Investment Update – 31st October 2024

Market Overview

The third quarter of 2024 saw dramatic swings in markets but ultimately ended the period with positive performance across most asset classes, with both global equities and fixed income markets delivering strong returns.  This positivity was underpinned by a combination of factors, including moderating inflation, a shift in central bank policies, and resilient corporate earnings.

Equity Markets

After significant volatility, global equity markets continued their upward trajectory in the third quarter, with the MSCI World Index posting a gain of 6.5%, reflecting the ongoing optimism in financial markets despite economic headwinds.

In the UK, the FTSE 100 index returned a more modest 0.9%, whereas in the US, performance was much stronger with the S&P 500 index up 5.9%.  While the technology sector had been the primary driver of market gains earlier in the year, the third quarter saw a broadening of market participation.  Small companies and ‘value’ stocks, which had lagged in the first half of the year, staged a comeback.

A change in the dominant sectors (sector rotation) was a key theme in the quarter, with traditionally defensive sectors such as utilities and real estate performing well.  This shift was partly driven by falling yields in the bond market (due to falling interest rates), which made dividend paying stocks look more attractive.  Conversely, the technology sector, which had dominated earlier in the year, returned a more modest 1.6% in the third quarter.

European equities showed resilience despite ongoing economic challenges in the region, with the STOXX Europe 600 index gaining 2.2%, buoyed by strong corporate earnings and a more supportive stance from the European Central Bank (ECB).

Emerging markets rebounded strongly, particularly Chinese stocks, following new stimulus measures announced from Beijing.  However, despite the MSCI Emerging Markets index rising 7.7% in the quarter, emerging markets still lag developed markets so far this year.

Bond Markets

The bond market rally that began in the second quarter gained momentum in the third quarter, driven by a softening of central bank policies and lower inflation expectations. The Bloomberg Global Aggregate Bond Index returned 3.8%, marking a significant turnaround from the challenging environment for fixed income in 2023.

In the US, government bonds (Treasuries) performed well, driving yields down, with the benchmark 10 year yield dropping below 4% for the first time since early 2023.  Corporate bonds outperformed government bonds, with the Bloomberg US Corporate Bond Index returning 4.2%.

Economic Landscape

The global economy has shown remarkable resilience in the face of numerous challenges, including elevated interest rates, geopolitical tensions, and lingering supply chain disruptions.  Although growth has moderated from the robust pace seen in the immediate post pandemic recovery, most major economies continue to expand.

United States

The US economy maintained its growth trajectory in the quarter, albeit at a more moderate pace compared to the first half of the year.  Economic growth for the quarter was 2.8%, down from 3.0% in the second quarter, but still above the long term trend.

US Real GDP Growth

Source: Bloomberg 30 Sept 2024 (GFC = Global Financial Crisis (2007-2009))

The labour market remains tight, with the unemployment rate holding steady at 4.1% in September.  However, there are signs of gradual cooling, with job openings declining and wage growth slowing.  This easing of labour market pressures has been welcomed by the Federal Reserve (the Fed) as it seeks to bring inflation back to its 2% target.

Inflation, as measured by the Consumer Price Index (CPI), continued to ease in the quarter.  The index rose 2.4% year on year in September, down from 3.0% in June.  While still above the Fed’s target, the trend is encouraging and has allowed the central bank to adopt a softer stance (ie more likely to cut interest rates).

There is a similar expectation of lower interest rates projected in most development markets:

Expectations for interest rate moves by major banks in developed markets

Source: Reuters poll, Oct 31^st 2024, LSEG Workspace

In the US, consumer spending, a key driver economic growth, has remained resilient despite higher interest rates and the fading impact of pandemic era savings.  Retail sales rose 0.4% in September, suggesting that consumers are still willing to open their wallets despite economic uncertainties.

The housing market has shown signs of stabilisation after a period of weakness induced by higher mortgage rates.  While activity remains below pre pandemic levels, home prices have begun to rise again in many markets, and new home sales have picked up.

US house prices vs inflation (CPI)

Europe

The European economy continues to face headwinds, with the energy crisis of 2022-2023 leaving a lasting impact.  However, there are signs of stabilisation and even modest improvement in some areas.  The Eurozone economy grew by 0.4% in the third quarter, avoiding a technical recession but highlighting the fragility of the recovery.  Germany, the region’s largest economy, continues to struggle, with its manufacturing-heavy economy particularly impacted by weak global demand and high energy costs.  Inflation in the Eurozone has eased significantly, with the headline rate falling to 1.7% in September, the lowest level in over two years.  This has allowed the ECB to pause its rate hiking cycle and consider potential easing measures in the coming quarters.

