Stock Market & Economic Commentary – June 2024

“Wealth is the ability to fully experience life.”

Henry David Thoreau 1817-1862 American naturalist, philosopher, and author. He wrote the book “Waldon,” a refection upon simple living in natural surroundings.

The UK General Election.

At the time of writing this commentary, the results of the General Election are still unknown although a Labour victory, with a significant majority, is looking increasingly likely.

The next government faces a difficult fiscal position. Countering the effects of the pandemic and the energy crisis has forced the current government to spend, borrow and tax on a vast scale. Public debt stands at the highest level in 60 years and taxes are at the highest level in over 70 years.

You get a sense of the mismatch between public spending and the country’s ability to pay for it, from the fact that the UK will need to borrow to fund spending in each of the next five years – despite historically high levels of taxation and the Office for Budget Responsibility’s forecast of growth returning to normal levels. The pandemic and the energy crisis have left the UK and the next government with a fiscal hangover.

Today public spending accounts for almost 45% of GDP, but dissatisfaction with public services is rife and, on current plans, some services face further cuts. Faster growth, if the next government were able to achieve it, would make a difference. But that is a stretching target, not a certainty. Improving public services, containing debt levels, avoiding big tax rises, and rebooting growth – the new government faces big challenges.

History shows that the performance of stock markets is not greatly influenced by whichever party is in power. Economic growth, corporate profitability and dividend growth, innovation and invention, human enterprise and entrepreneurship are the main drivers of investment returns.

Economic Update

Europe’s economy seems to have turned the corner. In the first quarter of this year, the economy expanded by 0.3%, the strongest reading in a year and enough to lift the region out of recession. This doesn’t look like a flash in the pan. Economists expect the EU to keep growing this year and through next.

With inflation down to 2.4% and core inflation running well below US and UK levels, the European Central Bank (ECB) was the first major central bank to cut interest rates earlier this month. The quarter-point cut to 3.75%, not yet replicated by central banks in the US or UK, was the first time interest rates have been cut in 5 years and is a milestone in the fight against inflation after the biggest surge in prices for a generation.

A return to growth ends a miserable period for Europe. The pandemic, soaring inflation and the energy crisis have hit the region hard. Excluding Ireland, whose GDP data is flattered by the treatment of multinational companies’ profits, the EU economy is only 3.0% larger than it was in 2019. Over the same period the US economy has grown by 9.0%.

American economic outperformance against Europe long predates the pandemic. Cheap home-grown energy from oil, gas and renewables gives America a cost advantage over Europe where the natural gas price is currently about four times that of the US. The average cost of electricity is twice what US consumers pay.

Europe’s chemicals sector has been buffeted by high energy prices with plant closures, and some producers shifting capacity to lower-cost countries, particularly the US.

Government spending is also fuelling the US recovery, with a vast programme designed to rebuild infrastructure and transform the semiconductors and renewables sectors. Fiscal policy is also running looser in the US than Europe, with a federal deficit forecast by the IMF of 6.5% of GDP this year compared with the euro area’s 2.9%. Crucially, the US is easing fiscal policy, further boosting growth, while the euro area is tightening.

Europe needs new sources and drivers of growth. An obvious place to start would be by doubling down on economic integration within the EU to build a larger, more competitive market, closer to the US model.

The 1990s and early 2000s saw rapid economic integration in Europe, with the creation of the single market and the euro and EU enlargement into central and eastern Europe. That period ended with the financial crisis. Now, with growth coming back in Europe, would be a good time to restart it.

Race across the World.

The TV programme Race Across the World concluded earlier this month. If you haven’t watched it already, I would recommend viewing it on “catch-up” TV for three reasons.

First, it’s a travel programme, showing the amazing sights of the countries through which the participants navigate. Second, it shows the culture of the people living in those countries. Third, it is about human relationships and how the contestants, individually and as couples, cope with the challenges they face. While it is a race, with a prize of £20,000 for the winning contestants, winning is balanced by the desire to see the sights and be immersed in diverse cultures.

