Investment Update: August 2024

INVESTMENT UPDATE AUGUST

*All return in local currency terms

Overview

The equity index results in the table above mask a high level of sector rotation and underlying volatility during July, particularly in the US, as concerns arose about the viability of the AI related stock rally coupled with some significant currency moves. As we know at the time of writing, immediately post the month end this volatility increased substantially and manifested itself in some large index moves.

On the bond front however, we saw further progress, with yields declining and prices rising again, following better than expected inflation numbers in the US. The UK ten-year gilt yield moved below 4% for the first time since December 2023, as speculation grew about the potential for an interest rate cut by the Bank of England.

US

The toing and froing of the US election had quite a part to play in aforementioned pickup in equity market volatility. Failings of the US Secret Service were evident at the Donald Trump rally at Bethel Park, Pennsylvania where the former president narrowly escaped assassination. Market reaction was initially muted, but analysis of the implications soon gave rise to equity market volatility. The expectation for Mr Trump to win the November election took a strong boost. Trump’s policies include imposing further tariffs on a wider range of imported goods.as well as a weaker dollar, which while potentially beneficial for some US companies, are also inflationary. The situation was then later in the month muddied by President Biden’s announcement of withdrawal as an election candidate and markets had to consider the possibility of a Kamala Harris win, which would have less of an impact in this respect. Despite neither of the candidates showing serious signs of addressing the US budget deficit, government bond yields managed to decline following a better-than-expected CPI (inflation) number than the market expected.

The background of lower inflation and better prospects for interest rate cuts this year had a marked effect on the previously underperforming small company index, the Russell 2000, which at one point rose nearly 10% in a day. However, this was coupled with worries about the sustainability of the level of AI related spending by the likes of Alphabet (Google) and Meta. Coupled with earnings that weren’t topping analysts’ expectations in the sector, we saw the technology stock rich NASDAQ index decline 6% from its intra month peak. The darling of the AI word, Nvidia, and a major constituent of that index, fell over 12.5% from its intra month high. Whilst the broader S&P index, of which Nvidia is also a significant constituent, delivered a positive return, in dollar terms at least, the rise can be attributed to a better performance from the wider, non- Technology related, index constituents.

This can be evidenced by the returns of the S&P 500 equally weighted index vs the ‘standard’ market capitalisation weighted S&P 500 index over the month. Whilst the equally weighted version outperforms the capitalisation weighted version over the longer term, more recently the high concentration of the top 7 stocks has led to significant outperformance of the capitalisation weighted version. However, the better performance of the wider market reversed this trend:

Source: Morningstar. Explanation: The S&P 500 index that we quote at the top of this update, is the version where the percentage of each stock included is dictated by the size of the company. Of late the price performance of the top 7 stocks combined has reached nearly 30%, so the performance of this small number of companies can have a significant impact on the index as a whole. In the equally weighted version, each of the 500 stocks in the index gets allocated in equal proportion i.e. 0.2% per stock. That means the percentage of these top 7 stocks combined is only 1.4% (0.2%x7). So, these stocks’ influence is diluted.

Returns for sterling investors were dampened, as a strong pound following the UK election had a negative impact. With 70 companies reporting so far (and 81% of companies beating expectations by 5.66%), the US earnings season is off to a good start, which in part goes to explain returns widening out to the broader market. The estimated growth rate for 2nd quarter earnings is now 10% and rising (as it typically does). The breadth of earnings seems good, with all sectors now posting positive and rising year-over-year estimate growth. It’s a solid backdrop if the economy is indeed in a soft landing.

Europe

Although we saw positive progress in the broader European index, the French market continued the decline set off by the snap election and the consequential hung parliament. Whilst we have all enjoyed the Olympics, President Macron stated that he would not form a new government until after they had finished. Consequently, the country remains in political limbo. Elsewhere we have seen downward pressure on some of the luxury European brands, which have been the standout performers of late, as demand seems to slow in this previously resilient consumer sector.

UK

The stock market was pretty sanguine about the UK election result, as the results were widely expected and the FTSE managed a decent return over the month, although this was probably due to the aforementioned prospect of a UK interest rate cut in August.. This was coupled with a strong pound and positive moves in the gilt market. These factors combined to lead the second tier of the UK market, the FTSE 250, to have an extremely positive month (up over 6%), as companies in this area of the market tend to be sensitive to both currency and interest rate movements. The first speech by the new Chancellor, Rachel Reeves, ahead of the budget in October, suggested that a £20bn fiscal ‘black hole’ left by the Conservative government, meant that she would have to take some ‘tough decisions’. This seems to be focussed on infrastructure and increased taxes outside of income tax and VAT, although it didn’t prevent her from quickly agreeing to award public sector wage rises to the tune of a cost of £9bn to the Treasury. Although its highly likely the better off will be paying more taxes, or losing benefits, it is still unlikely that we will see a deviation from the policy of fiscal prudence that has been suggested by the new government thus far. There are also some accounting policies that the chancellor might adopt, such as the way losses arising as a result of Quantitative Easing (QE) undertaken by the Bank of England are treated, which might give her more room for spending.

Japan

A surprise interest rate rise of 0.25% by the Bank of Japan, coupled with an announcement about slowing down bond purchases, both of which were intended to address the strengthening yen and resulting inflation, certainly had the desired effect, with the yen advancing over 7% against the US in a period of two weeks. This, however, had knock on effects elsewhere. The stock market, having achieved a new all-time high earlier in the month, lost as much as the currency had gained from that point, as investors worried about the impact on the earnings for Japan’s large exporters. The effect of the yen’s rise on the carry trade, where overseas investors borrow yen to fund trades elsewhere, created ripples in other markets.

Asia and Emerging Markets

The volatility that we saw in Technology stocks in the US was reflected in certain Asian markets, such as Taiwan and Korea, which are heavily weighted towards semiconductor stocks, so we saw falls here after months of positive returns. China, the world’s second largest economy is making slow progress to escape the Covid related slowdown and the huge debt mountains linked to the giant state-backed real estate companies. The People’s Bank of China has made two modest interest rate cuts to stabilise and promote economic growth. The Chinese currency is being allowed to drift weaker, supporting export initiatives.   The results from planned export campaigns have partially succeeded but will take more time to bear fruit. The headwind of trade tariffs, particularly onerous in the United States but less so in Europe will slow progress. China’s notable stockpiling of copper as a key raw material in modern goods has begun to unwind. Having imported vast quantities of the metal to support the manufacturing drive, China is now a net exporter of the metal.

This move seriously depressed the copper price globally during the month. At stock market level, India is accelerating in terms of overall value relative to China, which remains subdued:

Outlook

Despite the pickup in volatility, portfolio values were fairly stable during the month, although we did see a further increase in volatility immediately after the month end. The political backdrop in the US is likely to continue to have an impact, given the differences in economic policy of the two presidential candidates. However, the underlying liquidity provided by the US Treasury and the prospects of a September interest rate cut by the Federal Reserve, certainly lend support to equity markets at present. The rotation in favour of smaller companies has been captured at model portfolio level and will likely play an important role for a while longer. Our fixed income duration (sensitivity to interest rates), having been shortened in our most recent portfolio rebalance, has proven an effective stance. As rate cuts continue to flow through from developed markets we are well situated, and risk remains in line with expectations.

Rockhold Asset Management, with contribution from Alpha Beta Partners, Marlborough and LGT, August 2024.