Stock Market & Economic Commentary - October 2024

“I can’t change the direction of the wind, but I can adjust my sails to always reach my destination.” Jimmy Dean 1928-2010 American singer, television host, actor, and businessman

Economic Update

According to the latest Deloitte survey of UK chief financial officers (CFOs), optimism among the UK’s largest businesses edged lower in the third quarter following a strong bounce in the wake of the general election in July. Nonetheless, confidence and risk appetite are still running at above average levels.

The survey closed shortly before Iran’s missile attack on Israel on 1 October and encompassed a period of greater tension in the Middle East. As has been the case for the last five quarters, CFOs say that geopolitical developments represent the greatest external risk to their businesses. Concern about the risk of a potential hard landing in the US has risen sharply and this ranks as joint second greatest risk alongside weak UK productivity.

Unlike the period following the invasion of Ukraine in 2022, when CFOs’ worries about energy supply and prices spiked in tandem with geopolitical concerns, CFOs today are relatively sanguine about the risks around energy, in part, perhaps because of a decline in the oil price between July and late September.

The survey has mapped CFO perceptions of external uncertainty since 2010. The third quarter survey registered a modest increase in perceptions of uncertainty, but the absolute level remains low by the standards of the last eight years.

The UK labour market has softened since the start of the year and CFOs expect wage growth to slow markedly, from 4.6% in the last 12 months to 3.2% in a year’s time. With a waning of inflation pressures CFOs expect the Bank of England to cut interest rates from the current 5.0% to 4.0% by next September. Credit conditions are improving, with CFOs reporting that credit is cheaper than at any time in the last two and a half years.

An overwhelming majority of CFOs expect to raise spending on digital technology and assets, such as software, IT and AI, both over the next 12 months and on a five-year view. Investment in business performance and workforce skills emerge as lesser, though significant focus areas, especially in the longer term. CFOs are most cautious on spending on real estate, machinery, and other physical assets.

The UK economy saw an unexpectedly strong recovery in the first half of the year, with GDP growth outstripping that in any other G7 economy. The latest CFO Survey points to continued growth ahead, albeit probably at a slower pace than in the first half of the year.

Surprisingly, a year of elevated geopolitical risk in the Middle East, and OPEC production cuts designed to bolster prices, have seen oil prices drift lower, not higher. After the recent fall, the oil price is 10% lower than it was on 6 October last year, the day before Hamas’ attack on Israel. Part of the reason is that oil demand from China, the world’s second-largest oil user, has softened in the last year. Some smaller OPEC producers have exceeded their production quotas which has reduced the effectiveness of OPEC’s attempts to bolster prices. Last month the Financial Times reported that Saudi Arabia is likely to abandon its unofficial oil price target of $100 per barrel as it prepares to raise production from December. This story has also weighed on the oil price.

So far, financial markets have remained calm in the face of rising risks in the Middle East. The relationship between oil prices and western growth seems to have weakened and energy markets are more resilient and diversified than in the past. Yet the Middle East remains a vital energy producer and rarely has the risk of direct conflict between Israel and Iran been greater. The global economy may be better placed to cope with oil shocks, but it is not immune from them.

Stock markets

“The market is better at predicting the news than the news is at predicting the market. Gerald Loeb 1899-1974. Stockbroker, Investment Banker & Wall Street Trader, and Author of “The battle for Investment Survival”.

“The times they are a changing.”

Mr Fletcher died years ago, and Messrs Shepherd, Cooper and Thatcher are nearly extinct. Master Baker can still sometimes rise to the occasion though.

Surnames often reflect trades from the past and remind us of how times change.

When I was at school, I was periodically asked what I thought I would do when I grew up. At the age of 10, I fancied myself as a cowboy actor (Burt Lancaster, Kirk Douglas and James Dean were my heroes) or a veterinary surgeon as I come from a farming family. At secondary school, I said something about acting and was invited to take a career aptitude test. The recommendation came back, “banking, accountancy or finance for you, my boy.” My dreams of a West End stage appearance were shattered.

The world can change quickly – it feels today that it is changing faster than ever. Usually, it is driven by technology. Cars made saddlers redundant, farm machinery did it for agricultural labourers, and digital finance has seen off many of those banking jobs my teacher had earmarked for me!

If jobs are changing, then of course so are companies. Looking at the original FT 30 constituents from 1935, the index includes Bolsover Colliery, five car manufacturers (Austin, British Leyland, British Motor Corporation, Wolseley, and Morris), several thread, yarn, and textile firms, and Woolworths.

Evidence there, if it was needed, that there are few “buy and hold forever” stocks. What is more interesting is how some of the survivors have evolved. WPP started out as “Wire & Plastic Products.” It was bought by Martin Sorrell in 1985 and became an advertising group.

Smiths was making wind up clocks in 1935. Today, among other things, it manufactures the scanning equipment for airports.

Fast forward to the present day, and OpenAI, the purveyor of productivity-enhancing chatbots, recently received a cash injection from existing investors of $6.6 billion. In what seems like the blink of an eye, OpenAI has grown to become one of the most valuable companies in America with a valuation of close to $200 billion. The company’s products are now so advanced they can answer PhD level questions on physics.

