308. Navigating market highs around the globe: insights from Q1 2024

18 April 2024 (pre-recorded 15 April 2024)

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[NTRODUCTION]

Staci West (SW): Hello and welcome to the Investing on the go podcast brought to you by FundCalibre. I’m Staci West, and today I’m joined by Darius McDermott and Juliet Schooling Latter for our quarterly market update. We’ll be looking back over Q1 of 2024 and a number of market highs, so we have a lot of regions and sectors to get through today.

[INTERVIEW]

SW: Let’s start our whistle-stop tour with the US. The S&P 500 continues to reach new records. In fact, it’s closed at an all-time high 22 times already through the first three months of the year. Let’s start with what’s driving this and should investors look to invest in a market when it’s at these highs or have they simply missed the boat?

Juliet Schooling Latter (JSL): Well, US strength has sort of broadened out this year so it’s not just the Magnificent Seven that’s driving stock market gains. I do feel a little wary of the US at the current levels, particularly as inflation is proving quite stubborn there. One headline that sticks in my mind and raises alarm bells with me is that UK investors added more to US funds in the first quarter than they did in the past nine years combined. So that worries me.

I mean you can’t ignore the US, it’s such a huge proportion of global markets and it could well continue to perform, but I think I’d be taking some profits and moving down the cap scale to the less expensive, smaller cap stocks. They have done a bit better recently, but they’ve been unloved for so long that I think they’ve still got further to go to catch up.

Darius McDermott (DM): Yeah, I mean the Magnificent Seven – I think it’s the “Magnificent Two” in 2024, Nvidia and Meta being the stronger two of those stocks – at a headline rate the US does look expensive, on a forward looking PE basis, but it’s not ridiculously expensive.

Yet we still have a US inverted yield curve and for those who can’t remember what that means, I’ll give it a basic stab. It just means if you lend to the US government for two years, they’ll pay you a better rate than if you lend to them for 10 years, which of course is counterintuitive: the longer you lend to anybody, you should get a better rate for. And a US inverted yield curve normally leads to a recession, which we just haven’t had. Growth in the US has been much stronger than most people predicted, as Juliet said.

Also, inflation has been much stronger than people predicted and hence rate cuts in the US which everybody was hoping and expecting at the start of the year, now look at least delayed if at all in 2024. So, that has been a big change in sentiment yet the US stock market has continued to go up. Companies are doing well and growth has been much stronger than people anticipated. So, I think everything Juliet said about valuations is absolutely prevalent and correct. I just would be a little nervous on those valuations as well.

SW: You both mentioned the Magnificent Seven in your answers and these mega-cap technology companies seem to be stealing the headlines, but Japan’s stock market, the Nikkei 225 also closed above its previous all-time high this quarter. What’s driving Japan’s market higher, is it also technology?

JSL: Well, Japan’s really exciting at the moment I think. We’ve been talking about corporate change in Japan for years and just getting bored with waiting for it to actually happen. Things don’t really move quickly in Japan, but finally they seem to be getting somewhere. So, the Tokyo Stock Exchange urged companies with book values of less than one to improve their valuations, but they’re now widening that. And corporate Japan is coming under increasing pressure to change. And then added to that, Japan’s finally experiencing inflation after decades of deflation. And effectively wages haven’t really increased there in 30 years, but we’re now seeing wage increases of sort of 5% come through. And so the Bank of Japan has raised rates for the first time since 2007. And finally also, there’s lots of domestic money sitting in cash, which is starting to move into markets. In January and February, flows into NISAs — their tax-free investment accounts — tripled. So, all in all, I think it’s looking quite exciting.

SW: What about the yen? Does the weak yen not eat into returns for UK investors?

DM: I mean, yes it does, absolutely, yes. If the stock market goes up 1% and the yen decreases 1% versus sterling, you get zero. But the yen has now been weak, particularly on the interest rate differentials that there are in the developed world versus Japan – actually Japan might raise rates a little bit, we might cut rates a little bit and that really should then give some strength to the yen, which, of course then, would boost those returns, it’s the opposite relationship. I mean, the yen has been weak, but you know, there are a number of Japanese funds out there [that] over a 12 month period, have given positive returns. So I think that’s in spite of the yen as opposed to because of that yen weakness.

