Year End to New Year – key trends for portfolios in 2024 and 2025
Our CIO, James Calder, looks back to the central bank decisions, elections and many other key issues that have influenced our management of your portfolio this year. Looking ahead to 2025, he explains his reasoning for being quietly optimistic and identifies the important trends that we anticipate will influence our investment management strategy.
In one of my first letters of 2024 I stated that it would be the year of politics with over two billion people voting in general/presidential elections. Political events have dominated which as investors we react to and sometimes look to front run. The theme of politics has been preeminent but there have of course been other factors, which I shall comment upon and together with the more challenging subject of what happens next.
But first let me provide you with background on how markets have performed. At the time of writing (early December) the year has shaped up well, with most markets delivering respectable performance. Looking back to December 2023, whilst the year ended on a positive note, the previous two years were disappointing, and further ground still needs to be recovered.
Global performance, year to date till the end of November, ranges from modest to very respectable dependent, of course, on the market. The US equity market is the clear winner, and the global equities sector comes in second place, dominated by its holdings in US names. Much has been made of the influence of the ‘magnificent seven’ a term relating to seven technology stocks that have had an unusually positive influence on the overall US equity market (taken to be the S&P500). These include Apple, Amazon and Tesla. Their performance this year has been the standout absolute addition to the index return. Other sectors have also proven positive. But other sectors account for only a small portion of the index and have a limited effect. Therefore, an oversized sector, technology, continues to provide an oversized contribution to performance. It is hard to estimate when this might change as this sector is seen in part as a beneficiary of the next structural change, Artificial Intelligence. A significant part of our US exposure is invested within the index, and therefore benefits from technology’s performance.
I am very aware of repeating the mantra of inflation and rates over the past years and sadly this missive will be no different. But the mood music has changed. After expectations peaked in the summer of 2023, we entered this year with the consensus of market participants taking an exceptionally positive view on cuts. Reality proved otherwise, with the announcement of cuts moved back further and further. Whilst the inflation data proved to be on a significant downwards trend it was not enough to convince central bankers to cut as aggressively as the market expected. Taking the UK as an example, the two 25bp cuts announced in late summer are all we can expect in 2024. This is substantially less than predicted at the beginning of the year. The US surprised with a double cut (50bps as opposed to the usual 25bps move), likely playing catch up. Europe is cutting more aggressively, reflecting the dire situation that many of their leading economies find themselves in.
Rate expectations drive short term sentiment but of course have a meaningful impact on the economy. We continually wrestle with expectations. Post Global Financial Crisis (GFC), when central banks embarked on what became known as the ‘ZIRP’ (zero interest rate policy), one could, with comfort, state that rates were and would be flat for the foreseeable future. The return of inflation put paid to that, and the once friendly central bankers became less friendly. Calling rates is, as we have seen over the past two years, difficult. However, the trend is identified. We are now in a rate cutting environment; the question is by how much and how quickly. The apparent optimism at the beginning of 2024 has dissipated to be replaced by stoicism. We believe that interest rates will continue to fall through 2025, but terminal rates are now more likely to be in the low 4s or high 3s for the UK.
Inflation is now under control but will be volatile within a banding of circa 2-3% with seasonal impacts (the energy cap in the UK for example) playing their part. Unemployment, wage, and service inflation numbers will and are seized upon by our central bank’s rate setters as the signposts for their decisions. Whilst the headline inflation rate is restrained, some inputs are not, leading rate setters to remain cautious.
So, to politics. Two elections mattered most to us in managing portfolios. Firstly, the Labour Party sweeping to power in July with a substantial majority. More recently, the re-election of Donald Trump taking the swing states and popular vote to become the 47th US President in January 2025. The former has had their first budget which I have commented upon in a previous note. The latter has a very specific set of goals which will bear upon markets; rhetoric surrounding trade tariffs is causing concern around the world.
Commenting upon outlook, it is one of trends as opposed to specific targets. I remain optimistic that markets will continue to provide attractive returns. Whilst none of this is easy the difficult part is identifying the relative winners. The US is taking up significant bandwidth in terms of our assessment. A bombastic President with an ‘America First’ policy is leading to in-depth discussions regarding our US exposure, particularly those areas that will benefit from a domestic tailwind, such as small and mid-cap equities. It is important to take a breather and contemplate what this means. Small and mid-cap investing to the UK based investor implies additional risk. Setting the scene, one tends to overlook just how large the US market is, when we talk about small and mid-cap. In the US the average small cap company market capitalisation is counted in the billions of US Dollars whereas in the UK and keeping to the same currency a small cap market capitalisation average is in the very low hundreds of millions. Therefore, our US weight will be undergoing further assessment.
