Clarion Investment Diary – February 2024.

The Clarion Investment Committee met on 22 February 2024. The following notes summarise the main points of consideration in the Investment Committee discussions but have been updated to include commentary on recent events and the wider implications for financial markets.

Economic, Political and Business Snapshot

Economics

FT analysis of OECD data suggests that the downturn in house prices in advanced economies “has largely petered out”.
Credit rating agency S&P Global Ratings upgraded its forecast for US GDP growth from 1.5% to 2.4% this year.
Minutes from the US Federal Reserve’s January meeting reveal that rate-setters were wary of cutting interest rates too quickly as the “economic outlook was uncertain and that they remained highly attentive to inflation risk”.
US 30-year mortgage rates rose above 7% in February as robust economic data reduced the chances of interest rate cuts.
UK business output rose more than expected in February as the S&P UK PMI index rose on strong growth in the service sector. The reading has eased concerns that the recession from the second half of 2023 will extend into this year.
The UK public sector recorded a smaller-than-expected surplus of £16.7 billion in January, meaning that the UK chancellor still has a narrow margin for manoeuvre in the upcoming Spring Budget.
UK two-year government bond yields fell below 4.6% last week after the Bank of England governor Andrew Bailey said that interest rates may be cut before inflation reaches the 2% target.
UK housing sales rose by 16% in the first six weeks of 2024 compared with the same period last year, indicating a pick-up in momentum in the housing markets as interest rates are expected to be cut this year.
Birth rates in England and Wales fell to a new historic low of 1.49 children per woman in 2022.
The UK’s energy regulator Ofgem announced that the energy price cap will fall by 12% in April to £1,690, but is yet to reach the pre-energy crisis level of around £1,200.
European gas prices fell to pre-energy crisis level due to high levels of imports of liquified natural gas, warm weather and demand reduction.
The S&P PMI activity index for the euro area rose to an eight-month high driven by a recovery in France. However, the index showed the economic downturn in Germany deepening.
Euro area consumer confidence rose more than expected in February as inflation fell and unemployment remained at a record low.
Euro area’s annual rises in collectively negotiated wages reached 4.5% in Q4 2023, down from 4.7% in the previous quarter, the first slowdown since Q2 2022.
Germany’s central bank warned that the economy is likely to contract by 0.3% in Q1 2024 due to uncertainty over government policy, recent transport strikes, cautious consumers, and weak industrial demand.

Business

Chipmaker Nvidia’s market capitalisation jumped by $277 billion on 22 February, the largest single-day increase for a publicly traded company, after reporting a surge in revenues on soaring corporate spending on artificial intelligence.
Biotech company Moderna posted a net loss of $4.7 billion in 2023 as demand for its Covid-19 jab faltered.
Advertising group WPP reported a 70% fall in profits last year as marketing expenditure by technology, healthcare, and retail clients fell.
Food and drink manufacturer Nestlé reported a 1.5% fall in sales in 2023 as inflation hit consumer demand.
Electric truck maker Rivian announced a cut of 10% in its labour force due to higher interest rates, geopolitical uncertainty, and slower EV take-up.

Global and political developments

Donald Trump’s 20-point victory over Nikki Haley in the South Carolina primary appears to have cleared his way to the Republican nomination.
The FT reported that EU member states agreed to impose new sanctions against Russia, specifically targeting Chinese and Indian companies accused of supporting Moscow’s war effort.
Hungary’s ruling party Fideszsignalled that it is willing to ratify Sweden’s membership of NATO, removing the last opposition to Stockholm’s accession to the defence bloc.

Please click here to access the February Economic and Stock Market Commentary written by Clarion Group Chairman, Keith Thompson.

Commentary

Global growth slowed last year as the effects of high inflation and rising interest rates weighed on activity in the rich world, but things could have been worse.

Activity has weakened but among the major economies only Germany and the UK have fallen into recession, and a mild one at that. Activity in the US and Japan has accelerated. Emerging market economies as a whole have shown good growth partly as a result of China’s recovery from the pandemic.

A number of big, much analysed risks, failed to materialise. This time last year the talk was all about to the risks to growth, everything from energy blackouts and surging energy prices to mass layoffs, collapsing house prices and deep financial crisis. None occurred.

The shocks that did occur, including the regional banking crisis in the US, the conflict in the Middle East and the emergence of deflationary risk in the Chinese economy, have not so far had pronounced negative effect on growth.

According to the Internal Monetary Fund global growth slowed from 3.5% in 2022 to 3.0% in 2023, a rather higher growth rate than the IMF had forecast at the start of the year, largely because of the strength of the US economy.

The IMF expects global growth to remain at about 3.0% this year, with emerging markets generally holding up well but a more uncertain picture in developed economies.

It is too early to say that the global economy is out of the woods. The last two years have witnessed a bout of inflation, an energy price shock, and a tightening of monetary policy the likes of which have not been seen for 40 years. The impact on growth has been moderate by the standards of past economic cycles but has not been fully felt.

