Market Commentary, January 2025
In the first weeks of Donald Trump’s second presidency, Chief Investment Officer, James Calder, reflects on the US economy and considers the impact on global markets. Focusing on our own strategy, James considers how we are positioning our client portfolios to take advantage of these developments and discusses implementing our decision to increase allocation to the US.
The inauguration of Donald Trump as the 47th President of the United States was held on 20th of January 2025, heralding the start of a populist ‘America First’ presidency. On day one, a bombshell of ‘Executive Orders’ gained headlines and set a forthright approach to policy. Ignoring the rhetoric and setting political views aside, we as investors must react to the new situation. In other words, we play the hand we have been dealt. Many commentators are seeking to describe what impact the Trump Presidency will have upon market returns. But, taking a moment to reflect, the US economy that President Trump inherits is robust. Employment and GDP growth continue to surprise on the upside. Inflation, through a restrictive interest rate policy from the US Federal Reserve (the FED), is under control. President Trump’s hand is by no means weak. In fact, the predicted pace of rate cuts has lessened due to the strength of the economy.
Two years of back-to-back 20% plus returns from the US’s cornerstone equity index, the S&P 500, is impressive (and comes after a fall of almost 20% the previous year). However, the substantial driver of this has been the dominance of the technology sector, particularly the ‘Magnificent 7’ or ’Mag 7’ (Alphabet, Amazon, Apple, Meta Platforms, Microsoft, NVIDIA, and Tesla). These stocks are trading at valuations greater than those of the wider market and parallels are inevitably made with the Technology, Media and Telecoms (TMT) bubble experienced in the late 1990s. I have been reflecting on Mark Twain’s quotation that ‘History never repeats itself, but it does often rhyme’. Is there enough ‘rhyming’ to be concerned? On one hand the valuations today are pricing in substantial future growth. However, unlike the TMT bubble where valuations were extreme and companies had little if any earnings, today some of the ‘Mag 7’ achieve significant revenues. Part of the ‘Mag 7’ thesis is the rise of Artificial Intelligence (AI), and the productivity gains it will provide. So far, few companies can demonstrate the monetisation of AI, except for NVIDIA which sells the chips enabling the technology. To be candid I believe the jury is yet to make a final decision on AI. Our S&P 500 tracker has benefitted from the momentum here and will continue to track the fortunes of the ‘Mag 7’.
At our January 2025 Investment Committee meeting we decided to increase our weight to US equities. In our view, the Trump Presidency will be positive over the short to medium term for US equities due to the actions surrounding his ‘America First’ policy. An easy and obvious way to implement this is simply to upweight our current exposure. For some background, our exposure is a mixture of the S&P 500 index through a passive fund (it tracks the index) and some active manager exposure where the strategies fulfil specific objectives. What the active strategies have in common is their divergence from the index, which has led to differing performance due to their limited to zero exposure to the ‘Mag 7’. The approach of simply upweighting was considered but discarded in favour of taking a specific view. We are initiating, where appropriate, a position within an equally weighted S&P 500 tracker. I aim to avoid getting too technical, but some explanation should be useful here. This is a rules-based approach to investing which is straightforward; it takes the S&P 500 index by names (the stocks) and equally weights them instead of replicating them by size. This means that no sector and individual stocks will dominate. Therefore, the investment will still provide exposure to the ‘Mag 7’ but to a much-reduced degree. In other words, our exposure is further diversified, avoiding the concentration of the market, whilst still being exposed to the general growth of the US market.
As UK based investors, we maintain a ‘home’ bias. Client liabilities are in Sterling so a predisposition to the UK is not unreasonable. The weight, of course, can and will be moved depending on the direction and strength of our conviction. It has been our view that the UK equity market is not only cheap relative to other developed markets but also to its own history, therefore maintaining a positive view. At our recent Investment Committee, we challenged ourselves to justify this view. I reminded my colleagues that our discussion was occurring when the ‘doom-loop’ of poor news flow surrounding the UK was at its most extreme since the Truss ‘mini-budget’. The negative headlines include corporates complaining about the forthcoming increase in National Insurance; implementation of the ‘workers’ rights bill’; declining GDP numbers (in the last half of 2024); and poor retail sales. These factors have combined to lead to fears over the Chancellor breaking her own fiscal rules and being forced down the path of further tax rises or spending cuts.
