Macro
Quarter three has been encapsulated by slowing global economic data with all of the US, China and Europe participating. Even the UK, which had been experiencing the best momentum of the major developed economies this year, saw some signs of weakness late in the quarter.
Central banks saw fit to take action as their data led approach came to the fore. As expected, both the European Central Bank (ECB) and the Bank of England (BoE) cut interest rates by 0.25% and somewhat surprisingly the Federal Reserve (Fed) decided to enact a 0.5% cut in their September meeting. Indeed, the Fed have appeared for the first time to call victory on their fight against inflation and have shifted focus to their mandate on employment, as a result of the weakness in labour market data throughout the quarter.
We had communicated in our Q2 commentary that interest rate cut expectations had been pared back, however, given the aforementioned signs of weakness, these have now been scaled back up with 2.1% of interest rate cuts expected in the US by the end of next year. Indeed, more interest rate cuts are expected before year-end in each of the US, Europe and the UK.
We believe the current stagnation in European activity leaves room for the ECB to cut rates harder and faster than expected by the market, especially now the Fed have started cutting.
On a more positive note, the most significant news came out of China late in September when they announced their largest stimulus package since Covid-19 in an attempt to shore up the property market and encourage consumers to spend. The combined measures amount to 3% of GDP, and we believe the most important, include cutting mortgage rates on existing homes, cutting reserve requirements on banks to free up more room for lending and an announcement of stock market reforms which include the promotion of share buybacks. The market took this very well with both Hong Kong and Shanghai up over 15% in September. This is an encouraging step in the right direction as the Chinese economy is in the midst of a balance sheet recession. It remains to be seen whether the Chinese also enact some fiscal easing which we believe would be welcomed and may be needed for this improvement to become sustained.
Markets
At the headline level, Q3 was largely another positive quarter, with the Chinese market stealing the show in the last month. However, this headline performance did mask bouts of volatility and several market sell-offs.
The first sell-off occurred at the end of July, when the Bank of Japan announced an interest rate rise whilst weak US labour market data was simultaneously released. This led to a closing in interest rate differentials between the two, a strengthening of the yen against the dollar and an unwinding of the Japanese carry trade (where investors borrowed cheaply in yen to invest in higher growth areas such as US technology shares). The second occurred at the start of September, and again, this was driven by weak US labour market data and concerns about slowing global demand. In both instances, markets recovered, and the US market continued to test all-time highs through September.
When all was said and done within equities, China and Emerging markets led the way, with all of the UK, Europe and US producing low single-digit returns. In both the UK and US, mid-caps outperformed their large-cap brethren as market leadership started to broaden.
Within fixed income, bond yields fell sharply throughout the quarter, and the US yield curve is no longer inverted for the first time in over two years. The negative correlation between equities and bonds now looks to be reinstated, and we believe core bonds will act as good insurance in the event of recession, although not our base case.
It was a mixed and volatile month on the commodity front.
Oil hit a three-year low in September as demand slowed globally, and Saudi Arabia announced they will abandon their unofficial $100 per barrel oil price target. Commodities had been selling off throughout the period until the news in China, and iron ore subsequently rose 20%, whilst copper was up over 6%.
Gold continued its remarkable run and was up over 10% over the period due to escalating geopolitical issues and a weakening dollar.
Finally, in currency, the yen ended the quarter up over 10% against the dollar while sterling also strengthened.
Positioning and outlook
Politics and the US election are likely to dominate market sentiment in the coming months. A poor display in the first televised debate now leaves the betting odds in Vice President Harris’ favour. However, it is too close to call as former President Trump should not be written off as he was in a similar if not worse polling position in 2016, the last time he gained office. Markets typically trade flat into elections, but we expect periods of volatility in the lead-up.
Equity markets this year have broadly followed earnings revisions upwards, although as can be seen in the chart below, these have now turned negative. This may imply some more downside in the near term, particularly in the US, where valuations are extreme.
Household allocations to equities are also near all-time highs which is likely to accentuate any periods of volatility that incur.
The Magnificent 7 have rightly led the market over the last 18-months due to superior earnings momentum. However, we would expect the broader market to start to catch up as their earnings growth slows and the rest of the market starts to improve.
We used the period of market weakness at the beginning of August to add some US mid-cap exposure where we expect improving profitability in the next 18-months and where the area should benefit from some flows away from the Magnificent 7. We funded this by taking profits from US treasuries.
Short-term election volatility aside, we are optimistic about most major markets. Falling inflation and the beginning of an interest rate-cutting cycle should bode well for company profitability.
Despite the weakness in the last month due to the pending autumn budget, we are still extremely optimistic about both the UK economy and markets. Since the start of the year, the expected level of GDP growth for 2024 has been revised upwards to 1.1% from 0.4%. Rising house prices, interest rate cuts, and real wage growth is a positive cocktail that sets UK companies up for improving profitability over the course of the next 18 months. Once the budget is out of the way, things should continue to improve.
As ever, and as long-term investors, we welcome periods of volatility and will use them to add to areas where we have the most conviction.
Kind Regards,
Robert Matthews, Head of Research and Chartered Wealth Manager
Important Information:
For more industry terms and definitions, visit our glossary here.
All Index data figures are sourced by Morningstar and correct as at 30 September 2024, unless otherwise stated.
The value of investments or any income arising from them may fluctuate and are not guaranteed. Past performance is not necessarily a guide to future performance.