The effect of rising interest rates on mortgage costs, and of rising rents, have yet to fully feed through to consumers. Unemployment lags the economic cycle and is likely to nudge higher this year. Business insolvencies are likely to rise.

As a result, activity in the UK, the euro area and the US is likely to be lacklustre in the first half of 2024 but, with further falls in inflation, activity is likely to stir in the second half on the back of rising real incomes and lower interest rates.

UK GDP is likely to stagnate in the current quarter but by the end of the year growth is likely to be running close to a trend. A similar outcome, of a weak start being followed by firmer second half seems plausible in the US and the euro area.

For now, the risks to global growth lie firmly on the downside. The resilience that helped support growth and shrug off the effect of shocks last year cannot be taken for granted. Economic activity is more volatile than the stylised forecasts of economists suggest. Few expect to see a strong or swift recovery.

There are three particular sources of risk.

Number one is that inflation proves more embedded in the system, with wages and underlying prices, excluding energy and food, holding up. That could force central banks to raise rates increasing the risks of a hard landing.

Geopolitics is an obvious second source of risk. Conflicts in Ukraine and the Middle East, disruption to trade in the Red Sea, and elections in the US and more than 50 other countries are the current focus, but new shocks could emerge quickly and unexpectedly.

Sometimes they have little discernible effect on overall growth, as with the 9/11 attacks on the US. On other occasions, as happened in the wake of the invasion of Ukraine, with a surge in gas prices, the economic effects are significant.

The risks are greatest when geopolitics disrupt financial markets, energy supply or trade. (The last two factors motivate current concerns about the economic impact of attacks on freight shipping in the Red Sea).

Elections, particularly the US election on 5 November, are another event risk. The US elections currently seems likely to be a contest between radical visions of America, with Mr Trump promising major new import tariffs, an activist, pro-fossil fuel industrial policy, and tax cuts.

The third category of risk relates to financial markets. High interest rates and weakening growth often exposes hidden weaknesses or contradictions in financial systems. This has been a feature of major rate hiking cycles.

The dotcom crash of 2000, the global financial crisis of 2008 and last year’s blow up in regional US banks were all preceded by significant rate rises. Most measures of stress in financial markets are currently running at reassuringly low levels and central banks and regulators have responded swiftly and effectively to the shocks which have emerged, such as the turmoil in the UK government bond market in late 2022.

Still, history suggests that this is the stage in the economic cycle when things have a habit of going wrong in financial markets. Vigilance is warranted.

The good news is that inflation, the principal cause of the West’s problems, is heading down. UK inflation has dropped from an October 2022 peak of 11.1% to less than 4% and is running at even lower rates in the US and the euro area.

Progress from here will be erratic and dependent on a fading of commodity price pressures, softer wage growth and an absence of supply shocks. But it is quite possible that inflation could drop to around the 2.0% mark in the UK, US and euro by the middle of the year paving the way for central banks to reduce rates.

Financial markets have become more optimistic on this front and are now pricing interest rates cuts of more than 100bp in the UK, US, and eurozone by the end of this year.

Falling rate expectations have, in turn, bolstered stock markets, with US and euro area equities showing solid returns since late October. Since the end of December rising oil prices and the disruption to trade in the Red Sea have unsettled markets. But investors still seem to be positioned for a relatively benign outcome for the global economy this year.

That the global economy has weathered the effects of high inflation, high interest rates and an energy shock as well as it is quite an achievement, but a soft landing is not in the bag.

Engineering a return to low inflation without landing the economy in recession is notoriously difficult, especially against a background of elevated geopolitical risk. The most likely outcome is that growth will come back in the rich world this year but quite a lot needs to go right for that to happen.

Strategy

The investment committee continue to monitor the bond duration within the portfolios. The likelihood of interest rate cuts in the first half of 2024 is viewed with scepticism as a result of continued inflationary pressures.

The average bond duration of the underlying bond holdings remains targeted at approximately six years, in line with the average duration of the corporate bond market.

The Clarion portfolios remain underweight to the US and overweight to the UK against their respective benchmarks. This is due to the view that mega-cap stocks within the US equity market are overvalued, and markets should re-price over the longer term.

Conversely, it is the committee’s view that small-cap stocks are currently trading at attractive earnings multiples presenting a more favourable outlook for potential outperformance over the short to medium term.

Furthermore, the more adventurous portfolios remain overweight to Asia Pacific equities. This is driven by the view that valuations within the Chinese equity market specifically are currently compressed due to ongoing geopolitical tensions and economic challenges. Despite these concerns, it is the committee’s view that this risk has been priced in and that there is scope for potential strong outperformance over the long-term.

