Profit-taking to close an excellent year
While December started with a bang it ended with a whimper. China rebounded 4.2%, driving gains of 1.5% for Asia and emerging markets as a whole, but global bonds drifted a further 1% lower, with UK gilts down by 2.3%. The rise in government bond yields caused a headache for governments around the world, and further good news for the gold price, whose move signals how uneasy markets are becoming over the level of government budget deficits and long-term debt. The US dollar index rose to hit a two-year high.
A hawkish surprise from the Federal Reserve
In sector terms, the month saw renewed leadership from large-caps, growth and technology stocks, with a sharper sell-off in small-caps and domestically orientated value sectors, a partial unwinding of the 'Trump trade' which had seen these areas surge in the weeks following his re-election.
The main catalyst for market weakness occurred on 18 December. The US Federal Reserve cut rates by a further 0.25% as expected but went on to spook markets with a more hawkish accompanying statement that reduced the number of expected rate cuts in 2025. The perceived change in policy led to a jump in bond yields. Compounding the change in sentiment was stronger-than-expected economic data, which raised fears that inflationary pressures might spoil the party.
The US economy remains in good health. GDP rose 2.8% in the third quarter, the same rate as the second, and the Atlanta Fed's estimate for fourth-quarter growth stood at 3.2%. Nonfarm payroll numbers were strong, with a further 250,000 jobs added in November. Inflation, however, remains sticky at best: headline consumer prices edged up to 2.7% from 2.6%. As a result, forecasts for interest rates in 2025 were dialled back to just two cuts of 0.25% each, down from four, leaving US bond yields some 100 basis points higher over the past three months.
Turmoil in the gilt market puts the Chancellor in a tight spot
In the UK, November's GDP figures disappointed expectations, although the economy did at least manage to return to a marginal growth rate of 0.1%, the first time it had expanded in three months. This is not an ideal start for a new government championing a pro-growth agenda. Moreover, inflation rose by 2.6% on an annual basis in November, up from 2.3% in October and 1.7% in September, with higher energy costs largely to blame. On a monthly basis, however, prices rose just 0.1%, implying a slowdown from the previous month's rise of 0.6%.
The Chancellor has come under fire due to turmoil in the gilt market. The cost of government borrowing surged on fresh inflationary concerns, with 10-year gilt yields reaching 4.85% at their peak. The sell-off is unnerving for many reasons, but perhaps most because of the burden rising yields place on the cost of both issuing and servicing government debt. The Autumn Budget, barely two months old, risks unravelling in the event of a breach of the Government's own fiscal rules. Many critics blame the rise in yields on Budget policies, although the move has also been driven by external factors, as higher bond yields in the US have set the tone worldwide. In the face of this uncertainty, the Bank of England chose to keep interest rates on hold at 4.75%, while suggesting there was room for further cuts through 2025 if required; indeed, a number of economists predict that UK rates will fall more quickly than market predictions of two 0.25% cuts.
Elsewhere, the European Central Bank cut rates by 0.25% for a third consecutive meeting and made it clear that more were to follow. Eurozone economic growth is also struggling, but inflation is less of an issue for the region.
A note from the desk
I am pleased to share our monthly update on market events. The overview seeks to summarise market movements together with our views and the rationale for the positioning of investments going forward. As always, should any aspect of this commentary prompt a question, we would welcome the conversation.
Martyn Charlwood · Managing Director
Animal spirits, and the price already paid for them
Trump 2.0 has certainly unleashed animal spirits. There is a sense of optimism that Corporate America will lift markets higher, especially with the new President's business-friendly reflationary policy mix. Expectations on Wall Street are high for continued economic growth and earnings. The greatest perceived risk is one of economic overheating, which might be exacerbated by the incoming administration's expansionist approach.
Another key issue for the US is that valuations are at historically very elevated levels, which suggests that much of the anticipated future growth is already priced in. High valuations historically correlate with lower future returns, suggesting that investors should temper expectations of significant gains in the coming decade.
Diversification into cheaper markets is an effective way of managing portfolios from both a risk and a return perspective. We believe performance will broaden out in 2025, as the combination of stronger growth and lower rates provides a catalyst for rotation. US equities could lag other areas of the globe where prospects are improving, and relative values compared to the US have rarely been so compelling. Perhaps the greatest opportunity is in global small caps, which are trading at a multi-decade discount relative to their larger counterparts.
High valuations historically correlate with lower future returns. Much of the anticipated growth is already priced in.
The outlook remains positive for markets in 2025, with attractive opportunities in regions outside of the US, particularly in small caps and value stocks.
The United Kingdom
UK equities offer exposure to many high-quality companies trading at valuations significantly below global peers, together with a compelling income stream. Sector exposures in the UK are very different to other global markets, bringing important additional benefits in terms of diversification: minimal exposure to technology, but greater exposure to cash-generative financials, energy and basic materials, along with high-quality consumer staples. This should prove beneficial if expectations for a sector rotation in 2025 prove correct.
Emerging markets and China
The US monetary policy outlook is likely to be most supportive for emerging markets, where equities look set to benefit from stronger domestic growth; the region has delivered positive performance after the end of a US rate-hike cycle in four of the past five cycles. Chinese policy is unambiguous in trying to engineer an equity market recovery, with the authorities throwing the kitchen sink at the economy. It is hard to be bearish when both of the world's biggest economies are loosening monetary and fiscal policy simultaneously.
Bonds over cash
While equities remain our preferred asset class, the prospect of lower rates means that bonds should outperform cash. From an income perspective, yields are now attractive in both absolute and real terms relative to the level of inflation. Bonds also provide diversification in the case of slower growth but will not protect portfolios from the possibility that inflation remains higher for longer, which remains our central view, with the exception of index-linked bonds.
Gold and commodities
Alternative assets such as infrastructure, renewables, gold and commodity stocks offer a valuable additional source of diversification, allowing us to hedge against inflation and other potential risks. Stimulus by China could exert further upward pressure on commodity prices. We continue to view gold as essential portfolio insurance: the combination of higher geopolitical risk, lower interest rates and strong central bank demand has created a highly favourable environment for the yellow metal, and our exposure to both physical bullion and gold mining shares has been a major contributor to outperformance versus benchmarks.
Infrastructure and renewables
The infrastructure and renewables sectors look set to benefit from some weighty commitments outlined by the Government in its new policy agenda, including £35bn in roads and updating the digital grid, £20bn in green transport and a further £12bn in energy transition and renewables investment such as hydrogen, offshore wind and solar energy projects.
Capturing the upside, controlling the risk
Overall, we continue to manage investments in a manner that allows us to capture the upside in financial markets while also effectively controlling risk, to dampen volatility and smooth the path of returns.
Important information
This article is a marketing communication intended for general information only. It does not constitute personal advice, a recommendation, or an offer to buy or sell any investment. If you are unsure whether an investment is suitable for your circumstances, please seek personal advice.
Past performance is not a guide to future performance. The value of investments and any income from them can fall as well as rise. Capital values are at risk and not guaranteed. Forecasts and views expressed in this commentary represent our assessment at the time of writing and are subject to change.
To discuss how this commentary applies to your own portfolio, we would welcome a conversation.
Make an enquiry →