Stock Market & Economic Commentary – April 2024

“Progress is impossible without change, and those who cannot change their minds cannot change anything”. George Bernard Shaw. 1856-1950. Irish playwright, critic, polemicist and political activist.

The UK Economy.

The last couple of years have been hard for the UK economy. Growth has ground to a halt and consumer spending power has come under heavy pressure. The economy dipped into recession in the second half of last year. The consensus about the UK remains downbeat, with a focus on weak growth and poor productivity. But this narrative underplays some of the more recent developments.

Inflation, from which so many of the UK’s current problems stem, has collapsed, dropping from a peak of 11.4% to 3.2% in March. By June inflation is likely to fall below the Bank of England’s 2% target for the first time in three years.

Lower inflation should pave the way for the Bank of England to cut interest rates, currently 5.25%. Financial markets are predicting the first 25bp cut sometime around mid-summer with UK rates ending the year at 4.5%.

Falling rates are already feeding through to consumers and corporates. Interest rates on mortgages and corporate debt have eased back since the peaks seen last summer. Financial conditions, as measured by various financial stress indices, remain supportive. The latest round of bank results shows little evidence of distress in the household or corporate sectors. If inflation and interest rates fall as expected, credit conditions will ease further.

Bank of America’s latest survey of institutional investors shows that fund managers are more bullish on global growth than at any time in the last two years. The proportion of fund managers expecting a ‘hard landing’ for the global economy has dropped from 30% last October to around 11% today.

Risk appetite is rising. Global equity markets have continued on an upward, albeit bumpy, trajectory, and European M&A activity picked up in the first quarter of this year.

Falling inflation is bolstering consumer firepower with wage growth outstripping inflation. Cuts to National Insurance in the Budget and last year’s Autumn Statement will help consumers.

Unemployment is the dog that hasn’t barked in this economic cycle with rising employment through the second half of last year even as the economy moved into recession. UK consumers are more confident about their own financial position than at any time since late 2021.

Last month, Simon Wolfson, CEO of Next, one of the UK’s leading clothing retailers, said, “It has been a long time since we started a year in a more positive frame of mind.”

Business confidence has edged up in recent months. In his March Budget address, the chancellor championed improving levels of optimism which are now running above trend. A Purchasing Managers’ survey confirms an improving picture for UK manufacturing and service activity in recent months.

Lower inflation and the prospect of interest rate cuts have bolstered housing activity. Chartered surveyors report more properties are coming onto the market, growing interest from new buyers and higher sales. Halifax and Nationwide data show UK house prices have edged up since last October. Housebuilder Bellway recently reported that sales were 21% higher in February and March than a year earlier.

After a weak end to 2023, UK GDP growth rose by 0.2% in January. The mild recession that hit the UK in the second half of 2023 is probably over.

The US also seems to have navigated its way to an economic soft landing with economists increasingly confident that 2024 will be another good year for growth. The UK is in poorer shape but is showing signs of life. Barring external shocks, UK growth should edge higher over coming quarters.

The US

Perhaps the greatest surprise of 2023 was the strength of the US economy. Could it be about to pull off the same trick again this year?

In real terms, the US economy grew at around 3% in 2023. In nominal terms, accounting for inflation, growth was likely above 7%. Companies live off nominal growth, so it is no surprise their profits were strong last year.

This is starkly different from the consensus view which was one of recession. The now infamous Bloomberg view in October 2022 of there being a 100% chance of a recession in 2023 based on their models will live long in the memory as one of the great contrarian signals of our time. Since then, the S&P 500 is up by more than a quarter.

The best estimates of the US economy are that it grew at a rate just above 2% in real terms in the first quarter of 2024, and around mid-single digits in nominal terms. It would seem the momentum of last year has continued.

A strong US consumer is complemented by strength in capital expenditure, for projects such as electrification and data centre growth, and government expenditure which rose to a record high as can be evidenced by large budget deficits.

No wonder the US economy is strong!

The question is what could change this rosy situation? Much like a view on the possibility of a recession, it is more likely to be an external event than the economic cycle.