The UK economy has shown surprising resilience, with GDP growing 0.2% in the third quarter.  However, high inflation and interest rates continue to weigh on consumer spending and business investment.

Asia

China’s economy showed signs of improvement in the third quarter following a series of stimulus measures announced by the government.  GDP growth for the quarter came in at 4.6% year on year, beating expectations but still below the government’s full year target of around 5%.  The property sector remains a key concern for China, although recent policy measures, including looser restrictions on home purchases and increased support for developers, have helped stabilise the market.

Japan’s economy continues to benefit from a weak yen and the post pandemic recovery in tourism.  However, persistent deflation remains a challenge, with the Bank of Japan maintaining its ultra loose monetary policy even as other central banks begin to ease.

Interest Rates and the Central Banks

The third quarter of 2024 marked a significant shift in global monetary policy, with several major central banks pivoting from tightening to easing, with interest rates starting to fall.

The Fed cut its benchmark interest rate by 0.50% in September, its first rate cut in four years.  This move was driven by moderating inflation and concerns about the impact of high rates on economic growth.  The Fed’s updated projections suggest the potential for further rate cuts in 2025, though the pace and extent of easing remain ‘data dependent’.

US Inflation and Interest rate (Federal funds target rate)

Source Reuters 30^th October 2024, LSEG Datastream

The European Central Bank (ECB) also joined the rate-cutting trend, lowering its key interest rate by 25 basis points, as shrinking business activity in Germany and France was offset by expansion in other Eurozone countries.

The Bank of England (BoE) followed suit, cutting its benchmark interest rate for the first time since 2020 by 25 basis points in August and then again after the quarter end in November.  The Bank emphasised that it would be cautious about cutting rates too quickly to ensure inflation remains low and stable in the long term.

UK interest rate

Source: Bank of England

Forecast

Considering the final quarter of 2024 and look ahead to 2025, several key themes and potential risks are worth monitoring:

• Economic Growth: While the global economy has shown resilience, there are concerns about the lagged impact of higher interest rates on economic activity.  As ever, we are tracking key indicators such as consumer spending, business investment, and labour market trends for signs of a significant slowdown.
• Inflation: The moderation in inflation has been a key driver of market optimism. However, it’s important to note that inflation remains above central bank targets in many economies.  Any resurgence in inflationary pressures could lead to a reassessment of monetary policy expectations and potentially impact market sentiment.
• Geopolitical Risks: Ongoing tensions in various parts of the world, including the Middle East and Eastern Europe, continue to pose risks to global stability and economic growth.  Escalation in these conflicts could lead to market volatility and potential disruptions to global trade and energy markets.
• Technological Disruption: The rapid advancement of Artificial Intelligence and other emerging technologies continues to reshape industries and create both opportunities and challenges for businesses and investors.
• Climate Change and ESG Considerations: The transition to a low carbon economy and the increasing focus on environmental, social, and governance (ESG) factors are likely to continue influencing investment decisions and corporate strategies.
• US Presidential Election: The result of the US presidential election could introduce additional market volatility.

Investment Strategy

Given this complex and evolving landscape, a balanced and diversified approach to portfolio construction remains crucial, and the following considerations are key:

• Maintain Diversification: A well diversified portfolio across asset classes, geographies, and sectors can help manage risk and take advantage of opportunities in different market environments.
• Quality Focus: With economic uncertainties persisting, it is more important than ever to favour high quality companies with strong balance sheets, consistent cash flows, and competitive market positions.
• Income Generation: With interest rates generally stabilising and falling, income generating assets such as dividend paying stocks and investment grade bonds are attractive.
• Opportunities: The rotation in sector strength witnessed in the quarter highlights the importance of remaining flexible and open to opportunities across different market segments.
• Risk Management: Regular portfolio rebalancing helps to manage downside risk in the event of market volatility.

Conclusion

The third quarter of 2024 has demonstrated the resilience of financial markets and the global economy in the face of numerous challenges.  While there are reasons for optimism, including moderating inflation and a shift towards more supportive monetary policy, it’s important to remain vigilant to potential risks and market shifts.  Most importantly, as ever, it is important to maintain a long term perspective.

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