Commentary on November 2024

FESTIVE GREETINGS FROM CHARLWOOD’S

MARKET OVERVIEW

Global markets continued their impressive run in November, rising a further 3.6%. US equities led the way with a 6.7% surge to new all-time highs following Donald Trump’s emphatic victory in the Presidential election. The UK also rebounded strongly, while Asia and emerging markets came under pressure amid worries over potential trade tariffs. Global bonds also ended on a positive note despite volatility earlier in the month surrounding the US elections, while the gold price gave back some of this year’s spectacular gains.

US equities were buoyed by expectations that Donald Trump’s business-friendly policy programme will lift growth, lower taxes and cut regulation. The Republican party also gained control of Congress, which should make it easier to implement the new policy agenda. However, concerns were also raised over the potential for any further fiscal stimulus to reignite inflation and the impact of plans for higher tariffs. Small-cap stocks outperformed strongly, rising 11.4% amid expectations that domestically exposed companies will benefit most from Trump’s policies. Cyclical sectors such as consumer discretionary, energy and financials also rose sharply. The banks drew support from expectations of a lighter touch approach to regulation.

On the economic front, the US continued to grow at a solid pace. The Atlanta Fed’s estimate for the Q4 economic growth rate is currently 3.2%, above the 2.8% recorded in Q3. US annual inflation, as measured by the consumer price index, ticked up to 2.6% in October from 2.4% in September. As expected, the Federal Reserve cut interest rates by a further 0.25%, taking the federal funds rate down to 4.50-4.75%. The accompanying statement noted that labour market conditions had generally eased but that inflation was still “somewhat elevated”.

UK equities rose 2.6% over the month, recouping the losses suffered in the run up to the October Budget. UK funds saw their first month of inflows since May 2021, breaking a 41-month streak of unrelenting net selling. There was also a stabilisation in government bond yields following their recent move higher. These two factors added to the view that no major surprises in policy have emerged from the Labour Party’s first budget. Inflation rose slightly in October, with the CPI up 2.3% over the year driven by higher energy bills. As expected, the Bank of England cut the base rate by a further 0.25% to 4.75%. The Monetary Policy Committee concluded that the Budget was likely to boost both growth and inflation and that a “gradual approach” to removing policy restraints remained appropriate. As a result, most economists have ruled out another rate cut in December.

UK takeover activity was also back in the spotlight after a summer lull. Insurer Direct Line saw its share price soar after rejecting a bid from Aviva. Waste management group Renewi also received a new bid from Australia’s Macquarie Asset Management, after a previous offer was rejected last year. AIM listed pub and restaurant chain Loungers accepted a bid from private equity group Fortress at a 30% premium.

The UK has finally rid itself of the “Europe’s most politically troubled economy” title, having handed it to the Eurozone, where the two largest economies are both experiencing political turmoil. The German coalition government collapsed after Chancellor Scholz sacked his finance minister and called a snap election, which is scheduled for February. The political melodrama in France has also continued to play out following a disastrous election earlier this year, which left an unworkable parliament divided into three roughly equal blocks. In the latest twist, newly appointed Prime Minister Michel Barnier has resigned following a vote of no confidence, having been unable to obtain sufficient parliamentary support to pass a budget. The stalemate looks set to continue, with a lame duck government in place until the next elections can be held in 2027. This has spooked the French bond market, where yields may soon offer a higher rate of interest than even Italy. Eurozone equities closed flat overall.

Asian and emerging market equities declined 1.0% but did end the month on a more optimistic note. The prospect of a second Trump presidency raised the risk of heightened political tensions over trade and technology. As part of his election campaign, Donald Trump pledged to impose tariffs of 60% or more on manufactured goods from China.

Japanese equities also finished the month with a slightly negative return. However, the increased likelihood of a rate hike in December pushed the yen to a six-week high, boosting the returns for a sterling-based investor to 1.8%. Semi-annual corporate results showed that share buy backs have continued to surge, confirming that the favourable valuation backdrop for Japanese companies remains in place.

LOOKING FORWARD

The fundamental backdrop for financial markets remains favourable. The global economy is growing and looks set to accelerate, central banks are cutting rates, while inflation is finally close to or at target.

Animal spirits in the US are alive and well. The positive expectations arising from Donald Trump’s return to the White House are that he is going to usher in a great new era of government efficiency, lower taxes and deregulation which will bring about a boom in the economy and corporate profits. However, the inflationary risks of these policies should not be discounted and, as a result, the potential for further interest cuts is likely to be less than current expectations. Hence there are likely to be some bumps along the way and certainly in the short term there is potential for a pullback. US equities have had a phenomenal run, which has left valuations looking stretched.

Diversification into cheaper markets is an effective way of managing these risks. We believe performance will broaden out in 2025, as the combination of stronger growth and lower rates provides a catalyst for rotation. US equities could lag other areas of the globe where prospects are improving, and relative values compared to the US have rarely been so compelling.

Technology has dominated performance over the past few years, but other sectors may be set to benefit from the changing macro environment going forward, leading to less concentrated sector returns. Looking outside of the Magnificent 7 there are some exciting opportunities. Perhaps the greatest is in global small caps, which are trading at a multi decade discount relative to their larger counterparts. Similarly, more stable politics in the UK and some cyclical improvement should improve sentiment in the UK, while less concerns over China should be more supportive for Asian and emerging markets.

OUR STRATEGY

We remain constructive about markets in 2025 and see valuation opportunities in regions outside of the US, particularly in small caps and value stocks.

UK equities offer exposure to many high-quality companies trading at valuations significantly below global peers. They also offer a compelling income stream. Sector exposures in the UK are very different to other global markets, bringing important additional benefits in terms of diversification. The UK has minimal exposure to technology, but greater exposure to cash generative financials, energy and basic materials, along with high quality consumer staples. This should prove beneficial if expectations for a sector rotation in 2025 prove correct.

The US monetary policy outlook is likely to be most supportive for emerging markets, where equities are benefiting from stronger domestic demand and growth. The region has delivered positive performance after the end of a US rate hike cycle in four of the past five cycles. Action by the US Fed also provides greater flexibility for this region to initiate its own policy easing cycle without the fear of negative repercussions for its currencies.

Chinese policy is unambiguous in trying to engineer an equity market recovery. Stocks are set to receive a significant policy boost as the authorities are throwing the kitchen sink at the economy. Whether or not these measures will translate into consumption and overall growth and fix the deeper structural issues within the economy remains to be seen, but it’s hard to be bearish when both of the world’s biggest economies are loosening monetary and fiscal policy simultaneously. A stronger China would further increase the attraction of emerging markets in general and help unlock some of the value that’s been accumulating over the past decade or so.

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), which remains our central view. We are also mindful that the high level of fiscal deficits and outstanding public sector debt across major Western economies may well maintain upward pressure on yields for the foreseeable future.

Alternative assets such as gold and commodity stocks offer a valuable 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. Stimulus by China could exert further upward pressure on commodity prices. The combination of higher geopolitical risk, lower interest rates and strong central bank demand has created a highly favourable environment for gold. Our exposure to both physical bullion and gold mining shares across standard portfolios has been a major contributor to outperformance versus benchmarks.

Overall, we continue to manage investments in a manner that allows us to capture the upside in financial markets while also effectively controlling risk to dampen volatility and smooth the path of returns.