It is a strange observation that the UK, being an open society and one influenced by migration trends over many centuries, fails to appreciate the global challenges we now face. There appears to be a growing insularity, based on a nostalgia for past glories and an unwillingness to learn from others.

We seem to be unconcerned about the significant shift in global economic, and ultimately political, power that is underway. Yes, the US remains dominant, but its leadership may be slipping. Europe has been going backwards, in a relative sense, for half a century. The rise of Asia and other emerging economies is not a new theme – but the pace of relative gains is increasing.

From an economic perspective, this may not seem to be all bad news with rising global prosperity “floating all boats”. Additionally, capitalism has been the most important contributor to higher global living standards, including longer life expectancy.

Race Across the World was based in Asia. Starting in Japan, the objective was to get to Lombok in Indonesia, on a limited budget with no recourse to personal mobile phones or air travel. Japan is a fascinating country, especially as its infrastructure appears massively superior to ours.

Likewise, China has invested heavily in upgrading its transport and a recent research piece struck a chord. The premise is that China has changed in recent years, with high-quality infrastructure in many cities, and a re-orientation of the economy from real estate and cheap consumer goods to more value-added products and services.

Race Across the World demonstrated that places like Vietnam, South Korea, Cambodia, Malaysia, and Indonesia are showing exceptional dynamism. The route, including China, took the contestants on a journey of 15,000 kilometres through countries with a combined population almost twice that of Europe and the US. In the next few decades, the competition from Asia will only intensify.

Europe and the UK are caught in a bind, facing the same debt issues but without some of the enterprising spirit seen in the US. In simple terms, the public want better services and more government interventions to bring about higher levels of prosperity. The best way to achieve this is through higher real economic activity and this will depend on reversing the downward trend in productivity growth. Even if this were in the gift of government – and the poor productivity record in the public sector indicates a lot of room for improvement – it will take time.

So, until we have meaningful economic growth, we are faced with the prospect of spending cuts, higher borrowing, tax increases, or, more likely, a combination of all three. There is little prospect of spending cuts from a Labour government given the stringent approach already baked into plans for non-protected spending areas and commitments already made on the NHS and welfare. Liz Truss’s spectacular own goal in September 2022 and her failure to convince on ‘growth through unfunded tax cuts and higher government borrowing’ has shown the constraints now imposed by the bond markets.

Staying at the top is difficult. Others learn to compete better; complacency sets in, and the big picture is missed. History shows that it is hard to reverse these trends. Leadership becomes key. That no football team has won four consecutive English topflight league titles in well over 100 years, until recently, shows, in microcosm, the difficulty of staying at the top. As great as Jurgen Klopp at Liverpool has been, it was his misfortune to go head-to-head with the outstanding football leader of our time in Pep Guardiola.

Stock Markets

” A group of people who think differently is a market. A group of people who think alike is a mob.” Naval Ravikant, age 49, American entrepreneur and investor. He is the co-founder, chairman and former CEO of AngelList. He has invested in over 200 early-stage companies including Uber and Twitter with over 70 successful exits.

The changing face of stock markets.

As noted above, the ECB cut interest rates for the first time in 5 years earlier this month. This was the first time the ECB has ever cut interest rates before America. In announcing the historic decision, Christine Lagarde, the President of the ECB, while sporting a jewelled necklace that signalled “I’m in charge”, emphasised that the cut was a brave and positive move towards lower borrowing costs.

However, it increasingly feels like the thing to watch is not the timing or quantum of interest rate cuts, but Nvidia, Nvidia, Nvidia! The US chipmaker, whose market capitalisation was a “mere” $10 billion 10 years ago, has assumed a dominant role in global stock markets. Earlier this month the company struck some new milestones when its market capitalisation vaulted over $3 trillion making it larger than both Apple and Microsoft.

The company is now worth more than the combined value of the 100 largest companies quoted on the London Stock Exchange.

Whether Nvidia’s share price is up, down, or sideways, it drags global stock markets along for the ride. Big tech stocks, including Nvidia, “are being rewarded for being some of the most successful companies of all time, with unbelievable cash flows”, says Paul Quinsee, head of global equities at JP Morgan Asset Management. “The profitability is just extraordinary”.

