Stock Market & Economic Commentary - February 2025

Economic update

The most recent Deloitte quarterly survey of chief financial officers (CFO) of the UK’s largest companies shows a decline in business optimism although it remains well above the lows seen in 2020 and 2022.

CFOs started 2025 with a focus on cost reduction as the main response to the forthcoming increase in National Insurance Contributions (NICs). Raising productivity and prices emerge as lesser, though important, strategies for dealing with higher NICs.

With cost control to the fore, CFOs have trimmed expectations for corporate investment, discretionary spending and hiring, in the next 12 months. Employment expectations have seen the sharpest fall since the start of the pandemic in early 2020.

Worries about high inflation and interest rates that dominated CFO thinking for much of the last four years have now faded. CFOs see wage pressures easing over the next year and expect the Bank of England (BoE) to reduce interest rates by a further 50bp to 4% by the end of 2025. An easier monetary environment is feeding through to credit conditions, with CFOs reporting that credit is more available than it has been for most of the last five years.

Geopolitics continues to top CFOs’ list of external risks for the sixth consecutive quarter. But energy prices, which were a major concern for CFOs a year ago, have dropped down the risk list, in part, because oil prices fell in 2024 despite ongoing conflicts in the Middle East and Ukraine.

The decline in CFO optimism seen in the latest survey has not been accompanied by the sort of sharp rise in perceptions of uncertainty that was seen during the pandemic and in 2022 as inflation surged. Indeed, CFOs’ perceptions of uncertainty are running well below the levels seen in most of the last six years. Although they face increased costs in the form of higher NICs, CFOs are no longer contending with endemic uncertainty, high inflation and the tight credit conditions of recent years.

The survey also examined CFOs’ views on the attractiveness of countries and regions as destinations for business investment. The UK is seen as offering a better location for investment than the euro area or China. But North America ranks by some margin as the most attractive location, highlighting the competitive challenge Europe faces from a fast-growing US economy.

UK government debt

Stepping aside from the Deloitte CFO Survey, the big development in financial markets in recent weeks has been a steep rise in UK government bond yields.

The yield on 10-year UK government bonds, a key measure of borrowing costs, has risen from 3.75% in mid-September to a 16-year high of 4.90% in recent weeks. This sharp increase reflects growing concerns in the bond market about the UK’s fiscal health and economic strategy.

This can be seen in the spread, or differential, in borrowing costs between the UK and its European peers. That UK borrowing costs have risen relative to Germany, where growth and inflation are weak and public borrowing is low, is unremarkable. More surprising is that against France and Spain, countries with relatively high debt levels, and, in the case of France, a budgetary crisis, UK spreads have also widened.

The UK Chancellor, Rachel Reeves, has reiterated her commitment to fiscal discipline, emphasising adherence to her self-imposed fiscal rules despite rising bond yields. However, if borrowing costs continue to climb, her options may narrow. In this scenario she would be forced to consider further tax rises or public spending cuts.

Reducing public spending would be one way to maintain fiscal balance, though politically and socially challenging. At a time when President Trump is asking NATO members to contribute 5% of their GDP budgets to defence, and public services desperate for funding, this would be a difficult route for the government to follow. Building on this theme Darren Jones, the chief secretary to the Treasury, recently wrote in the Daily Telegraph, of “rooting out waste across the public sector. Departments… must find savings and efficiencies across their programmes.”

The Chancellor faces a challenging balancing act as she works to curb the rising cost of government borrowing. While maintaining her commitment to fiscal rules, she may have to evaluate potential trade-offs between tax policies and public spending. What is clear is that despite the significant increases in planned public expenditure announced in last October’s UK budget, the government still faces hard decisions on what to prioritise. Higher bond yields accentuate the challenge.

Stock markets

“The good life is a process, not a state of being. It is a direction not a destination” – Carl Rogers, American psychologist and a founder of humanistic psychology (January 1902 – February 1987).

Pericombobulations!

There is a scene in the great British sitcom “Blackadder” when Dr Samuel Johnson proudly arrives with his new dictionary and proclaims that it includes every single word in the English language. Blackadder, keen to take him down a peg, offers “my most enthusiastic contrafibularities.” As Johnson gasps with annoyance at a word he’s missed, Blackadder says that he is “anaspeptic, frasmotic, and compunctuous” to have caused such “pericombobulations.” Then he leaves, saying he’ll return “interfrastically.”

The Covid-19 pandemic has exasperated humanity and attempts to understand it in much the same way that Blackadder infuriated Dr. Johnson. Every time we thought we had the virus’ measure, it gave us more “pericombobulations,” creating new problems that required a new vocabulary.

In that spirit, we need to examine what has happened in the five years since 19 February 2020, when the US S&P 500 index closed at what was then an all-time high of 3383. Barely five weeks later, on 23 March, it had fallen by more than 1140 points. That frighteningly fast fall of 34% was driven by Covid, the biggest external economic shock in the modern era. It is often said that stock markets climb the stairs but descend by the elevator and that was never truer than in 2020 when markets lost more than one third of their value in the space of only five weeks.

And yet only one day short of exactly five years later, on 18 February 2025, the S&P reached yet another all-time high. Even investors who bought at the top five years ago are now sitting on a very satisfactory “interfrastic” return.

