Inflation didn’t miss by much in the US – 3.2% versus 3.1% predicted. In the Eurozone, inflation climbed to 2.9% in December, from 2.4% in November, but was back down to 2.8% in January. In the UK, inflation rose marginally to 4% in December, up from 3.9% in November, after economists had predicted a slight fall.

Nevertheless, it has been enough to trouble the bond markets. The US 10-year treasury yield is back above 4%, and shorter-dated yields have moved even higher. The UK 10-year gilt yield has moved from around 3.5% at the start of the year to just under 4% today and the 2-year from 4% to 4.5%. This disrupts the view that government bonds are a one-way bet for the year ahead.

See also: It’s time for multi-asset managers to ditch bond proxies

The US Federal Reserve has pushed back on market expectations for a rate cut in March, saying that “the committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably towards 2%”.

Nevertheless, most believe that rate cuts are deferred rather than cancelled. Anthony Willis, investment manager on Columbia Threadneedle’s multi-manager team, says: “Chair Jay Powell spoke positively about the progress made so far but said there was a need to have more confidence on the disinflation path”. The Fed is “not looking for better data, but a continuation of the better data” that has already been seen. Powell said that a March cut is not the most likely case, because the committee is unlikely to have hit that level of confidence by then.

“Futures markets are pricing only a 35% probability of a cut in March – though the Fed will have two more inflation data points to digest by then. Powell’s comments suggest that if inflation remains on track, then even if March is not likely, rate cuts are coming soon,” adds Willis.

See also: Facing the inflation dilemma head on

Jim Leaviss, manager of the M&G Global Macro Bond fund, also believes rate cuts are still likely: “Inflation has started collapsing – both core inflation and headline inflation. The numbers that the Fed looks at – core PCE inflation – are back down towards 2%. It is going in the right direction.”

Inflationary risks

That said, Leaviss also believes there may be longer term risks to the current benign inflation picture, particularly in the US. He points out that there is usually a balancing mechanism for government debt. Governments borrow more when the economy is weak; and when the economy is weak, inflation is falling and interest rates are generally coming down as well.

However, he adds, “this relies on a world in which governments borrow more when economies are weak, not where they borrow more to juice an already strong economy.” The US has seen two quarters of 4-5% growth, and its employment market is very strong. Nevertheless, he believes that widespread disgruntlement with rising prices is likely to usher Donald Trump into the White House, and that tax cuts are likely to be his priority once he gets there.

Tax cuts have historically been a significant contributor to rising debt to GDP. Leaviss says Trump’s election is likely to be inflationary and the US government will have to borrow more at higher bond yields.

Inflation protection?

Charlotte Yonge, assistant manager on the Personal Assets Trust, is also alert to the risks inherent in US borrowing: “The US government is spending money like it’s going out of fashion. This has provided a great fillip to growth. The fiscal deficit – the amount by which government expenditure exceeds receipts – was $1.3trn for the first three quarters of 2023, or nearly 5% of GDP.  We have never seen this level of government spending outside of a recession or its immediate aftermath.  On a gross basis, the fiscal outlay relative to the size of the economy is approaching a level consistent with the peak in government support provided during the Second World War.”

She believes this phenomenon is consistent with a multi-decade long trend and is not unique to America.  It is both a symptom and a cause of lower pain thresholds on the part of electorates around the world. She adds: “We expect that the next recession will see a fiscal response on top of a monetary one, such that the benefits extend beyond owners of capital to labour as well. This, as we saw with Covid, is likely to mean inflation for goods and services on top of asset price inflation.  Governments’ increased readiness to respond to economic hardship will help define the shape of the next recession and subsequent rates of inflation.”

The consequence of this shift is likely to be more volatile and structurally higher inflation than we have experienced over the course of the last 10-15 years. In response, the trust now has around 40% in index-linked bonds, mostly in the US. This is well above the trust’s long-term average of around 30%.

For Leaviss, the bond market is still good value, and they are keeping a watching brief on the election outcome. He adds: “The Fed says that long-term interest rates, based on demographics, technology, globalisation, and those long-term factors that determine how much we save and invest, will be around 2.5%. The treasury market thinks it’s more like 5%. We’ve never seen this degree of dislocation.” As a result, he is focusing on longer duration government bonds, believing this is where the opportunity lies.

