Stock Market and Economic Commentary - May 2024

“Our greatest freedom is the freedom to choose our attitude.”

Viktor Emil Frankl (26 March 1905 – 2 September 1997). Austrian psychiatrist and Holocaust survivor. He founded Logo-therapy, a school of psychotherapy that describes a search for a life’s meaning as the central human motivational force. Logo-therapy is part of existential and humanistic psychology theories.

Economic Update

The doomsters who delight in talking down Britian’s economy are looking distinctly foolish. Earlier this month, amid blue skies and sunshine, it was revealed that the mild economic downturn of last year is behind us and that output is climbing sharply.

Growth exceeded all expectations in the first three months of the year. Having slipped into a technical recession in the second half of 2023, GDP growth of 0.6% in the first quarter represents the strongest expansion for two years, and the joint fastest in the G7 alongside Canada.

While we shouldn’t place too much weight on one data release – GDP numbers are choppy and often heavily revised – first quarter growth was remarkably strong, and the rebound was broad-based. This looks like a plausible recovery.

This makes a nonsense of forecasts from the perennially gloomy Organisation for Economic Co-operation and Development (OECD) and the similarly downbeat International Monetary Fund (IMF).

Services output increased for the first time since Q1 2023, with 11 out of 14 subsectors increasing, suggesting consumer activity was picking up as inflation fell. Manufacturing, which has been a weak spot, also expanded, driven by car production. These gains were only offset a little by a contraction in the construction sector.

GDP per head also rose, up 0.4%, after seven consecutive quarters without growth. High-frequency Purchasing Manager Indices suggest this strong momentum continued in April. Rising activity in the housing market and higher levels of consumer and business confidence are consistent with a continued economic recovery.

First quarter growth was strong, but this comes after a sustained period of weakness. The stagnation of the past few years means the total level of output in the UK is just 1.7% higher than it was on the eve of the pandemic, well below the 3.8% and 8.7% growth seen in the euro area and US respectively over the same period.

The UK recovery fits with a wider, international picture. The euro area returned to growth in the first quarter after a weak 2023, while inflationary pressures continued to ease. The US economy, which has bucked the trend of other western economies by growing strongly in 2023, continues to show good growth. Stronger activity overseas should help to boost UK exports. The Bank of England (BoE) has raised its forecast for UK exports this year from a contraction of 0.25% in February to an increase of 2.0% in its latest forecasts.

The path of UK growth is heavily dependent on what happens to inflation and there was good news on this front too. Following a rate setting meeting in early May, the BoE’s Monetary Policy Committee said it now expected underlying inflationary pressures to fade “slightly faster” than previously assumed and consequently “It is likely that we will need to cut bank rates over the coming quarters, possibly more so than currently priced into market rates.”

The Bank’s new forecasts predict both faster growth and lower inflation than previously expected. For both businesses and consumers that is a dream combination. With inflation forecast to continue falling, financial markets expect the Bank to cut UK interest rates by around 50bps, to 4.75%, by December.

The UK economy is on the mend. Barring external shocks, growth is predicted to continue through the rest of this year and next year at around trend levels. Falling inflation, rising real incomes and growth in the US and Europe should help to maintain the recovery.

The UK might not yet have reached the hoped-for sunny uplands after the twin setbacks of the pandemic and the energy crisis following Russia’s invasion of Ukraine, but a resilient nation looks to be well on the road to recovery.

The Path to Net Zero.

And some more good news and reasons for optimism on the path to net zero. The EU has announced that it reduced carbon emissions by a record 15.5% last year compared with 2022 levels. The decline was “due to a substantial increase in renewable electricity production (primarily wind and solar), at the expense of both coal and gas,” the European commission said. Emissions from industries covered by the EU’s Emission Trading Scheme (around 45% of total EU emissions) are now 47% below 2005 levels, when the scheme was introduced, and are well on track to achieve the 2030 target of a 62% decline. The price of emitting one tonne of carbon has risen from €20 before the pandemic to around €65 today, incentivising firms to move to renewable energy sources. The reduction in emissions has also been helped by firms being forced to cut gas use following Russia’s invasion of Ukraine, and by the availability of cheap solar panels from China.