SW: So, with that in mind, what’s your outlook for Japan going forward?

JSL: Well, I mean I remain positive on it. It has done well over the past year but it’s still got a long way to go to make up for decades of underperformance. So, if you look back, going back quite a long way, so 20 years, Japanese funds have returned 198% versus 604% in the US. So, there’s still quite a lot of catching up to be done there. I mean, there’s likely to be setbacks along the way, but it looks like it’s moving in the right direction.

DM: Yeah, and that observation period did start at the end of the ‘90s, sorry, the end of the ‘80s and the early ‘90s. There was a massive bubble in all sorts of Japanese assets, particularly Tokyo property, but their stock market, I mean, it got hugely overinflated, which is why it’s taken the next 20 years to get back to sort of new highs.

SW: And finally, we had another all-time high in the gold price. We won’t spend too much time on this as we had an excellent interview a few weeks ago on this topic. If you haven’t listened already, I highly recommend going back to Episode 307 and having a listen, but just briefly today, give us a few of your thoughts on the asset class.

DM: Well, gold has, as you say, broken through that sort of $2,000 barrier and got the $2,400s last week. It’s at $2,3xx something this morning [$2,359]. I think the uncertainty in the world, there is still war in Ukraine and there is considerably increasing tensions in the Middle East with Iran attacking Israel over the weekend. Gold, I think, has sort of been strong, primarily because of those sorts of macro concerns.

What hasn’t happened though is gold miners have lagged substantially. We often think of gold miners as a leverage play on the gold price. That hasn’t happened yet, so maybe given that higher gold price and value there, which again I’m pretty confident your guest discussed on the recent gold podcast, so yeah, let’s not spend too much time [going] into it, but often when things break through at a certain price, commodities, they can keep going for longer than people would expect. And with that global uncertainty, yeah, I quite like a little bit of gold in the portfolio.

SW: Now, coming back closer to home, headline inflation and core inflation in Europe both slowed in March after a pretty stagnant past year for the continent. Does it look like the economy is picking up again?

JSL: So, I think the picture in Europe certainly looks a bit better from here. As you say, inflation fell unexpectedly in March to 2.4% and business activity returned to growth for the first time in 10 months, with growth in services outweighing a pullback in manufacturing. So this paves the way for the ECB to reduce interest rates but also European earnings aren’t necessarily dependent upon the European economy with international revenues having increased by over 50% since 2010. So, you know, the health of the US and Asian economies are now quite important too. And sentiments towards European equities has picked up with net inflows into the region, which has been absent for quite some time.

SW: There’s also hope that China’s economy may start to recover. Do you share this view as well?

DM: Well, it’s been substantially disappointing following their Covid reopening. There is obviously cultural differences. Those of us in the West when we reopened, went out and spent – actually China did the opposite. Chinese people saved more because of everything that they had been through, so the Chinese consumer didn’t spend. That does leave the Chinese government – can they stimulate enough to get this sort of growth? I think we would expect some stimulus from the Chinese government and that could lead to a better period for Chinese equities which are cheap on all-known bases; cheap versus their own history, cheap versus other emerging markets, certainly versus the likes of say the [United] States, which is trading on a sort of premium to its historic long-term average, China is trading at a discount.

Whether you want to invest there, of course is a secondary question. It’s something we look at and talk about a lot. I mean, there’s no doubt it’s cheap versus its own long term history, it could have a period of recovery, yeah, sure.

JSL: Yeah. I mean, you know, it’s still got the headwinds of the property market decline and geopolitical tensions there. But yes, as Darius says, it’s certainly cheap so I think we are quite divided managers. We speak to a fairly divided [community], … you know, some [are] overweight China because it’s cheap and there are others who continue to avoid it.

SW: And I just want to take a moment to talk about fixed income. Bond markets began 2024 with certainty that a return to 2% inflation would allow the Fed to cut interest rates in March, but markets were disappointed and actually started in negative territory. So, how does the bond market look today?

DM: At least the starting yield on bonds is attractive. Inflation and then what happens to rates obviously does affect the capital; rate cuts – good for bonds; rate hikes – bad for bonds. But at least I’m getting paid north of 5, 6, 7% to hold bonds. So, I think from an income perspective as part of total return, that that side of the deal is holding up well.