Bonds markets have re-set since the start of the year and now reflect less optimism on rate cuts and falling inflation. Inflation is unlikely to bounce back significantly, but there are always unpredictable elements, such as the oil price, and markets are jumpy. It can still be the year of the bond, but investors will need to be selective.

This article was written for our sister title Portfolio Adviser

2024’s calendar of elections kicked off this weekend with the Taiwanese election, which immediately careered into controversy. However, markets appear to be untroubled by any potential escalation in geopolitical tensions it may bring about. Is this a sign of things to come, where markets largely ignore the outcome in the busiest year for elections in history?

The Taiwanese election demonstrated some of the potential pitfalls for the year ahead, as China condemned global governments for welcoming the pro-independence victor from the Democratic Progressive party. A US State Department spokesperson congratulated the Taiwanese for “demonstrating the strength of their robust democratic system and electoral process”. This drew ire from China’s foreign ministry, which said the comments “seriously violated US promises that it would only maintain cultural, economic and other non-official ties with Taiwan”.

Markets have taken no notice of this exchange, possibly because relations between the US and China were already weak and it does not alter their position significantly. This reinforces the prevailing narrative that elections don’t matter very much for developed markets. Certainly, analysis of stock markets through history seems to support this view.

Dina Ting, head of global index portfolio management at Franklin Templeton ETF, says: “Data for US markets show that over the longer term, presidential election outcomes tend to have very little impact on market moves.”

See also: Momentum: Seven risks for investors to watch for in 2024

Analysis from Brian Levitt, global market strategist at Invesco, shows that in the US, neither party can claim superior economic or market performance. The stock market posted positive returns across most administrations, with the rare exceptions of presidencies that ended in deep recessions. He adds that the S&P 500 index has delivered an average annual return of approximately 10% since it started in 1957 through both Democratic and Republican administrations.

A similar picture emerges in analysis of UK markets. Research by AJ Bell of all 16 of the general elections since the inception of the FTSE All-Share in 1962 shows that the UK stock market is indifferent to a change of government – and may even welcome it: “On average, the FTSE All Share has recorded a double-digit percentage gain in the first year after an election which sees one prime minister ejected from office and another ushered into it. There are also greater average gains when a government changes relative to when it remains the same.”

However, it can create volatility, and this appears more likely this year than in previous election cycles.

Ting adds: “Typically, the widest range of possible market outcomes relative to other periods of the election cycle occur during the uncertain 12 months preceding election day. With current volatility in the low teens, we see the risk of politically induced spikes throughout the year. Historically, the 12 months leading up to elections post average volatility of 17% in years when the same party continues its hold on the White House; in years when the presidency flips, that figure rises to over 20%. Given the fraught political backdrop, we may see a more nervous market than what is currently priced.”

Anthony Willis, investment manager at Columbia Threadneedle, says there is significant potential for politics to influence markets in the year head. He sees an ‘ugly battle for democracy in the US’ adding: “We are likely to see legal processes involved and the Supreme Court will probably have a role. With the election so tight, it may make a difference. This will be a backdrop all year.”

He also believes it may affect economic outcomes for the year ahead: “Incumbent leaders are going to do all they can to stay in power, so expect governments to do what they can on the fiscal side.”

Oxford Economics is expecting major changes to tax policy in 2025 whatever happens in the election: “Republicans will rush to prevent Trump-era tax cuts from expiring at the end of the year, while Democrats will also feel an urgency to prevent a similarly timed expiration of expanded subsidies for health insurance. In a divided government, a grand bargain that permanently extends key tax priorities of both parties would add at least $1trn to deficits through 2033, and even more beyond.”

Under either party, trade policy is likely to remain protectionist, though in different ways. The Democrats may continue to favour industrial subsidies and regulation, while a Republican administration would likely turn to imposing more tariffs on the rest of the world.

In emerging markets, it is possible that a change of government may create specific investment opportunities. In Mexico, for example, there is a view that the incumbent government has not been friendly to companies looking to ‘near-shore’, meaning the country is missing out on an historic opportunity to draw in investment. The elections in June 2024 could bring in a more investment-friendly government and exploit an easy win for the Mexican economy.

Equally, elections around the world may provide an important barometer of the support for democracy. In major countries such as India and the US, democracy is wobbling. EU parliamentary elections may also see the strength of support for far right parties across Europe. It may be destabilising for markets if democracy appears to be under significant threat.