Stock Markets

“The big money is not in the buying and selling, but in the waiting.”
Charlie Munger (1924-2023). American businessman, investor, and philanthropist. He was vice chairman of Berkshire Hathaway from 1978 until his death in November 2023.

Investment psychology.

Springtime finally arrived in the first few days of the month. A few cuckoos announced their arrival. Woodpeckers have been knocking away for weeks, making nest holes in rotting trees to raise their brood.

Spring also brings optimism and fresh ideas for investors. Newspapers are awash with bright, shiny, new investments to line your savings nest. Early birds will be topping up this year’s ISA allowance and selecting new investments.

Before adding anything new though, it is worth scrolling through your portfolio and taking time to review holdings from previous years which may have failed to fulfil their promise. These are easy to spot – usually in glaring red, underlining your losses.

There might be good reasons to ignore them – benign neglect has benefits as an investment style. You might harbour a nagging fear that they will shoot up the moment you sell the losers. Or you could fall for the “sunk cost” excuse where an investment has lost so much that things could hardly get worse. Bitter experience has taught many investors that they can. A share that has halved in value can easily halve again.

Some investors cannot accept their failures and instead double down on them. This is so common among professional investors that there is a phrase for it: “averaging down.” This involves buying more shares at a lower price, reducing the average price you have paid for your holding. This can be a dangerous game. It might be better described as throwing good money after bad.

Investors need to be aware of “cognitive dissonances”. The late Daniel Kahneman won a Nobel Prize for his work in this field. His 2011 book “Thinking, Fast and Slow” catalogued ways in which investors muck up and others have since added to the list.

Kahneman tells us emotion and instinct are powerful influences, often playing against more logical impulses. It is worth noting that the more experienced you become as an investor the more inclined you will be to trust your instinct more and your analysis less. This may not be a good thing.

Investing can be dangerous and can seriously damage your wealth. Much safer to use the services of an experienced wealth manager and financial planner.

Equity markets continue their recovery.

After a short breather in April, equity markets started to rise again in early May. Supported by a strong economy, a good first quarter earnings season, and a continued belief that the interest rate cycle has peaked, the inherent value of equities is increasing, and share prices are following.

One of the lowest-probability bets investors can make is that equity markets will fall. Looking back over history, for those investors willing to show patience, one of the truisms of investing is equity markets go up. Investors who bought the day before the great depression of 1929, the World Wars, the bursting of the technology bubble in 1999, and the financial crisis were handsomely rewarded in time despite these catastrophic events.

There is no natural ceiling to how high equity prices can go. This is because they reflect factors such as innovation, rising wealth and societal improvement. As these things increase, so will equities in the long run. This isn’t to say they cannot become overbought in the near term, or that events will occur to see temporary declines. Buy the dip is however the lesson of more than 100 years of equity investing, and I doubt this will change in the future.

Artificial intelligence reality check.

Combining two of the market’s favourite obsessions was news that Bloomberg have released a new Artificial Intelligence (AI) model to analyse 60,000 recent Federal Reserve headlines. 60,000 attempts to predict the direction of US monetary policy satisfies the definition of madness, especially with the recent poor track record of success. Perhaps the machines will do a better job of divination.

AI saved the markets in late 2022. In that year, a rapid rise in interest rates undermined nearly all asset prices and particularly those of growth-oriented companies. At the time it seemed certain we were entering a new dawn for value investing as areas such as oil and gas led the way. In the fourth quarter of 2022, AI entered our lives in the form of ChatGPT which allowed language-based queries and answers, as opposed to the more data-led AI which preceded it. This rapidly expanded the uses for AI, and markets began to discount this in better prospects for many companies.

