Stock Market & Economic Commentary – March 2024

“Life is really simple, but we insist on making it complicated.” Confucius, Chinese philosopher, born Kong Qiu 551-479 BCE.

ECONOMIC UPDATE

Britain’s recession is over, inflation is beaten, and interest rates are heading down. That, in a nutshell, was the upbeat message from the March UK Budget. But delve into the Budget numbers and a more daunting picture emerges.

First the good news. The independent Office for Budget Responsibility (OBR) thinks that the UK’s recession, which saw growth contracting in the second half of last year, is over and that activity will pick up from here. Rather than stagnation or a sluggish recovery, the OBR forecasts that, by the end of this year, the UK economy will be growing above trend, a performance that will be maintained through 2025, 2026 and 2027.

Inflation, the UK’s central problem for the last two years, is in retreat. In the coming months, the OBR sees inflation dropping below the Bank of England’s target of 2% and staying around this level for the next three years. On this view inflation is beaten and interest rates and mortgage rates should fall later this year.

Faster growth and lower inflation will help consumer firepower. Rather than contracting by 0.8% in 2024 as the OBR thought in November, the latest OBR forecast shows real household incomes rising by 1% this year.

There are caveats. These are forecasts, fallible as always, and optimistic, projecting faster growth and lower inflation than most economists. Real incomes are set to rise but, after the ravages of inflation and slow growth, are unlikely to reach pre-pandemic levels until 2025 or later.

Indeed, real incomes are likely to end this parliament at lower levels than at the start in 2019. This would represent by some margin the worst outcome for households of any of the 18 parliaments since records began in 1955.

But it is the picture on fiscal policy – on tax, public spending, and debt – that looks most challenging.

Countering the effect of the pandemic on jobs and incomes obliged the government to spend on a vast scale, driving an expansion in the size of the state and pushing borrowing to 60-year highs.

The pandemic passed, but was followed by the energy price shock of 2022, to which the government responded with energy subsidies and help for lower-income consumers. There has been no breathing space from crises.

As a result, the government has not been able to embrace public sector austerity to repair the public finances. On the contrary, since October 2021 each successive Budget has loosened fiscal policy.

This activism has protected the economy and consumers, but at a cost. Public sector debt now stands at the highest levels in 60 years. Returning debt to pre-pandemic levels will be a Herculean task. The pandemic and the energy crisis have left the UK with a fiscal hangover.

Ever since the late 1990s successive UK governments have adopted fiscal rules that seek to contain levels of public sector debt. When shocks have hit, these rules have been broken or eased, giving the government the freedom to raise spending and borrowing. It is an irony that the age of fiscal rules has seen levels of public sector debt rise from around 30% to over 90% of GDP. When a crisis hits, plans go out of the window. Or, as Mike Tyson put it: “Everybody has a plan until they get punched in the mouth”.

If the OBR is right the recovery has already started but some things haven’t changed. The UK is a heavily taxed economy, one where, despite high levels of public debt and expenditure, public services are under pressure. Weak growth lies at the heart of these problems. These are challenges for the Budgets that will come after the general election.

STOCK MARKETS

“People should like something less when its price rises, but in investing they often like it more.” Howard Marks, American investor and writer and co-founder of Oaktree Capital Management, the largest investor in distressed securities in the world.

Are equity markets in a bubble?

The US market has continued to power ahead, adding more than 25% in a single straight line since the lows at the end of October last year to make new all-time highs.

This has caused many investors to question whether the asset class is in a bubble. Unsurprisingly, there are dissenting views.

Identifying bubbles after the event is easy. Doing it in real time is much harder and even when one does so correctly, navigating the bubble is a treacherous business because unless one has the fortune of immaculate timing, the pain of not being involved on the way up is just as painful as being involved on the way down.

As it is often noted, the main difference between a bull market and a bubble is if you are invested in it!

For the owners of Nvidia shares, they will argue that the rapid adoption of AI in society has and will continue to result in an explosion of demand for their advanced semi-conductors. For those on the sidelines, they will point to the rapid rise in Nvidia’s share price and draw comparisons to the technology boom, and eventual bust, of the late 1990s when the excitement was about the roll out of the internet.

Some investors argue that the term ‘bubble’ is used too often. Bubbles do occur in asset prices, but infrequently. A bubble implies extreme overvaluation which could lead to a major and permanent loss of capital for investors. In hindsight, there was clearly a bubble in 1999 in technology share prices, and again in 2007 in residential home prices, but outside of those two occasions markets have oscillated between reasonable levels of under and overvaluation. It is the internet-led technology bubble, where most comparisons to today are made.