Events which are talked about include a blockade of Taiwan by China, an escalation of tensions in the Middle East, a dislocation in debt markets due to the high level of government spending, or maybe changes in political leadership around the world.

In reality, no one knows what the future holds and that is perhaps the key lesson of the last few years. A positive bias in considering potential outcomes has historically, and objectively, led to better investment outcomes.

Despite rising geopolitical risk and a resurgence of superpower competition, it is quite feasible that the US economy could once again surprise to the upside this year. Investors are likely to experience better returns by erring on the side of optimism.

Recessions

There are many topics which are overly discussed in the investment industry, but recessions perhaps beat them all. However, since 1999 there have been only three recessions in the US and Europe.

March 2001 to November 2001 – this occurred in the wake of the technology bust of the late 1990s.
December 2007 to June 2009 – the cause of this recession was the financial crisis and subprime mortgage lending. Falling home prices caused a credit crunch in the banking system, which led to falling economic activity.
February 2020 to May 2020 – the severe economic effects of the Covid pandemic, as large parts of the global economy were shut down, led to a rapid decline in economic activity.

For those who prefer a longer-term perspective, there have been 48 recessions since 1776 when the United States was formed. This equates to a recession every 5.2 years.

Taking the period since 1929, when the Great Depression occurred and modern central bank management of the economy began, there have been 15 recessions at a rate of one every 6.3 years, which implies some level of improvement in economic cycle management. Since 2001 we’ve had recessions at the rate of one every 7.3 years.

But is it right to count Covid as a recession? Economies were shut down by governments rather than being impaired by mismanagement of the economic cycle. Take out that recession and we’ve had only two recessions in 23 years, or one every 11.5 years.

The point here is recessions are, on average, becoming arguably much less frequent, but commentary around the potential for a recession, stoked by an increasingly short-term and negative media, is increasing. It’s a mismatch, investors would be advised to note.

As a thought experiment, how would it change your view as an investor if there were no more recessions? What would you do if that was the case? Which asset classes would you own, and which companies within them?

The big winner would be equities, which thrive off economic growth and innovation. The big losers would be cash and debt, which beyond offering a level of stability and income (not to be dismissed as helpful for many investors) would not benefit from this scenario.

The point is not to say there will be no more recessions. Events will occur, like Covid, which will create dislocations in the global economy that result in a fall in economic activity.

However, aside from this type of event risk, recessions are becoming less frequent as the management of the economy learns from previous mistakes. Planning a portfolio based on no recessions is perhaps too optimistic, but arguably no more incorrect than planning for regular ones.

Stock Markets

“An investor who has all the answers doesn’t even understand the questions. Success is a process of continually seeking answers to new questions.” Sir John Templeton (29 November 1912 – 8 July 2008). American-born British investor, banker, fund manager and philanthropist. In 1999 Money magazine named him “arguably the greatest global stock picker of the century”.

Markets have seen a return of volatility in the last few weeks. We’ve seen a combination of higher-than-expected inflation in the US, a function of a strong economy, and heightened geopolitical tensions in the Middle East.

This has pushed equity investors to take profits after a strong start to the year and led to weakness in bond markets. The question is where do we go from here?

The issue facing investors is that the US economy is proving to be stronger than expected. Expectations of a hard landing last year were replaced with expectations of a soft landing, which was replaced with expectations of no landing, which is now being replaced with forecasts of above-trend economic growth.

With US consumers seeing high levels of employment and record wealth via equity and home prices, and the US government enacting a massive industrial policy through the Inflation Reduction Act and deficit spending, it is no surprise economic growth is better than expected.

We are dealing with a stronger, not weaker, economy than expected. The consequences of this are important as it would suggest that after the recent volatility abates, stock markets should rebound.

Equity markets are ultimately driven by corporate profitability which should continue to grow if the economy does. Equities also benefit from the big investment themes of AI and infrastructure investment. This can provide extra support irrespective of the economic situation.

