Commentary for July and August 2024

Market Overview

Global equity markets advanced a further 0.5% over the months of July and August. Following strong gains in July, August began with a sharp pullback, as fears of a sharper slowdown in the US economy were triggered by a series of weaker data. Nonfarm payrolls, a key indicator of the labour market, showed that significantly fewer jobs had been added in July. The ISM survey also recorded an unexpectedly sharp downturn in manufacturing sector activity. However, fears were eased as subsequent data releases showed a more resilient picture, with retail sales, weekly jobless claims and NFIB small business optimism all better than forecasts. Growing expectations that the Fed would cut rates in September also helped lift equity markets back into positive territory by month end and fuelled a 2% gain in bonds.

In regional terms, UK equities advanced 3.2%, led by an impressive 6% surge in small caps. Japan and Europe rose by 2.3% and 2.1%, respectively. Equities in both the US and Asia closed 0.5% lower, while emerging markets declined by 2%, driven by a 4.1% fall in China. Gold continued to outperform both equities and bonds, recording a new record high. For the first time ever, a bar of gold is now worth a cool one million dollars. The oil price rose initially, as tensions increased between Israel and Iran. However, it subsequently sold off along with other industrial metals as a result of weaker economic data in the US and China

The move lower in bond yields was accompanied by a rotation in sector trends. The big US tech stocks suffered a correction following a series of underwhelming earnings reports. Alphabet revealed that it was yet to receive any commercial benefit from its heavy spending on AI applications. Amazon also disappointed due to heavy spending on AI, while its share price was hit further by news that the world’s most famous investor, Warren Buffett, has sold half of his stake. Microsoft shares fell as revenue from its cloud business missed estimates. Nvidia beat expectations but its forecasts lacked the wow factor investors have become used to. As a result, a number of high-profile industry analysts questioned whether the large-scale investments in AI across the sector will pay off anytime soon. The tech mega caps clouded what was a generally positive US earnings season elsewhere, with overall earnings growth in excess of 13% for the second quarter. Prospects for a cut in interest rates gave new life to small caps and a broad range of value stocks in economy-sensitive areas such as banks and real estate.

It was a busy period for central banks, where divergent policy moves added to volatility in markets. The Federal Reserve held rates steady while giving strong signals for a cut in September. The Fed’s decision came prior to the release of US unemployment data that showed an unexpectedly sharp slowdown. The negative market reaction was interpreted as a sign that the US central bank had made a policy error by not cutting rates, heightening the risk of a recession.

To compound the sense that the Fed may have waited too long, the Bank of England announced its first rate cut, following on from similar moves among European central banks in recent months. Subsequent rhetoric from US policymakers was more soothing, however, with a statement from Fed Chair Jerome Powell confirming an imminent cut in interest rates. Elsewhere, the Bank of Japan finally hiked rates for the first time since 2007.

The UK economy expanded by 0.6% in the second quarter, in line with expectations and continuing its recovery from last year’s mild recession. The unemployment rate fell to 4.2% from 4.4%. The Consumer Price Index held steady at 2% in June for a second month and ticked up slightly to 2.2% in July, as fuel prices fell by less in annual terms. More importantly, wage inflation continued to decelerate, with growth slowing from 5.8% to 5.4%. Consumer sentiment hit its highest level in three years, an encouraging sign for retailers and travel companies. Retailer Next upgraded its profits, Frasers Group (whose brands include Sports Direct) and homeware retailer Dunelm Group also issue positive trading updates. Nat West and Barclays performing strongly as profits were significantly ahead of forecasts. Shares in property platform Rightmove were also strong as a result of a £5.6bn bid from Rupert Murdoch’s Australian REA Group.

Performance Update

We are pleased to share that all of our standard portfolios have had a strong start to the year, significantly outperforming their respective benchmarks and in doing so have achieved first or second quartile over all key periods of one, three, five and ten years, as at the month end for both July and August.

Looking Forward

After more than two-and-a-half years of interest-rate hikes aimed at taming inflation, the US Federal Reserve is finally set to follow other major central banks across Europe and the UK and reduce rates at September’s meeting. Markets are now expecting policymakers in the US, the UK and Europe to push through faster rate cuts over the coming year. The US economy and labour market are clearly cooling, and the downside risks to growth have increased. However, the Fed now stands ready to act and has plenty of scope to ease policy from current levels.

The recent broadening out of sector leadership is a welcome shift for active managers such as ourselves. As rate cuts proceed and markets anticipate a boost in growth, investors will increase their focus on areas of the market most likely to benefit from the stimulus, allowing small caps and value shares to continue to catch up to their growth peers in performance terms.

Our Strategy

Equities outside of US mega caps remain attractive given an environment of stronger growth, gradual policy easing and improving corporate fundamentals. On a global basis our standard portfolios are overweight the UK, Japan, Asia and emerging equity markets.

UK equities remain our highest conviction call. Economic data has surprised to the upside, inflation has been subdued and a stream of bids for cheap companies has continued to highlight the value in stocks. This should allow further scope for UK equities to continue to close the valuation discount relative to their global peers. The market is currently valued at 10X price to earnings. Historical data from Liberum dating back to 1927 shows that when valuations are below 10X, returns in the following 3 to 10 years have averaged around 14% per annum. From starting valuations of 10-15X, returns have averaged around 9-10% over the following 3 to 10 years.

Japan remains attractive both in valuation terms and on improving fundamentals. A decade of shareholder friendly reforms is enhancing corporate returns and profitability. At the same time, inflation has finally reignited in the economy, allowing businesses to raise prices and wages for the first time in decades.

The US monetary policy outlook is likely to be most supportive for emerging markets, where equities are benefiting from stronger domestic demand and growth. India is taking steps to become an alternative manufacturing hub for global trade, with a low cost of labour, investment in infrastructure and pro-business environment. Economic growth is accelerating towards 8%. Action by the Fed also provides greater flexibility for this region to initiate its own policy easing cycle without the fear of negative repercussions for its currencies.

While equities remain our preferred asset class, the prospect of lower rates means that bonds should outperform cash. Bonds also provide diversification in the case of slower growth but will not protect portfolios from the possibility that inflation remains higher for longer (except for index-linked bonds). Alternative assets such as gold and commodity stocks offer an additional source of diversification and allow us to hedge against inflation and other potential risks and capitalise on wider opportunities outside of traditional bonds and equities.