Our view on the investment markets

Market Review

October 2024

The third quarter saw periods of volatility, but progress on cutting interest rates and a package of stimulus measures from China helped deliver healthy returns across the main asset classes.

Politics and geopolitics remained firmly in the news headlines, including the expected strong Labour majority in the UK election, but despite escalating tensions in the Middle East, investment markets continued to largely focus on economic and corporate growth, the improving inflation situation and the prospects for a series of interest rate cuts. 

There were some concerns that the previously robust US economy was showing signs of slowing down, but most commentators do not expect the US to slip into recession, and despite some weak spots, overall global growth has remained sluggish but more resilient than expected.

Some inflation components have remained elevated, especially the services sector where wage increases have a bigger impact, but overall inflation levels have made good progress towards the 2% levels that authorities generally target. Although services inflation remains above 5%, the latest overall UK consumer price inflation figure for August was a healthier 2.2%.

This progress on inflation and some concerns about slowing economic growth has seen major central banks shift their assessment of risks away from just inflation, and monetary easing gathered pace in the quarter. This included a significant first move in this rate cutting cycle from the US, where the Federal Reserve lowered rates by 0.5% in September. With some concerns over sticky inflation elements, the UK has been a bit slower to cut rates, although August saw the first cut since 2020 from 5.25% to 5%, and with an expectation of more to come in coming quarters.

Equity markets made further progress in the third quarter, with the China stimulus package seeing emerging markets with the strongest returns. Whilst UK consumer sentiment was impacted ahead of October’s budget, the UK economy has been in reasonable shape and the election result was relatively well received. There have been tentative signs that sentiment is improving towards the UK equity market, and the UK FTSE All-Share index third quarter gain of 2.3% took 9-month returns to just under 10%. 

Sterling had a strong quarter and this softened international equity returns for UK investors, with a sterling terms gain of 0.2% in the quarter (a gain of over 5% in local currency terms). This improved 9-month returns to 12.8%, with the US and emerging markets leading the way in 2024 with gains of around 15%. 

Fixed income markets were also supported by the prospects for lower interest rates, with both government and corporate bonds seeing gains. UK gilts returned 2.3% in the quarter, narrowing 2024 losses to just -0.2%. Corporate bonds gained 2.3% for both the quarter and 9-month periods, whilst a strong quarter has seen 2024 gains of 7.7% for high yield bonds and 8.3% for emerging market debt. 

The UK commercial property market recovery has continued, with rental growth, improving prices in areas other than the office sector and good levels of income support helping deliver an expected overall 9-month market return of over 3%. Overseas property markets have been slower to recover than the UK, with returns further impacted by the strength of sterling.

Returns on cash deposits remain comfortably above inflation, but are off their peak following the cut in the UK bank rate to 5% and with further cuts anticipated.  

Market Outlook

It is understandable that investors may be nervous when the news headlines are constantly highlighting economic challenges and a stream of political and geopolitical issues, but it is important to remember that investment assets are focused on many different factors that often don’t make the headlines and are mostly valued based on a forward looking basis.

2024 has been a year with a record number of elections and is seeing an ongoing range of geopolitical issues which have continued to produce a lot of background noise for markets to navigate. Political changes and an escalation of geopolitical challenges can have an impact on the fundamental economic and corporate drivers of investment markets, as we saw with the impact of the invasion of Ukraine on energy and food prices, but so far in 2024 markets have remained remarkably well focused on the overall resilience of economic and corporate growth, falling inflation and the improving scope for central banks to be cutting interest rates.

Economic growth has proved to be more resilient to the period of high inflation and increased interest rates than initially expected, although there remain pockets of relative strength and weakness amidst an overall subdued but positive picture. Some weak employment data raised concerns that the US may be heading for recession, but overall indicators just suggest a slowdown after their recent period of relatively good growth. With China looking to support its weak economy, and signs of improvement from the UK and some parts of Europe, the outlook is for a period of more balanced but still largely subdued growth across different regions. 

There are still areas where inflation has remained sticky, especially those where elevated wage increases have a larger impact such as the services sector of the economy, but overall inflation has largely returned to target and major central banks have had the confidence to be able to begin their long anticipated cuts to interest rates. A series of further rate cuts are forecast over the next few quarters, with the UK bank rate now expected to move towards 3% from the current 5% level. With rates still above inflation, cash can still provide a useful low risk option for savers alongside other investment assets, but is unlikely to match their medium to long-term return potential. 

