Our view on the investment markets

Market Review

April 2024

Following the strong end to 2023 for both equity and fixed income markets as lower inflation boosted hopes for a series of interest rate cuts, the first quarter of 2024 saw more mixed market progress as resilient economic data helped equities but delayed and softened the pace and scale of expected rate moves.

Conditions have varied across countries, with economic growth having been notably healthy in the important US economy, and with their patchy further progress on reducing inflation this led to no US rate cuts in the first quarter and significantly fewer cuts now expected in 2024.

Whilst better than previously feared, growth has been more subdued across the UK and Europe, with the UK seeing a modest technical recession of two successive negative quarters over the second half of 2023, although there have been more encouraging signs at the start of 2024. Good progress across energy, food and goods components has seen lower inflation in Europe and the UK, with the latest headline UK consumer price inflation level down to 3.4%.

Many central banks have now expressed their desire to cut rates and Switzerland has already moved. Although there are still concerns over elevated wage costs and service sector inflation, the Bank of England and European Central Bank are expected to be in a position to reduce interest rates potentially from June.

Geopolitical risks remained at elevated levels as conflicts continue, but market impacts were limited and equity markets enjoyed a strong first quarter as the rosier economic and corporate conditions outweighed disappointment over delayed interest rate cuts.

Despite being increasingly viewed as an undervalued market, the composition of the UK equity market and its lack of growth and technology stocks continued to hold it back compared to markets like the US. However, led by the industrials sector the FTSE All-Share index still achieved a gain of 3.6% in the first quarter.

Emerging markets and Asia Pacific ex-Japan lagged the UK, but gains of around 11% from the US and Japan and 6.8% from Europe saw international equities overall achieve a sterling terms return of 9.2% in the first quarter. Companies seen as benefitting from developments in artificial intelligence remained in favour.   

The growth and inflation backdrop was less beneficial to fixed income markets, with delayed rate cut expectations seeing declines in most government bond markets, and returns of -1.6% and -1.8% for UK gilts and index-linked gilts respectively. Elsewhere, there were first quarter gains of 0.2% for corporate bonds, 1.6% for high yield bonds and 2.0% for emerging market debt.

UK commercial property has seen tentative signs of recovery with valuation stabilisation being seen across some of the market, although the office sector continues to present a material challenge. Occupational markets remained resilient with parts of the market seeing rental growth. Overall first quarter market returns are expected to be broadly flat.

The returns on cash deposits have benefitted from the significant increases in UK interest rates, although the current bank rate of 5.25% is expected to begin to decline during 2024. 

Market Outlook

Ongoing geopolitical issues and a year with a number of important elections has the capacity to produce a lot of background noise for markets to navigate, but to date they have remained relatively focused on the progress of inflation reduction, economic and corporate growth and the potential for central banks to begin reducing interest rates.

Although economic growth has seen notable geographic differences recently, overall progress towards returning to more normal inflation levels has been broadly encouraging. Following a period of significant interest rate increases, central banks are looking to gain sufficient comfort that inflation is back under control and are seen as now being relatively close to beginning to ease monetary policy.

The relative strength of the US economy has delayed moves by the Federal Reserve, but both their forecasts and those of the markets still suggest some cuts in 2024. In the UK and Europe growth has been more subdued, and with inflation making good progress we could see earlier moves by their central banks.

With the last few years having seen a major pandemic, conflicts in Europe and the Middle East, 40 year high inflation and a significant increase in interest rates, equity markets have been remarkably resilient. It has been a more difficult period for most bond and property markets, although it has seen a welcome improvement in the yields available on assets such as government and corporate bonds.

Key to further progress by markets will likely be how inflation develops, but it is broadly expected that ongoing pressures from elevated wage costs, sticky service sector inflation and a higher oil price will be more than offset by improvements elsewhere. Following another mild winter and plentiful supplies to replace Russian gas, lower household energy prices will lead to a notable reduction in UK inflation in coming months.

Most economies have coped well in the face of much higher interest rates, especially in the US, with the impact of higher borrowing costs being somewhat offset by the resilience of consumer spending and fiscal policy support. Whilst US growth may soften in coming months, the likelihood of dipping into a recession have lessened, and the more subdued economies of the UK and Europe are showing signs of a return to growth, with above inflation wage rises providing a potential boost to consumer spending. For the global economy as a whole, most forecasters see a further period of modest economic growth in the short term before picking up from 2025.

Whilst there are risks to this scenario such as if geopolitical tensions escalate, if we do see the expected further reductions in inflation, resilient economic growth and the turning point in the interest rate cycle, then the fundamental background for most investment assets should be broadly positive.