There is a suspicion AI has been overhyped. Technology has a habit of doing that, with many things seen to be transformative eventually fizzling out. In the mix of this, however, there have been innovations such as the personal computer, internet, and smartphones, which have fundamentally changed society and created huge investment opportunities.

AI will eventually take its place alongside the defining investment trends of our lifetimes. In the last few months, evidence has built that the reality check we all need on AI is similar to the one we needed about the internet in 1999. Despite the temptation to dismiss it as hype, AI will profoundly change society and create (and already has created) significant investment opportunities. We are very early on in its evolution and, more precisely, mainstreaming it into society. Make no mistake, your future AI assistant is already in your pocket in the form of a smartphone.

There are multiple ways to invest in this area, from large software companies such as Microsoft, to semiconductor companies such as Nvidia. Perhaps the most underappreciated opportunities, however, are in the physical world. AI is a physical world phenomenon. It requires huge amounts of electricity, land, buildings, cables, and ventilation among other things. Suddenly, industries such as utilities, property and construction are becoming AI plays.

AI will likely transform every business. Drug discovery will be made easier, transportation networks will operate more efficiently, investment managers will make better-informed decisions, healthcare providers will diagnose disease more effectively. The list goes on.

The main point here is there is a logic to AI having saved the market in 2022. It has the potential to lift economies and markets to a new level. Of course, like the internet, this will not be linear and will present challenges along the way, but it is at least as important, and likely much more so, than the future path of interest rates and inflation, that dominate so much of investment discussions currently.

Thinking differently – To infinity and beyond!

The skill to being a successful investor is to have views that consensus opinion will agree with – in the future. Investment opportunities by definition come from believing something which the general consensus does not. As the saying goes, it isn’t what you think that matters, just what you think relative to everyone else.

The ability to think differently often defines successful and unsuccessful investors. Investing in the present, using consensus views, is a path to mediocrity at best. Thinking 12-18 months into the future, and actively looking for ideas which are different from the consensus are two good ways of becoming better at this.

What are the non-consensual views today which may or may not become accepted in the next 12-18 months?

For example, there is also a mammoth mismatch between public perceptions of Britain as a basket case economy and reality. This reflects the state of public services with the NHS struggling, the railways unreliable, and our waterways and beaches laid with sewage. But there is another UK of science, technology and strengthening business investment which promises brighter prospects.

The economic background is improving – inflation is heading towards the target of 2%, the BoE is plotting an interest rate cut and output is going “gangbusters” according to the normally phlegmatic Office for National Statistics.

An Investors Chronicle survey shows that Britain stands second to the United States among the G7 richest nations with the largest number of “triple A” companies, well ahead of France and Germany

Innovation continues apace. Only last week British AI start-up Wayve raised £800 million of funding (much of it from overseas) for its autonomous driving technology already being tested on the roads of north London. The Wayve demonstration model may have trouble with potholes, a symbol of public sector dysfunction, but had no trouble with zebra-crossings and tricky roundabouts. If AI could do the same for the NHS as Jeremy Hunt plans for the railways (unions permitting) the country would really have something to cheer.

Investors, both overseas and domestic, are picking up on these positives, with the FTSE 100 hitting new highs in recent trading.

I can think of a few other non-conformist examples: China is in a healthier economic state than believed; equities are in the early stages of a new bull market; investors need to hedge the risk of a stronger, not weaker economy; inflation will not return to 2% in the coming years; Trump will be the next President of the United States. If all these things came true, investors would need to be running very different portfolios than they are today. Even just as a thought experiment, it helps to shake views out of the present time and focus on what isn’t, rather than what is, the accepted view in markets.

As we have written previously, despite the challenges and all the unrest in the world, we are optimistic about what the coming years will bring.

To infinity and beyond!

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

May 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.

Stock Market and Economic Commentary – May 2024