It seems implausible that Nvidia’s share price can keep on climbing this fast, otherwise by the end of the year the company will be worth well over $6 trillion. That would be reminiscent of the parabolic ascent of Cisco, which ended in tears in the dot-com era.

But a counterintuitive bedrock of support is still likely to come not just from the momentum jockeys and punters, but also from professional investors. How many of them will want to take the career risk of missing out on Nvidia gains, given it accounts for more than 6% of the US S&P 500 index. And for some investors, the risk-to-return ratio of some big tech stocks may be better than it seems in a world where safe-haven assets are in short supply.

Some asset managers now believe that Government Bonds no longer fit the bill of a safe-haven retreat, to balance out a diversified and generally risk-seeking portfolio. The nature of inflation – the mortal enemy of bonds – has shifted from something that is predominantly demand driven to something stickier. Reasons for that shift include nasty geopolitics and the global need for companies and governments to spend vast sums on defence and on trying to ensure the survival of the planet. Some asset managers argue that this new era is “changing the way we invest.”

“We have spent most of our careers believing the low-risk asset is bonds but now we need to completely review our assessment of risk. Our hedges are the assets traditionally seen as high risk”.

Long-term bonds, with maturities of 10 to 30 years, are so sensitive to shifts in inflation and interest rates that they’re increasingly being regarded as higher risk. Short-term debt and a “barbell” exposure to stocks and shares is preferred for a balanced portfolio. Highly profitable, cash-generative high-tech stocks such as Nvidia are being used as lower-risk assets.

But be wary! Just like anything in markets, this could all go horribly wrong. Artificial intelligence, the driving force behind demand for Nvidia’s chips, could still over-promise and underdeliver. Tariffs or regulation or some hitherto unforeseen source of competition could bite. Everyone knows this. Until then Nvidia chief executive Jenson Huang may also want to flash some “I’m in charge” jewels.

UK Equities

The Labour Party’s 1997 election theme song “Things can only get better”, feels like a timely nod to the current attractions of the UK equity market, for so long the wallflower at the global equity party.

The UK equity market, with its reliance on energy, mining, financial services, telcos, and utilities, lacks the tech component that has powered the US market. Even outside tech, US stocks command higher valuations than their UK or euro area peers. This helps explain why some London-listed UK businesses, including biotech firm Abcam and packaging firm Smurfit Kappa, have moved to the US market. Investors are simply more optimistic about prospects for future growth and returns from US-listed companies than their European peers.

This has left UK equities looking cheap relative to US equities and, indeed, euro area equities. The discount on UK equities relative to their US peers has rarely been so large. But just because something appears to be cheap doesn’t mean it will make money.

However, markets can and do change direction. Witness the stellar performance of Japanese equities in the last two years after decades in the doldrums or the fall from grace of Chinese equities since 2021.

The UK macro picture, with growth returning, inflation in retreat and sentiment improving looks better than it has for some time.

UK consumers’ perceptions of their likely financial position over the next 12 months have improved immeasurably. The cost of living/inflation/mortgage crisis – perceived as far worse than either the 2008 financial crisis or Covid – was a catastrophe, but consumers are now much more confident about their financial position. Driven largely by rising real wages, prospects for the UK consumer are looking brighter than they have done for some time. This should be good news for the economy, for UK companies, and sterling too, though it does raise doubts about how quickly the Bank of England should be cutting interest rates.

Diversification by overseas investors from their own markets has led to a significant increase in foreign holdings of UK equities. Roughly 60% of all UK equities are now owned by overseas institutions and individuals, up from 33% in 2000 and just 8% in 1963. The UK equity market has a more geographically dispersed and global customer base than ever. Overseas institutions have replaced UK pension and insurance companies as the major owners of UK equities.

A recovery in the relative fortunes of the UK stock market has been predicted many times before, almost always based solely on valuation grounds, but now there are additional catalysts that could boost the UK market. With global equities and particularly US equities looking expensive, we are comfortable with the fact that the Clarion Portfolio funds have a balanced exposure to UK equities.

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

June 2024

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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.