Whilst the previous substantial fall in bond prices was painful for investors, the resulting improvement in yields has meant that fixed income assets are offering better value than we have seen for a long time, and are once more offering their traditional attractions of both reasonable income and return potential and also useful diversification benefits within mixed asset portfolios. However, high levels of government debt in many countries and heavy bond issuance to fund deficits may act as a constraint on prices.

Our portfolios limited exposure to government bonds in recent years whilst yields were so low, but with 10-year UK government bonds (gilts) now offering yields of over 4% alongside the risk reduction benefits they provide in many potential stress scenarios, we are now building exposure back up in our strategic asset allocations. Other fixed income options such as investment grade corporate bonds, high yield and emerging market debt offer even more income to compensate for their greater risk. These additional yields over gilts (known as spreads) take overall yields up to some attractive levels of income by recent standards.

Equity markets have also been caught up in the ebbs and flows of inflation and interest rate expectations, with occasional short-term reactions to geopolitical events, but the improving growth narrative has driven many markets to all-time highs. 2023 gains were largely driven by a relatively small group of predominantly US-based technology companies seen as beneficiaries of the rapid growth of artificial intelligence (AI), but although they continue to perform well, growth in 2024 has been more widely based.  

After such a strong run for equities since the sell offs of 2022 the edge has been taken off some of the previous valuation attractions and there are a number of potential risks that could see short-term sentiment reverse. However, resilient growth and looming rate cuts could continue to support markets and there are other potential positive structural drivers from developments in areas like AI, decarbonisation and healthcare. Many equities continue to be priced at or below their long term average valuations, they have a long track record of delivering above inflation growth, and still offer reasonable opportunities for patient investors who are able to cope with any shorter term volatility.

The sector composition of the UK market and its lack of technology exposure has seen it behave quite differently to other markets in recent years, and it has also been impacted by the long term headwinds of investors reducing their UK exposure and elevated political risks since Brexit. Having been out of favour for so long valuations are now at notable discounts to other markets, even allowing for the relative lack of growth stocks, and the UK offers an attractive dividend yield. With the domestic economy showing tentative signs of improvement, relatively low political risks from the forthcoming election, and a market that is attracting corporate takeover interest and still hosts a number of good quality companies offering significant international revenue exposure, there is the potential for sentiment to turn towards the UK as we have seen recently for the previously out of favour Japanese market.

Within international equities the US remains the dominant market, having benefitted greatly over the last decade from their above average exposure to growth and technology stocks, the strength of the dollar, resilient consumer spending and substantial fiscal packages. As a home to many excellent companies the US continues to form a significant part of our global portfolios, but with a significant election looming and valuations above all other regions, we look to diversify exposures towards other more attractively valued equity markets.

Despite its previous reliance on cheap Russian gas and exporting goods to China, Europe has coped relatively well with challenges in these areas, and alongside Japan offers reasonable valuations and has seen positive market performance since 2023. Emerging markets contain a wide range of countries with different attributes, but despite fewer inflation and interest rate headwinds they have endured a long period of underperformance. This has been largely driven by weakness in China due to their disappointing economic recovery from Covid, property market weakness and tensions over their relationship with the US. Emerging markets overall continue to see elevated risks, but still offers superior economic growth and the potential for longer-term outperformance at relatively attractive valuations.

The outlook for UK property remains one of stabilisation, with potential for valuation recovery as interest rates fall back. However, further negative pressure is expected from the office sector which continues to be impacted by structural challenges and limited investor demand. Overall UK property total returns for 2024 are expected to be mid-single digit and strongly influenced by income.

With the UK base rate at 5.25% returns on cash deposits are at their best levels since 2008, although they are set to reduce over coming quarters and are expected to settle in the 3-4% range. Whilst this should still provide a useful low risk option for savers alongside other investment assets, cash is unlikely to match their medium to long-term return potential.

In conclusion, whilst economies have proved surprisingly resilient and inflation continues to return to more normal levels, there remain potential challenges to this improving environment from areas such as escalating geopolitical or election risks or stickier inflation further delaying rate cuts. However, if inflation continues to subside as expected we should see a welcome turn in the interest rate cycle which often proves a useful catalyst for market sentiment across many investment asset classes. The previous increase in interest rates sees both returns on cash and the yields available on fixed income assets offering much improved value and they now provide useful attributes alongside equities in mixed asset portfolios. The strong run for equities has perhaps lessened some of their shorter-term potential, but many UK and international equities remain relatively attractively valued given an improving corporate environment. Suitably diversified portfolios containing equities, fixed income and property (where available) offer the potential to deliver reasonable medium to longer-term investment returns.

Paul Glover
Chief Investment Manager
April 2024