However, in all these cases, there are two problems for investors. The first is that even if they can predict the outcome for an election, and then the economic changes that are likely to stem from it, it is difficult to pick the resulting market outcome. The second is that there is not much they can do about volatility, and the right course of action is usually to stay invested.

Levitt concludes that monetary policy and innovation are likely to be far greater drivers of market returns: “Investors should be less interested in politics and more interested in private sector business leaders who are going to harness artificial intelligence and robotics. They may be able to help cure debilitating diseases, evolve the nation’s energy sources, and develop new technologies and industries that aren’t even on the radar.”

Markets may not be as sanguine over all the election outcomes as they have been over Taiwan and there could be plenty of noise around elections in the year ahead. However, trying to predict investment returns based on an election outcome is tough and investors are likely to be better off riding out market volatility and staying invested.

This article was written for our sister title Portfolio Adviser

Until the last two months of 2023, the last year had been substantially dominated by the Magnificent Seven, those US mega-caps with exposure to the nascent AI trend. The rest of the US market was left behind – the S&P 500 equal-weight index returned 13.9% over the year, compared to 26.3% for the standard S&P 500 index. Other markets round the globe also struggled to match the returns from these technology giants.

If inflation revives, or any recession proves more severe than expected, all bets may be off, but in the absence of those scenarios, two questions may be front of mind for investors: whether these mega cap technology companies can keep motoring, and whether market leadership can continue to broaden out to the rest of the market.

See also: Tech funds top the rankings for 2023

Many fund managers agree that valuations for the mega-caps now look stretched. In his 2024 outlook, Mark Hawtin, manager on the GAM Star Disruptive Growth fund says: “On the broadest measure, the S&P 500 trades on 18x 2024 expected earnings; this is above the average levels of the last 30 years. However, the equal-weighted S&P trades at 14x 2024 earnings, at the lower end of the average 30-year range. The forward PE of the M7 names is 29x and this is the key factor in our base case: that growth equities will remain robust but that the winners will come from below the M7 names.” Hawtin believes AI will still be important, but investors will focus on its real-world applications: healthcare, storage, and Software as a Service (SaaS).

There are other reasons to be cautious on the mega caps. Research from Evelyn Partners shows equity market concentration in the US is now at its highest level since the 1970s, with the ‘Magnificent Seven’ now representing 28% of the entire S&P 500 index. Equally, says AJ Bell investment director Russ Mould, if rate cuts do not appear on schedule, the aggregate $11.8trn market cap for these companies could look vulnerable: “Their share price and profit wobbles of 2022 showed they are not entirely immune to the economic cycle, so an unexpected recession could be one challenge. Sustained inflation could be another if it keeps rates higher than expected.”

However, few investors see an imminent collapse for these companies. For the most part, they are delivering high earnings, have a strong pipeline of growth and are likely to be supported by wide AI adoption over the next 12 months. It is difficult to see a scenario where markets make progress, but big tech companies collapse. Phil Haworth, head of equities at Aegon Asset Management says: “Few had anticipated these stocks outperforming their cheaper, smaller, more cyclical counterparts in a year of rising long real yields and surprisingly robust GDP growth. We believe the ‘magnificent seven’ may continue to perform well, especially those like Nvidia and Microsoft which are driving the development of AI.”

Broad-based growth

Nevertheless, Haworth says we should ‘absolutely’ expect greater market breadth in 2024. Andrew Bell, chief executive officer at Witan, says: “We’re positioned for a broad-based global recovery, where performance will be shared more widely than just seven stocks in the US market. Central banks are pausing interest rates. The pause is a turning point, not a pause on the way up. They will stick with their 2% inflation target, but interest rates will be falling way before we get to 2%, as long as the direction on inflation is right.”

“We think 2024 is going to be a year of recovery within a wider range of sectors in the market, across a wider range of countries.”

Alex Tedder, head of global and thematic equities at Schroders, agrees: “Investors will need to diversify more, while thinking much more about valuation, and focusing in on the structural trends that have become manifest in the last couple of years.”