I wonder if OpenAI will be a “buy and hold forever stock?” Who knows but for now at least it seems less of a company and more of an idea. Grappling with the science of artificial intelligence is not for the weak of heart. The same is true of investing in OpenAI and similar high-tech, speculative companies and investors today are perhaps powered as much by instinct as intelligence.

Stimulus and more stimulus

The last few weeks have seen a material shift in the investment environment, with several events occurring that demand some consideration.

First, and somewhat uniquely, we have the three major economic regions of the world, the US, Europe, and China, all putting stimulus into their economies when they are observably growing quite nicely. The US is currently growing at around 3% per annum, China at 4%+, and Europe at 2%. Stimulus is usually countercyclical, increasing in times of economic weakness, not procyclical, where you add stimulus in the good times.

Second, and more specifically to China, the government was previously ambivalent to problems in the property and consumer sectors given that overall economic growth led by exports has been okay. Now, however, the government is talking about making tangible steps towards supporting these important areas of its economy. This is a significant change in policy, and whilst the precise details are not yet fully known, it is a material event helping to push the Chinese stock market up 25% in the last week of September.

Finally, tensions in the Middle East continue to rise. Given that around 30% of oil production is in this region, escalating tensions can have an impact on oil prices which are an important variable in economic activity. Higher oil prices can lead to recessions.

Of these three variables, the first two – stimulus generally and what China is now doing – are positive for stock markets. All other things being equal, which they rarely are, economic growth and corporate profitability, two key variables in equity prices, will be stronger than markets would have expected a few weeks ago. Of course, there are downside risks too, inflation will likely be higher, but overall, it is a favourable scenario.

Rising geopolitical tensions, taken to the extreme, would not be good for stock markets, however. While no one can forecast what will happen in the Middle East, there are some concerning scenarios which could play out. However, experience suggests that geopolitical tensions always subside and so from a market perspective are buying opportunities. I think that this will remain the case, but there is always a risk involved.

On balance and adding in the wave of productivity-enhancing innovation happening in the global economy, a favourable environment for stock markets to grow seems much more likely than a meltdown. Strong economic growth, increasing stimulus and high levels of innovation is perhaps most comparable to the late 1990s. At that time, interest rates were also falling due to concerns over Year 2000 IT risks (remember that?) at a time of good economic growth and strong innovation. Between 1997 and 1999 the US stock market rose by over 50%.

I am not suggesting this will happen again, but it is a scenario which has some credibility, and one which will be discussed more widely if geopolitical events begin to calm down.

Experience and age

Experience and age are interesting topics when it comes to investment success. There is a general view that both are positive, not just in investing but in nearly all professions. For those in non-physical roles, “a good old one will beat a good young one” is the usual mentality.

Of course, age and experience do not give any rights or default superiority in investing. We can be prisoners of our experience as well as beneficiaries. A good example of this would be after the technology bust of the early 2000s, where many of those who witnessed it became too reticent to invest in the technology sector and missed out on the exceptional returns from the internet and cloud computing tech stocks. Equally after the financial crisis, many investors became too risk averse and missed the great equity bull market of the 2010s. Experience is neither good nor bad – what you do with it is what counts.

In that spirit, there are significant benefits to longevity in markets. They teach you lessons by being a constant feedback mechanism both for your own decision making and for economic and corporate events which happen on a regular basis.

Here are some of the best lessons markets teach us all:

Success in the long term often requires us to make decisions that may be detrimental in the short term. Buying what is in favour at any given time can work but buying what is out of favour and may become more popular is where the big money can be made. Recent events in China, noted above, are a lesson in this.
Macro beats micro over the short term, but over the long term, micro always beats macro. What happens at an industry and company level is much more important than inflation, interest rates, and economic growth. Markets taught us this in late 2022, when the emergence of generative AI more than offset recession concerns and began a new bull market in equities despite rising interest rates and inflation.
Patient optimism beats impatient pessimism. Delivering long-term investment returns requires a lot of patience. Compounding, as they say, is the eighth wonder of the world, but it takes decades to achieve and ideally should not be interrupted. Equally there aren’t many rich pessimists in the investment community. Over time, economies grow, and corporates grow with them, resulting in an upward rising equity market punctuated by one-off events. A long-term chart of equity markets teaches us this.
True investment success is built from the aggregation of sensible investment decisions, not from trying to hit home runs. Investment returns are a function of how much money you make less how much money you lose. Managing both sides of this equation is important. There is no value in being right for nine years and losing it all in year 10. We can see this in the implosion of the technology boom in the late 1990s, and to a lesser extent in 2022.
Most news, perhaps as much as 99%, isn’t relevant in the long run. Things that seem important in the moment are rarely important as time passes. Even the most extreme events – from pandemics, financial crises, recessions, wars and much more – fade into the distance as time passes and do not impact the long-term case for owning equities. The Covid pandemic, as a market event, is the latest demonstration of this.

Of course there are many more lessons. Learning new lessons and relearning old is a critical part of investment success but the experience of being an investor over many years is on balance a positive, so long as it is used in the right way.

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

Keith W Thompson

Clarion Group Chairman

October 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 & Economic Commentary – October 2024