Some of the comparisons seem accurate and some do not. The accurate comparison is the adoption of a pervasive technology that has the potential to transform society in ways we cannot yet comprehend. In 1999 it was the internet, today it is artificial intelligence.

Those in the bubble camp will note that the internet did indeed transform society but from an investment perspective there were very few winners and many losers, as investors in lastminute.com will attest. The hype around AI today is certainly reminiscent of the hype (and subsequent reality) of the internet.

Those not in the bubble camp will note many companies that fuelled the internet bubble were unprofitable, speculative businesses. Today nobody doubts the profitability and competitive advantage of large AI beneficiaries such as Microsoft, Nvidia, Amazon and Alphabet. Equally the valuations of these companies and other AI beneficiaries, whilst clearly not cheap, are nowhere near the levels ascribed to technology companies in the late 1990s.

Bubbles are only obvious in hindsight. No one can say for sure if we are in a technology-led bubble today, but the evidence does not clearly support this conclusion. We are entering a period of innovation which will result in societal changes very few can comprehend. It seems just as likely that this will be the rational driver of markets in the future more than any pockets of euphoria that can be found today.

Electrify, digitise, and be healthy!

A growing theme in recent months is the idea that whilst the macro-outlook could be described as challenging, the micro-outlook is compelling. Since the start of 2022, investors have, in hindsight, spent too much time thinking about interest rates and inflation (important but unforecastable) and not enough time thinking about, for instance, artificial intelligence (AI), electrification and weight-loss drugs (important and forecastable). This has led to some generational investment opportunities being missed.

Take electrification or described another way, the use of electrons. Electricity was first used in a practical sense in 1821 when Michael Faraday invented the electric motor. Knowledge of its existence goes back even further to the 1750s. How can a technology that has been around for more than 250 years still be transforming society?

The renaissance of electrons has been driven by two factors. The first is the desire to replace carbon-based energy with more renewable sources. Electrons can be created from wind, hydro and solar power; carbon molecules cannot.

The second is the huge demand for power due to the explosion of computation, itself driven by artificial intelligence. This double whammy could see demand for electrons and electricity grow by as much as 10% a year for many years to come. This has profound implications for the investment which will be needed to support this growth.

AI is not new either. It first became an area of scientific discovery in the 1950s and has been the subject of science fiction movies ever since. The fundamental inputs of it are data and computing power, and it is the explosion of both in recent years which has allowed much more sophisticated models to be created.

It takes approximately 20 hours for a 17-year-old to learn how to drive, yet Tesla is nowhere near this after millions of hours training. But, while AI is unlikely to overtake human intelligence anytime soon, it will allow many more tasks to be done by machines. This is important as demographic trends are pointing decisively to shrinking working populations and it will enhance economic productivity.

It seems likely that we are still in the early stages of the digitisation of society. For many this will bring fears as well as opportunities, in much the same way the personal computer and the internet did. Technological progress is however one of life’s inevitabilities and investors can and will benefit from it.

Weight-loss drugs are the other social revolution in its early stages. Obesity could be argued to be partly responsible for climate change, through excessive consumption and the pressure that puts on resources, as well as many serious illnesses such as diabetes and heart disease. That there may be medicines which, with clinical supervision, can be taken to reduce cravings for food with the potential to transform society.

In summary, a choice can be made to invest from a macro perspective and focus on interest rates, inflation, and economic growth. Or on a micro basis and focus on such things as electrification, digitisation, and health. Which of these themes will serve investors better over the next 10 years?

The positive, identifiable, and sustainable themes of technology, electrification, digitisation, and health are powerful and compelling investment stories which will gain traction in coming years.

And finally, a memo from a Fund Manager’s desk.

“Nearly every company we invest in has reported now. Here are a few things they are saying:

There is no sign of a recession in the order books of companies, or in meetings with CEOs. Most CEOs are surprised by the resilience of the global economy and now that interest rates have likely peaked, they see growth, not recession, ahead.
The investment in US infrastructure, via government-led incentives, is a once-in-a-generation opportunity for companies and investors. One company described it as the fourth industrial revolution which will see many years of strong growth in certain end markets.
UK-listed companies and global investors are far less concerned about the well-being of the UK equity market than UK investors and the media. Global investors are happy to own global companies listed in the UK and many of these have seen a material increase in the proportion of overseas investors on their share registers.
Investors are so pessimistic! As one CEO said, pessimism isn’t a valuable behaviour, it leads to missed opportunities.
2024 could turn out to be an interesting and profitable year with an increase in M&A activity.”

Corporates can be wrong. Like investors, they only see what is directly in front of them. That said, the message they are giving should provide some reassurance for better times ahead.

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

March 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.