Macro
In Q4, markets were at the mercy of the ubiquitous political uncertainty, but we remained focused and grounded by macro data and company fundamentals. The US economy continued to hold up well, with Gross Domestic Product (GDP) growth defying expectations by accelerating to 3.1% and consumer confidence tracked higher. However, there were spots of weakness in the data. The labour market is starting to ease and October’s Nonfarm (private sector and government agencies) payrolls registered the lowest level of job growth since 2020. Meanwhile, credit card delinquencies reached their highest level since 2010. Overall, the US economy remains strong, but will likely slow in 2025.
Here in the UK, the picture was much murkier given the uncertainty surrounding the Budget and the discontent with the outcome. Whilst Rachel Reeve’s held her promise to avoid taxing incomes directly, the increase to employer’s national insurance will likely feed through to consumers and hurt just the same. Retail spending has consequently disappointed alongside private sector activity. GDP growth or complete lack of, embodied the contrast to the macro data across the pond. Encouragingly, uncertainty ahead of the budget will now dissipate and the UK’s services centric economy should be more shielded from a potential ramp up in trade tensions as we head into 2025.
European data has also been lacklustre as the continent, particularly France, continues to be shrouded in political uncertainty. European industrial output disappointed, and the manufacturing sector remains in a strong contraction. However, as in the UK, the consumer is in a healthy position and should benefit from the excess savings from the pandemic and real wage (excess over inflation) growth that households are currently experiencing. Should data continue to remain in the doldrums, inflation is close enough to 2% that the European Central Bank (ECB) is in a position to cut at a faster pace to stimulate the economy.
Data over in Asia was relatively strong, especially in Japan where Purchasing Managers Index’s (PMI) improved, inflation looks increasingly sustainable and wage growth continues to support retail sales data. Meanwhile, in the world’s second largest economy, China’s incremental improvements were seen from the targeted stimulus measures. PMI’s moved further into expansion and consumer confidence ticked up, but a meaningful recovery in the consumer remains absent and retail sales consequently disappointed in December. The property market remains very weak and given the extent of people’s wealth held in real estate, it will likely take something dramatic from the government to reignite the consumer.
Markets
The quarter got off to a choppy start, as bond yields rose and investors took profits ahead of the US election. However, the bull market soon resumed when Trump resoundingly won one of the highest profile elections in history to become the 47th president of the United States. The quarter finished as it started, and the ‘Santa rally’ consequently failed to materialise, rounding out a mixed quarter for world markets amidst another positive period for US stocks.
It remains to be seen whether Trump’s bark is equal to his bite. Should he enact the corporate tax cuts that he has proposed, earnings are expected to see six percentage points increase and therefore he should be positive for markets. Domestic-focused smaller companies would be the largest beneficiary and the Russell 2000, the US small-cap index, was consequently up 6% on Election Day. However, the potential tariffs and deportations will likely be inflationary and the bloating fiscal deficit appears unlikely to be addressed, and therefore US bond yields continue to creep higher.
The US 10-year Government Bond yields are now in line with the UK 10-year Government Bond yields at 4.6%, with UK yields also rising sharply over the period given the greater than anticipated fiscal demands from the Budget. However, yield moves from here are likely to divert given the weakness in UK data and strength across the pond. In December, the Fed cut rates by a further 0.25%, but crucially guided for just two rate cuts in 2025. We see scope for these cuts to be further reined in if the US economy continues to hold up.
French, Japanese and Korean politics also added to global political uncertainty, with a snap election in Japan, attempted martial law enactment in Korea and a no-confidence vote in France. All three stock markets sold-off as a result, with France and Korea particularly struggling to recover. The collapse of the French government and announcement of a fourth new government in 12 months saw French Government Bond yields overtake Greek yields.
The dollar hit a two-year high on the back of the Fed’s hawkish comments and this left the yen close to record weakness and the euro nearing parity.
Gold saw a negative quarter, but impressively it still outperformed the S&P 500 in 2024. Meanwhile, oil was up slightly, but still registered a loss for the year.
Positioning and outlook
Despite deficit and political concerns, US valuations remain elevated and earnings growth forecasts are optimistic. This could remain the case for some time as the Artificial Intelligence (AI) trend continues to gain legs with recent progress in quantum computing and the ‘Magnificent 7’ likely evolving into the ‘Fateful 8’ to add AI chip manufacturer, Broadcom. The top 10 companies in the US now make up 40% of the S&P 500, but just 12% of its sales. As earnings broaden across the remaining stocks, we will likely see a less concentrated market as the ‘Magnificent 7’ digest their valuations and earnings catch up.
Earnings are also expected to broaden out regionally. However, the prospect of escalating trade tensions on the back of Trump’s tariffs is a concern with China’s and, therefore, Europe’s economic recovery potentially hindered as a result. The UK should be relatively shielded from any escalations and with budget uncertainty dissipating, cheap valuations, attractive dividend yields and a low volatility market, we are relatively positive about the prospects for the UK market in 2025.
Within the UK, we are overweight to smaller companies, given that they typically outperform in rate-cutting cycles and there is a potential for greater than anticipated rate cuts if data continues to disappoint. We remain short duration and high quality within fixed income due to potential for yields to rise and spreads to blow out.
We put some cash to work ahead of the strong January seasonality, adding active exposure to US large and mid-caps to position for the broadening out of earnings and performance from the ‘Magnificent 7’.
With market volatility and geopolitical uncertainty rife, cash might seem like the best place to be. However, as demonstrated below, the typical 60:40 equity bond portfolio has typically outperformed cash by a strong margin even during the most volatility-inducing events.
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
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