The bond markets reacted negatively, pushing UK yields (the cost of servicing debt) beyond those reached after the disastrous Liz Truss ‘mini budget’. All politicians should be wary of getting on the wrong side of the bond market. Bill Clinton's chief strategist James Carville, put it best when describing the bond market and the impact it can have. “I used to think if there was reincarnation, I wanted to come back as the president or the pope or a 400 baseball hitter. But now I want to come back as the bond market. You can intimidate everybody.” Being impartial, the recent rise in UK bond yields was not confined to the UK but was across the board within developed markets (US yields also moved up), therefore the Chancellor cannot be held fully responsible. But the mood music within the UK is weak and a recessionary backdrop cannot be ruled out. For this reason, we reduced our overweight to investment in the UK, marginally.
Post the Investment Committee meeting, in fact the following day, the UK equity market rallied with the FTSE 100 index posting new highs over the following couple of trading days. So, what caused the optimism and is the UK now fairly valued? To answer my first question, the primary cause of the optimism was that very recent UK inflation data was less bad than expected. Flat lining economic growth dominated the final half of 2024. Poor retail figures in the run up to and including Christmas highlighted the trend of a weakening consumer. Sterling deteriorated significantly versus the US Dollar. All this combined to create a complete volte face regarding the consensus outlook for UK rate cuts. The two cuts predicted for 2025 have rebounded out to the previously predicted four. The first of these cuts is being widely anticipated in early February. It is now believed that the Monetary Policy Committee (MPC), the rate setters at the Bank of England, will focus on growth (or the lack of it) whilst accepting an inflation rate that is higher than the 2% target over the near term. The current rate policy is by the MPC’s own admission restrictive. UK Equity markets have reacted positively to the increased likelihood of a more benign interest rate environment as it is easier to do business. The FTSE 100 represents the one hundred largest companies listed in the UK. Many of these are multinational companies with the UK only accounting for a modest part of their revenue. A substantial number of them earn in US Dollars, so benefit when the Dollar appreciates versus Sterling. In other words, when their dollar earnings are converted into Sterling they benefit from a stronger dollar versus a weaker pound.
As to my second question, is the UK now fairly valued? Not by a long chalk. I believe the UK has some way to go. Markets do not move in straight lines, and I would expect some pull back. However, the trend will remain positive as long as the economy keeps within the tramlines of low(ish) inflation and more normalised interest rates leading to modest growth. Regrettably, the risk of outsized events or ‘fat tail’ (low probability but high impact) events has increased. Whilst it is far from our base case, the risk of stagflation (low growth, high inflation and high interest rates) has swollen. Inflation is falling, particularly those elements that the MPC worry most about. The balancing act now is to avoid pushing the economy into outright recession (which would lead to greater than expected cuts). I do worry that this ship may have already sailed.
As the arithmetic needs to add to 100%, when we increase one asset class it is of course at the expense of another. So how did we fund the increase in our investment in the US? For starters, a modest reduction in the UK got the ball rolling, as did a slight decrease in our property exposure, with the remainder coming from our alternatives exposure. Cash has been returning from the alternative income sector in the form of dividends and, in some cases, enhanced dividends and corporate activity.
President Trump’s second term, or Trump 2.0, as it is now known colloquially, will be a watershed moment in US politics. The nation may well re-set its relationship with the rest of the world, including its allies (in fact allies may well prove to be on the receiving end of the most aggressive of policies). As I mentioned at the beginning of this note, we can only play the hand we have been dealt. Pragmatism is at the heart of what we do and, fat tail risk events aside, I am optimistic. I still believe that client portfolios have exposure to undervalued assets and that attractive returns, for the risk taken, can be achieved.
Please note that this summary was prepared by our Chief Investment Officer, James Calder, on 22 January 2025 and reflects our current view of your portfolio and our investment strategy.