Equity markets especially have proved remarkably resilient to the challenges in recent years of a major pandemic, conflicts in Europe and the Middle East, 40 year high inflation and significantly higher interest rates. Whilst it has been a more difficult period for most bond and property markets, we have seen recent improvement and a welcome increase in the yields available on assets such as government and corporate bonds.

The inflation and growth outlook will likely continue to be the key drivers of investment returns, and whilst there are still pockets of inflationary concerns such as wages, overall it is forecast that inflation is expected to remain close to central bank target rates. Alongside resilient economic growth and lower interest rates, this has the potential to continue to provide a relatively positive fundamental backdrop for most investment assets. There are of course risks to this scenario on the economic side and also if any of the geopolitical tensions escalate or elections result in less market friendly policies, such as a shift away from the benefits of globalisation towards economic fragmentation and rising trade tensions and tariffs.   

For fixed income investors, the substantial fall in many bond prices in recent years has been painful, but the resulting improvement in yields has meant that these assets are once more offering their traditional attractions of both reasonable income and return potential and also useful diversification benefits within mixed asset portfolios. Lower inflation and interest rate cuts will especially help this area, but high levels of government debt in many countries and heavy bond issuance to fund fiscal deficits will likely act as a headwind for returns.  

With 10-year UK government bonds (gilts) now offering yields of around 4% alongside the risk reduction benefits they provide in many potential stress scenarios, we have been rebuilding exposures in our portfolios. 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) are narrow by historic standards, but default risks are relatively low and overall yields of around 5-8% offer some attractive levels of income.

For equities, the key to their resilience has been how well economies and companies have coped in the face of much higher interest rates, and the rapid improvement in inflation which has facilitated the turn in the interest rate cycle. The dominant US market has also seen significant benefits from the growth of its large technology sector, which has been boosted by excitement over companies that are seen as beneficiaries of the rapid growth of artificial intelligence (AI). 

After such a strong run for equities since the selloffs of 2022 and with many markets close to all-time highs, the edge has been taken off some of the previous valuation attractions, but despite some notable exceptions in areas such as the fast growing leading US technology stocks, many equities continue to be priced at or below their long term average valuations. Resilient economies and a series of rate cuts should continue to support markets and there are other potential positive structural drivers from developments in areas like AI, decarbonisation and healthcare. With their long track record of delivering above inflation growth, we retain our longer term conviction in equities and their ability to offer reasonable income and growth opportunities for patient investors who are able to cope with any potential 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. With a potential period of politically stability, an improving domestic economy supported by wages growing faster than inflation, and a market that offers global exposure with an attractive dividend yield that is attracting corporate takeover interest, there is the potential for investor sentiment to turn towards the UK.

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 substantial part of our global portfolios, but with a significant election looming and valuations above all other regions, we continue to look to diversify exposures towards other more attractively valued equity markets. 

Europe has seen challenges from its previous reliance on cheap Russian gas and exporting goods to China, but like the UK offers many good companies on reasonable valuations. Asian and emerging markets offer a wide range of countries with different attributes and attractions. China is a key focus in this area and has suffered from a disappointing economic recovery from Covid, property market weakness and tensions over their relationship with the US. Their recent stimulus package is an encouraging development, and whilst emerging markets overall continue to see elevated risks, they still offer superior economic growth and relatively attractive valuations, which offer the potential for good longer-term performance. 

Having stabilised and turned positive in recent quarters, the UK commercial property market is set to benefit from the improving economy and lower interest rates. The office sector may continue to struggle, but growth elsewhere and good income support is set to deliver mid-single digit overall UK property returns for 2024. Overseas real estate and infrastructure are being introduced to relevant portfolios to provide additional diversified sources of returns.  

In conclusion, whilst economies have proved surprisingly resilient and inflation has returned to more normal levels, there remain potential challenges to this improving environment from areas such as escalating political or geopolitical risks or stickier inflation delaying rate cuts. However, if inflation remains under control, we should see further interest rate cuts 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 softened their shorter-term attractions, but many UK and international equities remain relatively attractively valued given an improving corporate environment. Overall, suitably diversified portfolios containing equities and fixed income (and property and infrastructure where available) still offer the potential to deliver reasonable medium to longer-term investment returns.

Paul Glover
Chief Investment Manager
October 2024