter was revised upward to a stronger-than-expected 0.7%.

Emerging economies continued to drive global growth, with China and India posting expansions of 1.6% and 2.1% respectively. However, Japan bucked the trend, with its economy contracting by 0.5%, highlighting ongoing challenges in its economic recovery.

Inflation continued its downward trajectory in most regions, approaching central bank targets. The UK reached its 2% inflation target, aided by falling energy and food prices.

 

UK inflation fell to 2% in the second quarter

Source: ONS

 

In the US, inflation persisted above 3%, while the Eurozone saw inflation fall sufficiently to allow the European Central Bank (ECB) to implement an interest rate cut. However, wage growth and services inflation remained elevated in many countries, giving central banks pause before embarking on more aggressive monetary easing.

Labour markets remained tight, though there were some signs of easing. Employment levels remained high in most developed economies, with worker shortages reported in various sectors. This continued to put upward pressure on wages, presenting a challenge for central banks in their fight against inflation.

 

UK wage growth slowing but still above inflation

Annual wage and price growth, 3 months to May 2024

Source: ONS. (Prices averaged over 3 months to match wage growth indicator)

 

Interest rates
Central banks maintained their cautious stance on interest rates, with the ECB becoming the first major central bank to cut rates. The ECB lowered its benchmark rate by 0.25%, citing progress in bringing down inflation. However, the bank stressed that the path to further policy normalization would be heavily data-dependent.

The Federal Reserve and Bank of England held rates steady, pushing back market expectations for rate cuts. By quarter-end, markets were pricing in only 1-2 rate cuts from the Fed for 2024, down from 6-7 cuts expected at the start of the year. This adjustment in expectations led to some volatility in bond markets.

 

UK interest rates on hold

Source: ONS, BoE

 

Equity Markets
Global equities made gains, but performance was uneven across sectors and regions. Technology stocks, particularly those related to artificial intelligence (AI), continued to outperform. The announcement of massive AI-related capital expenditure plans by major tech companies like Microsoft, Amazon, Google, and Meta fuelled excitement in this space. Collectively, these companies announced plans to spend up to $200 billion annually over the next four years on capital projects, much of which is expected to support AI infrastructure.

US large-cap stocks, especially in the technology sector, led the way. The S&P 500 rose 3.6% for the quarter, with the largest tech companies continuing to dominate market performance. This concentration of performance in a handful of large tech stocks continues to raise concerns.

European markets lagged, with political uncertainty in France weighing on sentiment. The surprise announcement of snap elections in France caused significant volatility, with the French equity market falling 6.4% in June. This hampered broader European returns, which were just 0.6% over the quarter.

The UK market performed relatively well, with the FTSE All-Share gaining 3.7%. The improving economic situation in the UK, including falling inflation and stronger-than-expected GDP growth, supported market sentiment.

Emerging markets outpaced developed markets, rising 5.1% for the quarter. This was largely driven by strong performance in Asian markets, particularly China and Taiwan. Moves by Chinese authorities to support the real estate sector provided a boost to Chinese equity markets, while Taiwan benefited from its exposure to the AI theme through its semiconductor industry.

 

Bonds
Bond markets faced headwinds as expectations for interest rate cuts were scaled back. Global investment grade bonds fell -1.1% for the quarter. Government bond yields in the US and UK ended the quarter largely unchanged, while European sovereign yields rose slightly. The yield on 10-year US Treasuries and UK Gilts remained around 4-4.5%. These yields look attractive, especially if central banks begin to cut rates modestly later in the year.

 

Gold
Gold reached new highs during the quarter, surpassing $2,400 per ounce. This rally was supported by continued buying from central banks, particularly China, which has been diversifying its reserves away from US Treasuries. The potential for increased geopolitical tensions, the prospect of interest rate cuts in the US, and questions about the US dollar’s reserve currency status contributed to gold’s appeal as a safe-haven asset.

 

Gold price ($ per troy ounce)

Source: LSEG, FT

 

Outlook
As we enter the second half of 2024, the economic outlook remains cautiously optimistic.

However, several key risks warrant attention:

Inflation persistence: While headline inflation has moderated, core inflation and wage growth remain sticky. Any re-acceleration could force central banks to maintain tight monetary policy for longer, potentially impacting economic growth and market sentiment.

Economic slowdown: There are some signs of cooling in the US economy, particularly in consumer spending. Credit card and auto loan defaults are picking up, approaching 2010 levels. A sharper-than-expected slowdown could impact corporate earnings and market sentiment.

Political uncertainty: The upcoming US presidential election adds an element of unpredictability to the markets. The potential return of Donald Trump to the White House could have significant implications for trade policy, fiscal spending, and the independence of the Federal Reserve.

Geopolitical tensions: Ongoing conflicts, including in Ukraine and Gaza, continue to pose risks to global economic stability. Additionally, trade tensions between major economies, particularly involving the US, China, and Europe, could lead to increased protectionism and inflationary pressures.

Debt levels and fiscal sustainability: The high levels of government debt in many developed economies, combined with potential changes in fiscal policy, could lead to concerns about long-term fiscal sustainability and impact bond markets.

AI bubble concerns: The concentrated rally in AI-related stocks has raised questions about valuations and the potential for a sector-specific bubble. While the long-term potential of AI is significant, short-term expectations may have become overly optimistic.

 

The UK election
Labour’s victory was as much the Conservatives’ defeat. The Conservative vote collapsed by 20 percentage points, the largest decline by any governing party in British political history. Voters abandoned the party in all directions, not just for Labour, but for the Liberal Democrats, Reform UK and the Green Party. Plenty also stayed at home: fewer than 60% of eligible voters turned out to vote, the second lowest turnout in the past century.

 

UK general elections – turnout and winning party vote share %

Sources: House of Commons Library; Press Association; The Economist

 

The change in government is expected to have a relatively muted impact on financial markets overall, albeit with some potential sector specific effects. Stock markets generally prefer stability and policy certainty, and this is the general expectation. Sectors such as infrastructure and defence may find support given Labour’s pledges for green initiatives and increased defence spending, whereas the energy sector may face some volatility as investors await clarity on potential windfall tax changes. Sterling is expected to remain relatively stable against major currencies, with any future depreciation more likely due to broader economic factors rather than the change in government. Bond markets and government gilts are likely to see minimal disruption, as historical data suggests gilt yields tend to remain flat during government transitions. While Labour has ambitious spending plans, their ability to implement significant fiscal changes will be constrained by the current high levels of public debt, further limiting any impact on financial markets.

 

Investment Strategy
In this environment, a diversified investment approach remains prudent. While equities still offer upside potential, predominantly outside the expensive US tech sector, investors should be cautious about concentration risk and consider broadening exposure to other sectors and regions that may benefit from improving global growth.

Bonds continue to offer attractive yields, fulfilling their traditional role of providing reliable income and portfolio diversification. However, investors should remain mindful of the uncertain timing and extent of central bank interest rate cuts.

Alternative assets such as gold may play a useful role in portfolios as a hedge against geopolitical and inflationary risks. The continued buying of gold by central banks underscores its potential as a diversification tool and store of value.

Thematic opportunities remain attractive, particularly in areas driven by long-term structural trends such as ageing populations (healthcare), technological advancement (AI, semiconductors), and climate change mitigation (clean energy, infrastructure). However, investors should be wary of valuation levels and avoid overpaying for growth potential.

As always, we remain focused on the long term while expecting inevitable volatility depending on news flow. More generally, the interplay between economic growth, inflation, and interest rates will continue to drive market dynamics.

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