As we’ve touched on the inflation expectations totally change them in the [United] States. The market is still pricing in – is it June or July, the first Fed rate cut? We don’t think that’s going to happen. [JSL: I think it might even be September now.] Yeah, I think it’s definitely been pushed back. We wonder whether, with the strength of the US economy, whether there will be any rate cuts at all, which were very much being priced into markets at the start of the year. So look, I think the outlook, and we’ve already touched about potentially divergence between sort of Europe and UK, where there is more likelihood of cuts sooner – that UK and European bonds would probably be a favoured asset class over US bonds, but with all the geopolitical uncertainty, what happens is people fly to dollars and fly to treasuries. So, at least I’m getting paid enough to wait. And rate cuts come or rate cuts don’t come, actually the yield itself is attractive enough in fixed income for us today.

JSL: Yeah, I mean I think you can also look under the bonnet at CPI [Consumer Price Index] which is quite interesting and quite different for different economies. So, one of the major problems in the US is rental inflation, which is actually a huge proportion of CPI at 35%. And that’s currently running at 6% and looks like it’s going to accelerate due to a rise in immigration.

And as a comparison, in the UK we have about the same level of rental inflation, but here it only constitutes 8% of CPI. So, you can see how things are sort of impacted differently. But yeah, there has, as Darius says, has been a sort of major switch around. And it remains to be seen whether the US will cut it all now this year having had the expectation that there would be about six cuts at the beginning of the year.

SW: What happens to bond markets when the Fed does start cutting rates or if, as you said, they don’t cut at all this year?

DM: Well, if the Fed doesn’t cut, it’s probably because the US economy’s in a pretty good position, which is good for stock markets generally. The bonds, as I said, you’re at least getting paid to hold bonds and so it’s always nice when any asset that you own makes a capital gain. But if the Fed doesn’t cut, I think that’s because the US is in a pretty stable place. If the Fed does have to cut, it could be because actually growth is really starting to decelerate and then that potential for recession rears its head.

The other thing which we haven’t discussed at all is the electoral cycle that’s coming: India first, we don’t know when our own election in the UK will be, but we damn well know when the US election’s going to be! And that might have an impact. I think both potential presidents are going to want to spend. That means borrowing more. What does that mean for the US balance sheet? All those sorts of questions that would arise. So yeah, I think broadly I would be balanced because of the starting yield on bonds. But don’t forget there are elections coming later in the year, particularly obviously the main one is the US and that will have income sorry impacts depending on their spending plans.

SW: And just to wrap up everything today, do you think markets actually look like they’re in a better place than maybe the start of the year? I mean, sentiment seems pretty high across the board, at least for major markets as we’ve covered a bit today. So, has your outlook for the year changed at all to reflect this?

JSL: Well, you know, I mean markets have been really strong in the first quarter and the global sector’s up almost 7% and the US up over 9%. So, this does naturally make me a little bit more cautious. The dangers that we face at the beginning of the year persist, you know, with Ukraine and general geopolitical tensions. So, I do wonder if we are due for a pullback at some point. However, having said that, the UK, which I keep banging on about, it’s only up 2.5% and UK Smaller Companies continue to lag to that. So I’d be tempted to perhaps recycle some profits from the US into the unloved UK.

DM: Yeah, I think economies have been stronger than people expected. And as we’ve already discussed, that has implications around the rate cycle.

There was some bad inflation data out of the US last week, which has been just a bit more persistent, but at 3-3.5%, it’s not disastrous. So, stock markets have continued to be positive this year. I just think the electoral cycle and rates and inflation will continue to be a dominating macro effect with, of course, all the uncertainty that’s coming out of the Middle East at the moment so, I think I’m broadly neutral for the rest of the year, given that there’s been a strong start. But yeah, do still watch conflict in the Middle East, that could have bad outcomes for markets if there was to be a dramatic increase in tensions and more parties entering into that dispute.

SW: Darius, Juliet, thank you very much for your time today and I look forward to next quarter where we’ll undoubtedly talk about the US and UK in more detail. If you would like more of our insights, you can look back through our old quarterly podcasts or visit FundCalibre.com for regular articles, videos, and podcasts from not only ourselves but all of our Elite Rated managers. And don’t forget to like and subscribe to the Investing on the go podcast, available wherever you get your podcasts.