Everything must change for everything to remain the same

At the start of the year, we mentioned that 58% of the world’s democratic population were facing elections. To that tally we can now add France where the outcome has resulted in no clear majority in parliament. By contrast the UK, where the election came sooner than most pundits expected, now looks a beacon of stability and predictability. How the pendulum swings!

Whilst we are talking about politics it is worth mentioning the market has taken the result of the UK election with equanimity. Mainly because this is not a surprise to anyone, and Labour have made a lot of effort to convince the market of their fiscal discipline. As we write this, we have not heard the King’s speech and Labour have been very coy about their plans for domestic taxation. By the time you read this commentary any news will have been fully analysed by the media and we fully expect the crucial detail to follow later in the year at the first budget.

We have seen solid returns across most markets in the first half of 2024, helped by decent earnings growth. Consumer spending is holding up, supported by wages which are now growing faster than inflation which in turn has declined significantly from the peak in 2022. We also have a very benign backdrop for global liquidity and investors have been adding to equities. The US retail investor who still has excess cash savings has been joining the party meaning that the US led global market returns this year. When we analyse the drivers of returns we can see how narrow the market leadership is, with c. 70% of companies underperforming the index and over half the gains year to date being driven by a handful of companies (formerly known as the “Magnificent Seven” but dwindling to the “Fab Five” e.g. Microsoft, Amazon, Alphabet (parent of Google), Meta (formerly Facebook) and Nvidia). Although earnings growth has been solid, price gains have outstripped earnings growth meaning that these segments of the US market have become more expensive.

This concentration is an unintended consequence of the success of tracker funds (the majority of retail flows in the US are into tracker funds). These funds are, by definition, the opposite of valuation sensitive investors and the “more buyers than sellers” effect has become a significant influence if not distortion. However, when these flows change, the fall from grace can be significant. Tesla, one of the original” Magnificent Seven” is now c. 40% below its all-time high. For active investors like ourselves it is a continuous balance between participating in these momentum stocks through tracker funds and our exposure to active managers.

Elsewhere other equity markets have started to perform as investors are looking for less expensive equity exposure. It is worth mentioning Japan which in Yen terms has been one of the best performing markets returning over 20% but due to Yen weakness the return for UK investors (who measure their gains in sterling) reduced to 6.2% in sterling terms. 

Bond markets continue to trade within a tight range, reacting to the latest data release. Investors remain focused on trying to determine the path of inflation and decode the comments from various central bankers in order to determine the timing and pace of interest rate cuts. The European Central Bank was actually the first major central bank to cut rates and the tea leaves indicate that the Bank of England and US Federal Reserve will also likely reduce rates, maybe starting this quarter. Although the onset (and pace) of rate cuts will be a lot later and slower than expected at the start of the year this has not upset markets. With bond yields of c. 5% we can afford to be patient holders.

Despite the political changes the outlook remains more of the same – well, almost. We still have the US election to contend with and the only prediction we will make is that there will be a lot more noise to come. Economic data and earnings remain in that sweet spot of “not too hot not too cold”. We are beginning to see signs of a rotation to cheaper and frankly left behind markets and segments, notably small caps. We continue to maintain our neutral exposure to equities.One potential challenge on the horizon that we are watching is signs that the rate of growth in money supply is tapering. If money supply is the global liquidity that floats all boats we could have some volatility ahead.