deVere Group: Investment Outlook March 2024
Andrew.J. Barros ACSI
Area Manager at deVere Spain SL | Wealth Management Consultant for the Expats and International Investors
Investment Outlook
Tom Elliott
A fortnightly look at global financial markets
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Market sentiment:?Good, but challenged. Several major stock market indices, including the S&P 500, Nikkei 225 and Stoxx Europe 600, reached new highs in the past fortnight. This has been in anticipation of a pick-up in global GDP growth over the second half of the year, as central banks start to cut interest rates. Gold and Bitcoin have also recorded new all-time highs, reflecting geopolitical risk as well as anticipated interest rate cuts.
But recent stronger-than-expected U.S inflation data, and a still-strong labour market, has re-introduced uncertainty over the date of the first rate cuts from the Fed. In addition, there is a growing expectation of a ‘short and shallow’ cycle of rate cuts when they do start. A rate cut from the Fed, when it meets later this week is all but ruled out by the market, with June or September considered the more likely starting dates. The Fed’s hesitancy will affect other central banks’ decision making, notably the Bank of England, which is also meeting this week.
Global stock markets have so far proved resilient to the risk of ‘higher for longer’ interest rates, in large part because of strong corporate earnings growth. But yields on U.S Treasuries, often considered the ultimate risk-free asset, have risen. The Two Year Treasury yield, a maturity date that is highly sensitive to changes in interest rates, is up from 4.5% on the 8th?March, to 4.7% today.
Long term investors should remain invested in a diversified portfolio, with exposure to equities, bonds and alternative assets from around the world. Financial history shows that this approach helps generate the best risk-adjusted returns, over most long term time periods.
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U.S stocks – justifiably expensive.?When the S&P500 broke through the 5,000 barrier in late February, some sell-side houses to upgrade their year-end forecast. Goldman Sachs’ new number for 31st?December is now 5,200 (the index currently sits at around 5,118). But others warned of the U.S stock market being in a bubble territory, led by tech.?
True, U.S stocks are on high valuations relative to their history and to other regions. For instance the trailing price/earnings ratio on the S&P500 is around 27 times. This means that it will take 27 years for the average S&P 500 company’s most recently reported earnings to equal its current market capitalisation. In contrast, the same p/e ratio for the FTSE 100 is 11 times, the German DAX is on 15 times, while in Asia the Nikkei 225 it is 16 times and the Hang Seng on 9 times.?
But…the U.S economy has been by far the best performing of the G7 since the Covid pandemic began. And Big Tech’s fourth quarter earnings growth numbers broadly confirmed investor optimism on the sector. In other words, the U.S is expensive, but justifiably so.?
A greater risk to Wall Street is not so much the valuations of the Big Tech stocks, but the fact that their combined market capitalisation is around a third of the S&P500 index (if we include Amazon). As we have written previously, such a high level of sector concentration can be a cause of instability, for any stock market index.?
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Over the next twelve months, rather than the Wall Street bubble bursting, a more likely scenario is a period of catch-up for European and Asian stock markets, as central banks start to cut rates and a new economic cycle begins. Driven in part by the high weighting of economically-cyclical stocks in the major European stock indices, compared to on the S&P500. The FTSE 100 index looks particularly attractive, given that it offers exposure to a range of multinational companies that are on low valuations. With perhaps only a quarter of their combined revenues originating in the U.K, it is a global index.
The Great British ISA – a welcome proposal.?The U.K economy appears to be exiting a short recession, with January monthly GDP growth at 0.2% - higher than many had expected. This translates as 2.4% annualised, which is near the 1949-2023 long-term average of 2.3% (Source: Trading Economics). However, there is much fretting by economists that GDP growth merely reflects population growth, due to high levels of immigration. Measured on a GDP per capita basis, growth is amongst the weakest in the G7. This reflects weak productivity growth amongst those employed, and a disturbingly large number (perhaps 8 million) of economically inactive adults.?
Most economists agree that to raise productivity more investment is needed, in buildings and equipment, and in education and training. However the current U.K government is hamstrung in providing the lead, burnt by its experience with the expensive flop of the HS2 high speed rail project, and by its own MPs who see tax cuts rather than investment spending as the key to stimulating growth.?
However, chancellor Jeremy Hunt’s spring budget of a fortnight ago will help private capital formation and investment, and is to be welcomed. He proposed Great British ISA, in which up to ￡5,000 can be placed each year, for investment in U.K companies only. It will be on top of the ￡20,000 ISA allowance already available. It has long seemed odd that the U.K government is happy to give a tax break to British investors to buy stocks in overseas companies, this new ISA addresses the issue. ?
Sterling up.?The pound has been relatively firm against the dollar so far this year, it currently sits at its January level of $1.27. This reflects improved economic growth forecasts for the U.K in the second half of the year, and investors betting that the Bank of England will be more modest in its interest rate cuts than the Fed, even as inflation falls sharply in the near term. This is because of the weak productivity growth mentioned above, which means inflation pressures may return if growth accelerates a little.
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Bank of Japan ponders positive interest rates.?While the Fed, the ECB and the Bank of England are all likely to cut interest rates over the next six months, the Bank of Japan is edging towards a hike. It meets on Thursday. If it does raise interest rates, it is expected to take the main policy rate from -0.1% to +0.1%. These are astonishingly small numbers when compared to interest rates elsewhere.?
The reason is that fourth quarter GDP growth has been revised upwards, while recent labour market data suggests pay growth remains stronger than the central bank would wish for. This provides cover for the central bank, allowing it to normalise interest rates (ie, make them positive in nominal terms), long after its western peers have done so. For almost three decades the Bank of Japan has battled deflation with ultra-low and negative interest rates. It has, perhaps succeeded, with inflation at 2.2%. But economists warn inflation?expectations?have yet to rise, and so inflation has not yet been anchored.?
Speculation of a rate hike has helped push the yen up against the dollar this month, but at Yen 149/ $1 the currency is remains weak relative to its history. As recently as February 2022 it stood at Yen 115/$1. Many investors fear turmoil on Japanese bond and stock markets if the Bank of Japan raises interest rates too much, too soon. Or at all. A difficult decision.?
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Gold and Bitcoin at new highs.?Gold’s recent rally has taken the metal to a new high (at $2,181 a Troy ounce on 11th?March). The rally reflected the prospect of falling interest rates, which reduce the opportunity cost of holding gold relative to income-producing assets. Investor enthusiasm for gold also reflects geo-political instability, whether it be concerning China and Taiwan, Russia and Ukraine, or fear of the U.S government paying back its massive borrowings with devalued dollars.?
Bitcoin -which is often referred to as digital gold- has also been hitting new highs (reaching $73,135 on 13th?March). Given its relative newness in financial markets, it is hard to be sure what has been driving it higher in recent months. However, the decision eight weeks ago by the Securities and Exchange Commission to approve Bitcoin exchange-traded funds (ETFs) has undoubtedly driven investor interest, and helped support its price. Last week, it was reported that Blackrock’s iShares Bitcoin Trust was the fastest U.S ETF in history to reach the $10bn size, it now sits at $12.7bn, made up from Bitcoin appreciation and more than $7bn of inflows since the SEC’s decision.?
Bitcoin may also have been benefiting from the same prospects of lower global interest rates, and geopolitical instability, as have been driving gold. The return of the ‘higher for longer’ interest rate theme has since caused some selling.