The effects of the pandemic and the policies that tried to mitigate it are still being felt. To combat the threat of recession, Central Banks, led by the Federal Reserve Bank of America, pulled the money printing levers and flooded the world with liquidity. Money supply growth expanded by 500% in a matter of weeks if not days.

Now, as the great American economist and father of monetarism, Milton Friedman, will tell you, excessive growth in the supply of money is inherently inflationary but can also boost stock markets. Liquidity provides a fuel for equities to rise.

Inflation returned with a vengeance in the five years since Covid first struck, but anyone who bought equities at the top in 2020 has far outstripped CPI. So has anyone who bought gold, or investors in stocks outside the US. Bonds are the conspicuous exception. Not only have they failed to keep up with inflation, but they are down in nominal terms.

But perhaps the main lesson to be learned from an investment perspective is that when stock markets are in free fall it is best to blank out the short-term noise and to hold your nerve. With supposed experts telling us that this was the end, clocks would stop, planes would never fly again, and we would never hire a car or take a cruise again, it would have been so easy to panic, to bail out, to cash everything. Unfortunately, some people did exactly that, much to their eventual regret.

2024… a good year for most things.

2024 was a pretty good year for equities. The global market benchmark returned 14.9% following a 20.6% gain in 2023.

The US equity market was, once again, the star, returning 23% in 2024. Years of US outperformance means that US equities now account for 74% of the MSCI developed market equity index and 56% of the total global market.

A handful of US technology stocks have driven US equities, and with it the global index. One calculation by DataTrek Research suggests that without the contribution of the so-called “magnificent seven” big tech stocks (Amazon, Apple, Alphabet, Meta, Microsoft, Nvidia and Tesla) the S&P 500 would have risen by “only” 6.3% last year.

A strong US equity market can be seen, in part, as a reflection of the strength and dynamism of the US economy. Yet equity markets do not move in lockstep with GDP growth or, indeed, with economic sentiment.

German equities returned 12% last year in the face of a shrinking economy and widespread gloom about the economy. The Italian economy posted a lacklustre growth rate of just 0.5% in 2024, but Italian equities rose 16%. UK equities rose 9% last year even though sentiment and growth fell away in the second half of the year.

The point is that equity indices offer a very partial view of the health of the underlying economy. Such indices are dominated by multinationals that do not reflect the makeup of national output in which small and unquoted businesses and the public sector play a large role. Currency moves, and expectations of future growth and interest rates, are crucial for equity valuations, but less so for economic activity.

The US market has been hit by a couple of wobbles this year. In early January, concerns over the persistence of US inflation and impact of the new administration’s policies drove up interest rate expectations in the US and around the world. Then the news that China’s start up rival to OpenAI and ChatGPT, DeepSeek, appeared to have solved the problem of creating cheap, proficient AI models prompted a wave of panic in the US tech sector. The US company providing the pickaxes for the AI gold rush, NVIDIA, saw the largest one-day fall in the market capitalisation of a single stock in history.

Turning to other assets, 2024 wasn’t a good year for investors in government bonds. A global index of government bonds returned just 2.7%, far below the 15% return on equities (holders of UK bonds, or gilts, lost 4% last year). Bonds have been hit by the slow pace of interest rate reductions, concerns about levels of government debt and persistent inflation.

House prices in most rich countries rose in 2024 following declines in 2023 but lag far behind returns on equities. The latest available data show that house price inflation in the US and the UK is running around the 4.0% mark with prices in the euro area up 2.6% in the last year.

In terms of more exotic investments, gold has done well, rising 27% in 2024 and a further 12% so far this year. The possibility that the new US administration could apply tariffs to imports of gold has bolstered prices and triggered stockpiling in the US. Some speculate that central banks and governments might seek to switch out of dollars and into gold on worries about potential US sanctions. These factors, together with lingering concerns about inflation, have propelled the gold price to an all-time high.

Things have been difficult in two other niche markets. The classic car market in the US and the UK has struggled for the past two years, with prices mainly flat to down. One commentator suggested that demand for older classic cars may be waning as their owners age. The fine wine market has been falling since the peak in late 2022 and is down nearly 24% over the past two years. Wine has struggled as an asset class since it doesn’t provide a yield, falling demand from Chinese buyers has added to the sector’s woes.

Equities have certainly had a good run, but that performance has been heavily dependent on a handful of US tech companies. The ‘magnificent seven’ US tech stocks now account for 25% of the US equity market and 15% of the global equity market. Apple is currently worth more than the entire UK stock market.

Such a concentration in one sector in one country raises fears that the US and global equity indices are less diversified than in the past. Valuations are also high. The price earnings ratio, a measure of a company’s share price relative to its earnings per share, is currently running at around 28 x, significantly higher than the US market average of around 18 x over the past 50 years. The last time valuations were running at these sort of levels (aside from during the pandemic, when earnings did odd things) was during the dot-com bubble in the late 1990s and early 2000s.

Many commentators have drawn comparisons to that era which was followed by 10 years of lacklustre returns from US equities. As in the late 1990s, today’s valuations are premised on new technology – this time AI – delivering a step change in productivity growth across economies.

Let’s hope the markets are right but either way, a degree of diversification away from the US in favour of Europe, the Far East and even the UK seems to be a sensible strategy at this stage in the cycle.

As always, we thank you for your continued support and we look forward to updating you regularly throughout 2025. Please get in touch if you have any questions.

Keith W Thompson

Clarion Group Chairman

February 2025

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 & Economic Commentary – February 2025