The key themes can be summarised below as:

In the fixed income space, we hold a well-diversified mix of government bond, corporate bond, and index-linked funds with a medium-term duration to mitigate risk in case interest rates do not fall as expected.
In the UK due in part to higher wage growth, Index Linked Gilts look attractive at current prices.
Yields on Investment Grade Corporate bonds have become more attractive and consequently we favour an allocation to Global Fixed Income.
A general softening in the macro environment in developed economies favours a small reduction in equity exposure for the lower-risk portfolios.
We are underweight US large cap and technology stocks due to high valuations and favour mid to small cap stocks as part of the overall US weighting.
Due to their greater economic resilience, Asia Pacific as well as Emerging Market Equities are favoured for the higher-risk benchmarks.
In recent months, the investment committee has been carefully analysing the performance and risk reward statistics of the Dimensional funds dimensional.com. These funds can best be described as index-tracking funds with an active management overlay. Investment performance has been impressive, and costs are low, and it is likely that we will continue to introduce more Dimensional Funds into the portfolios as and when appropriate.

Continuing to hold a globally diversified portfolio of high-quality assets is important to provide resilience and grow the value of savings over the long term and remains the appropriate method for allocation of investor capital. Cash is unattractive as inflationary pressures, although moderating, look to be structurally long term.

Keith W Thompson

Clarion Group Chairman

February 2024

Creating better lives now and in the future for our clients, their families and those who are important to them.

Clarion Funds & Discretionary Portfolios:  

Defender Managed Portfolio  

The chart below shows the historical performance of the Defender Portfolio against a relevant benchmark since the start of the available data.

Changes to the Defender Portfolio  

The Xtrackers S&P 500 Equal Weight ETF was removed from the portfolio (2.50% to 0.00%)
The Dimensional U.S. Core Equity GBP Acc had its allocation increased (2.50% to 5.00%)

Prudence Fund & Managed Portfolio  

The chart below shows the historical performance of the Prudence Portfolio against a relevant benchmark since the start of the available data.

Changes to the Prudence Fund & Portfolio 

The Xtrackers S&P 500 Equal Weight ETF was removed from the portfolio (3.75% to 0.00%)
The Dimensional U.S. Core Equity GBP Acc had its allocation increased (3.75% to 7.50%)

Navigator Fund & Managed Portfolio  

The chart below shows the historical performance of the Navigator Portfolio against a relevant benchmark since the start of the available data.

Changes to the Navigator Fund & Portfolio 

The Xtrackers S&P 500 Equal Weight ETF was removed from the portfolio (5.50% to 0.00%)
The Dimensional U.S. Core Equity GBP Acc had its allocation increased (5.50% to 10.00%)
The Fidelity Index US P in GB had its allocation increased (5.50% to 6.50%)

Meridian Fund & Managed Portfolio  

The chart below shows the historical performance of the Meridian Portfolio against a relevant benchmark since the start of the available data.

Changes to the Meridian Fund & Portfolio  

The Xtrackers S&P 500 Equal Weight ETF was removed from the portfolio (5.50% to 0.00%)
The Dimensional U.S. Core Equity GBP Acc had its allocation increased (5.50% to 10.00%)
The Fidelity Index US P in GB had its allocation increased (5.50% to 6.50%)

Explorer Fund & Managed Portfolio  

The chart below shows the historical performance of the Explorer Portfolio against a relevant benchmark since the start of the available data.

Changes to the Explorer Fund & Portfolio  

The Xtrackers S&P 500 Equal Weight ETF was removed from the portfolio (6.25% to 0.00%)
The Dimensional U.S. Core Equity GBP Acc had its allocation increased (6.25% to 10.00%)
The Fidelity Index US P in GB had its allocation increased (6.25% to 8.75%)

Voyager Managed Portfolio  

The chart below shows the historical performance of the Voyager Portfolio against a relevant benchmark since the start of the available data.

Changes to the Voyager Portfolio  

The Xtrackers S&P 500 Equal Weight ETF was removed from the portfolio (3.00% to 0.00%)
The Dimensional U.S. Core Equity GBP Acc had its allocation increased (3.00% to 6.00%)

Adventurer Managed Portfolio  

The chart below shows the historical performance of the Adventurer Portfolio against a relevant benchmark since the start of the available data.

Changes to the Adventurer Portfolio 

The Xtrackers S&P 500 Equal Weight ETF was removed from the portfolio (2.00% to 0.00%)
The Dimensional U.S. Core Equity GBP Acc had its allocation increased (2.00% to 4.00%)

Pioneer Managed Portfolio  

The chart below shows the historical performance of the Pioneer Portfolio against a relevant benchmark since the start of the available data.

Changes to the Pioneer Portfolio 

There were no changes made to the Pioneer portfolio in February 2024

Risk Warnings   

Any investment performance figures referred to relate to past performance which is not a reliable indicator of future results and should not be the sole factor of consideration when selecting a product or strategy.  The value of investments, and the income arising from them, can go down as well as up and is not guaranteed, which means that you may not get back what you invested. Unless indicated otherwise, performance figures are stated in British Pounds.  Where performance figures are stated in other currencies, changes in exchange rates may also cause an investment to fluctuate in value.

The content of this article does not constitute financial advice and you may wish to seek professional advice based on your individual circumstances before making any financial decisions.