Forecasting markets is a difficult task, and their complexity is higher now than ever. Looking at company and industry trends often provides more insight as to what to do. That said, on balance it seems likely that buying into the ongoing weakness in equity markets is the right thing to do.

Safe Havens

Escalating tensions in the Middle East have prompted investors to ask, “Where are the safe havens in these difficult times?”

This has led to a surge in the gold price in recent weeks for the metal has long been the classic place to put savings at times of stress. But gold is an unsatisfactory investment. It has no yield and can often go through long periods where it produces zero return.

It is understandable that people should want security for their savings, but it is wrong to pile money into what seems to be a safe haven whenever there is an international crisis, however worrying that might be.

Investors should try to build portfolios that will be robust in the face of unexpected bad news of any sort.

That means spreading risk, looking for fundamental value, and accepting that we are human beings and will sometimes get things wrong.

For example, I can’t help but feel increasingly optimistic about the UK market. Eventually, the outflow from UK equity funds will reverse and, given the lack of liquidity in UK stocks, mid and small caps could move sharply higher. I’m old enough to remember 1975 when the FT All-Share index more than doubled in the six weeks between 20 January and the end of February.

Clearly, investors who sold throughout the second half of 1974 did not expect a move of this magnitude. Circumstances are nothing like as dire as the mid-70s but UK valuations are cheap relative to other markets and history.

It won’t take much to see another leg to the rally that started last October. The catalyst? Lower inflation, interest rate cuts, and a realisation that the economy is improving.

As for other markets, Japan looks to be on a roll after decades of artificially low interest rates, continental Europe is likely to see interest rate cuts soon and, in the US, plenty of liquidity is still searching for a home.

Stock market breadth

One of the most common pushbacks to a more positive view on equity markets is one of breadth.

The strength of the so called “Magnificent Seven” which includes Apple, Microsoft and Nvidia is well documented. These, and the others in the so-called seven, are indeed beneficiaries of many of the big trends we see around us (such as artificial intelligence) but it would be a mistake to think they have been the only drivers of global markets.

Despite a recent bout of turbulence, stock markets in Japan, India, and Europe are still close to all-time highs. These countries do not benefit from the Magnificent Seven. In the US, in February and March the industrial, financial, and materials sectors outperformed technology. These are important signs of breadth that are perhaps underappreciated.

Bull markets tend to start narrow and broaden out as they mature. The argument is always made early on that narrowness is a sign that the rally is not well underpinned. There is some logic to this, but what happens if broadening out starts to occur?

We have seen some notable weakness in several of the technology names which previously have led markets higher, including Tesla and Apple. And yet, until the recent bout of volatility, markets have continued to move higher as other areas have taken up the slack.

A changing of the guard always heralds some turbulence but the recent broadening out of the market is a positive sign.

Investing is always tricky

Investing – how hard can it be? Very is the answer, but not always for the reasons we might expect.

Perhaps the hardest part of investing is thinking long-term; what brings long-term success often contradicts what brings short-term success.

Delivering good long-term performance often involves owning (and not owning) investments which can be a detriment to short-term performance. Commodity companies, many of which have no long-term track record of delivering investment performance, may do very well in the short term.

But, over the long term, they have not yet been a path to success. Investors say they are long-term, but can they be long-term? Turnover rates in our industry suggest not.

Being rational is the other difficulty. When Charlie Munger, Warren Buffett’s partner, was asked what the most important characteristic of successful investors was, he said one word: ‘rational’.

The ability to be objective, balanced, and unemotional in the face of markets is indeed hard. We are humans after all. But it is a goal we should all set ourselves. One simple example of this is, rationally, as prices go down investors should want to buy, and when they go higher, want to sell. Most investors are not rational though and think the other way round.

Think hard, be long term and be rational. Add in an optimistic bias and this can be a great roadmap for success.

As always, we thank you for your continued support and we look forward to updating you regularly throughout 2024. Please get in touch if you have any questions.

Keith W Thompson

Clarion Group Chairman

April 2024

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

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.