“The ‘super seven’ have driven a re-rating in the US market, but are now trading on a negative yield gap, suggesting the market thinks they are more creditworthy than US treasuries.” He does not hold a negative view on the S&P 500 nor does he believe the rest of the S&P is egregiously valued. However, he adds, the capitalisation of “super seven” is greater than entire capitalisation of China, Japan, UK and France combined: “While these anomalies can persist for quite long periods, they do close over time. We think the rest of the world may catch up.”

He highlights China and Japan, but also the UK. He says the picture across emerging markets is improving because underlying rates of inflation are starting to fall. The inflation problems that used to weaken major emerging market economies appear to have dissipated. Equally, he says, there are certain markets where investors have given up: “China is a good example of that. Geopolitical concerns have seen it falling completely out of favour with international investors.” He believes Japan is also looking compelling, with the currency particularly weak and the economy competitive.

If there are no nasty surprises on inflation, and economies stick to their current path of a soft landing, investors may feel confident enough to explore other parts of the market and the Magnificent Seven may no longer dominate market returns. However, it is also difficult to see a scenario where big tech moves in a different direction to the broader market. While valuations are high, these companies can still make progress in the year ahead.

This article was written for our sister title Portfolio Adviser 

Advisers ignore it at their peril.

The adviser audience at the recent Square Mile investment conference showed 69% have been asked by clients about responsible investing in the last six months.

However, there remains considerable confusion on the right approach, whether it impacts client returns and whether investment companies that claim to have strong ESG credentials really deliver in practice.

ESG v other approaches

For Jennifer Anderson, co-head of sustainable investment and ESG at Lazard, today’s ESG is about cutting edge research and stewardship: “The first driver is that there are real complexities from climate change and social inequality,” she said.

“These are fundamental megatrends that are important for us to understand. Secondly, good stewardship is part of our fiduciary duty. As such, ESG should be part and parcel of any research.”

For Anderson, responsible and sustainable investment goes a level above that. Companies that are sustainable have to pass an additional hurdle.

For fixed income, it is a little different. There is no proxy voting, so it is difficult to have as much influence.

However, for Marty Dropkin, global head of research – fixed income at Fidelity, it is about engagement, working with companies to influence them to behave more sustainably.

What companies say and what they do

Fund management groups are clamouring to show their ESG credentials, but how can investors tell the difference between a company that is genuinely committed to this area and one that is merely ‘greenwashing’?

Gareth Davies, head of responsible investment distribution at Columbia Threadneedle Investments, said: “It is all about who is doing the work. Is there a well-resourced dedicated team of responsible analysts, living and breathing it every day?

“It is critical that companies scale up resource in this area and give those analysts the tools they need through, for example, data science and big data. Advisers need to look at whether funds are built on a solid foundation of expertise.

“But also, you need to look at what they’re holding,” he added. “Give them a sniff test.”

He believes there can be a ‘shocking’ gap between what companies say and what they do in practice. Equally, advisers shouldn’t place all their faith in labels provided by rating agencies. Davies suggested that they can give misleading results and may be too ‘black box’ in their approach.

There is also a question of integration. If the internal ESG analysts can be ignored by the portfolio manager, the system is worthless.

Lazard’s Anderson said: “The portfolio manager is important; if you ask them about ESG, the portfolio manager needs to own the dialogue on that. It’s about good due diligence and it does rely on asset managers to have thought about how they explain it to clients.”

Young investors to change retail ESG

To date, the institutional market has led the way, particularly the Northern European asset owners. The Swedish AP pension funds have been told by the government that they should be ‘exemplary’ in their approach to sustainable investment.

Anderson said that, as an active equities manager, it is almost impossible to win business from European institutions if an investment management business isn’t good at ESG.

The retail side, however, has not progressed as far. But as wealth passes down to a younger generation with different values, there is a huge opportunity.

To be successful, fund managers will need to understand client requirements and they may be different to the institutional investor priorities – they may want specific climate or vegan funds, for example.

Mandatory requirement

There is still a significant minority who believe that investors must sacrifice returns to incorporate ESG considerations (around 40%, according to a conference poll). This won’t wash, said Fidelity’s Dropkin, retirees need to pay bills.

He believes that funds should not benchmark against a sustainable index, but against a standard index. Companies need to show that they can invest sustainably and outperform an index.

Anderson added that the performance perception is a legacy from SRI and ethical funds.