Our home market bias remains (structurally the UK equity weight is higher than its weight within a global equity index). We continue to take the view that as Sterling based investors, we are comfortable with a home bias and point to its global weight of 4% being diminutive. The new government has yet to give details as to where its spending will be placed, but I am of the view that it will be a positive for the domestic economy. Hence our warm view towards the UK market as a whole. Relative to history and other asset classes it is inexpensive. I would caution that whilst UK recession is not our base case, its risk has increased, and we will maintain a watchful eye on the impact of the new Government’s first budget. There is limited fiscal headroom, and a reversal of our view could be quick if data disappoints. Prior to the UK budget we took the decision to cut, where possible, UK smaller company exposure due to concerns regarding tax changes. These came to pass but were not as penal as feared leading us to move back into UK small companies.
Fixed interest, or bond investing as it is more commonly known, has not been a source of great alpha (a financial technical term for added value) or returns since the GFC of 2008. The GFC led to unprecedented levels of monetary stimulus (central banks stimulating the economy by encouraging bank lending and of course very low interest rates). This had implications for bond investing, and an almost zero interest rate environment led to feeble returns, compared with history as the risk-free rate was basically zero (investments tend to be priced off the risk free rate). The return of inflation due to both loose fiscal and monetary policy led to the inevitable increase in rates, which has caused so much economic harm (but that was the point). Where do rates settle is a question we wrestle with continually and I have commented on this earlier in the note. What is becoming apparent, well at least to me, is that Fixed Interest will play a more prevalent role in portfolios, particularly those managed on a lower risk basis. If we can agree that we will get ‘three for free’ (base rates bottom here, a bit of reach) then a skilled fixed interest manager with an active mandate should be looking at returning at least 6%. If we can agree that the long-term return of developed market equities is in the 7-8% range (it will be more or less depending on the near-term backdrop) 6% for a lot less volatility is attractive. I have started work in this area and whilst it might be a simple case of adding to what we currently have. I will turn over some stones and see what else is on offer.
Within alternatives there has been progress on the corporate side; five of our holdings are in some form of wind up or returning partial cash to shareholders. This takes time but I expect 2025 to witness significant progress, whilst I will note again the timings for that cash hitting portfolios will be lumpy. These assets will continue to benefit from the fall in interest rates (they have long dated cash flows which will become more attractive as short-term interest rates fall). The latent value story has been slow, and we are remaining patient, whilst I am loathe to fall into the trap of capitulation.
I read economics for my undergraduate degree and was initially phased by how little of it seemed to matter in the real world when I started working (my Masters was more vocational and, with hindsight, useful). However, I do hark back to economics from time to time. It is useful for interest rates, inflation, tariffs and trade wars amongst other topics. One question or view that gets aired is ‘where are we in the investment cycle?’. At the risk of sounding dismissive, it does not really matter as long as we are not in recession. I can see the arguments for both a continuation of the current cycle or being in a brand new one. Whilst recession is not our base case, the risk has increased. So, what concerns me? In short, the largest obstacle is what will President elect Trump do. I am fond of pointing out that he is the author of ‘The Art of the Deal’. However, in a worst case scenario stagflation (rising unemployment, increasing inflation and low growth) may occur. For a President that benchmarks his success against the S&P500 and internal interest rates, this would be a hard square to circle. I still believe that the ‘America First’ policy will be something our clients can exploit, the concern is if the extreme rhetoric turns into substance. But the benefit of the doubt must be given that Mr Trump currently wants to take a bargaining position.
2025 will have its challenges, all years do, but I am confident (exogenous shocks aside as always) that positive returns can be generated. Some assets are verging on the expensive but for many I believe there remains attractive upside.
Please note that this summary was prepared on 3 December 2024 and reflects our current view of your portfolio and our investment strategy. You will shortly be receiving valuation reports for the period ending 5 October 2024. The commentary accompanying these reports is superseded by the information provided here.