She said: “I would encourage people to revisit what sustainable investing is and what it looks like today. Lots of funds underperform. People tend to be comparing lots of different styles and approaches. It’s very simplified to say sustainable criteria are part of the problem. It’s more about picking a good manager.”

Could we see a mass reallocation of capital in response to ESG?

Stephen Jones, chief investment officer at Kames Capital, said: “If you’re not looking at the non-financial factors that have a material impact on the financial statements, you’re not doing your job and that’s what the future is about.

“It is now possible to look at these factors in a way that hasn’t been possible before.”

Not only that, it will become a legal requirement; it will become impossible for investment managers to say that they don’t integrate ESG.

Ultimately, technology may allow fully bespoke portfolios, where investors can pick and choose the criteria on which they invest. This would indeed be a brave new world and one that advisers should be ready for.

For more insight on UK wealth management, please click on www.portfolio-adviser.com

Penetration for goods and services are low, giving companies ‘long growth runways’ in sectors as diverse as financial services and pizza. It is these opportunities he is trying to identify for the fund.

Shroff gives the example of the recent move to introduce digital identities: 1.2 billion people in India now have unique digital identities (UIDs) based on their fingerprints and iris scans.

This is higher than the number of people who can read: “This exemplifies both the challenge and the opportunity presented by India: a vast, young but poor nation using technology not simply to follow Western business models, but in certain cases to leapfrog them,” he says.

Thanks to these UIDs, 325 million previously unbanked individuals have been able to open bank accounts over the past four years. Shroff believes this is only the early stages of a shift in consumption patterns.

He suggests that in some areas, pizza for example, Indian consumption patterns will come to look more like those seen in Europe and the US.

In other areas India is already ahead: “Its huge millennial workforce already dominates viewer numbers for certain global social media and online video brands. And in other areas still, such as gold and jewellery, Indian consumers are simply forging their own particular path.”

Long-term growth

How does he seek to capitalise on this in the portfolio? The JPM team wants to find companies with good long-term growth prospects, with management teams who combine a strong ability to execute with robust corporate governance. The group has a quality and growth bias, but also maintains a valuation discipline.

In practice this translates into a long-term overweight in private sector banks: “The market for financial products is growing and also the private sector is gaining share at the expense of public sector banks, which are less well managed and less well capitalised,” he says. “That said, an important and positive development is that the long-awaited repair in the banking sector is now truly and well underway.”

The fund is also overweight in industrial names, including power equipment producer Bharat Heavy, commercial vehicle group Ashok Leyland and engineering group Larsen & Toubro.

The fund’s overweight position in consumer discretionary names is similarly varied and includes car maker Maruti Suzuki and Jubilant Foodworks, a food service company with a wide range of fast food operations – including pizza.

The fund’s largest sector underweights are in information technology and energy. Shroff expects Indian IT outsourcing companies to see some headwinds as new technologies put downward pressure on corporate tech spend. The energy underweight is driven by a zero holding in Reliance Industries, India’s largest stock, which they consider too expensive.

Interest rates are ‘high enough’

After a lacklustre period for the Indian economy, he believes it is on the mend. “Economic and corporate earnings cycles are depressed and should recover. Recent cyclical indicators have suggested slower economic growth, with the most recent corporate reporting season indicating that an overall recovery in earnings and profitability remains elusive.

“Partly on the back of this, in early February the central bank cut interest rates by 25 basis points; and as inflation remains within the RBI’s target of 4% (CPI is 2% currently) it means that real interest rates are high enough for the Monetary Policy Committee to ease policy further in the near term.”

Valuations are not cheap relative to history, he says, with forward P/E around the five year average. However, that’s partly because of the depressed corporate earnings cycle. Normalised earnings would make valuations appear cheaper.

The election may be a headwind: “We are not fearful, but for sure the coming months will involve some volatility as India’s rambunctious electorate participates in what famously is the world’s largest general election. Prime Minister Modi’s prospects look less strong than when he started his term. Following state elections in late 2018, announcements such as waivers of farm loans have already demonstrated some risk of short politically motivated short-termism. Perhaps the recent interest rate cut can be seen in that context.”

Whatever the electoral wealth, the longer-term story in India, says Shroff, is very strong. He believes the question is less about India’s capacity to grow, and more whether the country can create enough jobs to employ the huge numbers of new people who enter the workforce each year. It’s a nice problem to have.