Economic outlook
We are now more than halfway through 2024 and have had a period of relative economic stability since the events of Covid 19 and the Ukraine invasion, but we are far from the pre-Covid world. Over the last year or more, we have become accustomed – or reaccustomed – to a world which is more akin to that which we knew in the second half of the 20th century.
Economically, the first 20 years of the 21st century were unusual in experiencing very low inflation and even lower interest rates. Things changed after 2020, initially due to Covid and the war in Ukraine, but they were likely just catalysts to a change which was coming anyway: a return of inflation and, with it, more normal interest rates. While interest rates have been on a very long period – several hundred years – of decline, this has been very slow and the very low rates of the 2000-2020 period do look unusual.
Since Covid, economic figures have generally proved better than expected. The supply issues which caused such problems in 2020 have largely disappeared. In particular, energy prices have returned to something akin to their 2019 levels. Gas prices remain higher than 2019 but the dependence of Europe on Russian gas has gone. Partly as a result of this, inflation, having risen very sharply to near double-digit levels in both Europe and the US, has come down to the two to three per cent level. Fiscal policy has been very loose but without, as yet, causing major issues. Monetary policy has tightened but has not had much effect on economies.
So the economic picture has been – and largely remains – more stable than might have been expected. There are signs of economies slowing but most indicators are positive with little indication of serious recession in the next year or two.
Lurking in the background though are ongoing concerns about debt. Throughout the 21st century, most governments have been increasing their spending while not matching this with sufficiently raised taxes. Governments would say that there are strong reasons for spending more – particularly in areas like health, defence and climate change. But these additional demands don’t look like disappearing in the next decade. Indeed, the pressures to increase government spending are likely to get worse.
In the US, given that the dollar is the major reserve currency, any limits to government debt are unclear. US government debt has ballooned from under 50 per cent of national GDP 30 years ago to 120 per cent today and is forecast to push higher again. Pressures do exist: so-called bond vigilantes periodically push up government bond yields when they feel increased borrowing is excessive. The UK government under Truss collapsed on foot of failing to fund promised tax cuts. More developed economies could see a loss of confidence in their debt as happened in Turkey for example. One way or another, this is a game which will be played out over quite a long time.
Fixed income
Bond performance over past year
All bonds 10+ years, 18/09/2023 – 17/09/2024, local pricing
Since the beginning of 2022, we have seen a major change in interest rates. These had generally been falling since before 2000 and had reached levels never seen before with negative rates on some government bonds up to 10 years duration.
Rates rose during the first half of 2024 but have fallen in the third quarter. US Treasuries are now yielding about 3.6 per cent, having touched five per cent towards the end of 2023. German 10-year rates are around 2.1 per cent with the UK about 3.8. We have had a volatile couple of years in bond yields, with capital values providing more of a rollercoaster ride than their ‘safe haven’ reputation would suggest likely. Inflation does appear to be stabilising around two to three per cent which should help.
With longer-term bonds yielding reasonable sums, a case can be made for investing in bonds with duration. There are conflicting views on future levels of interest rates – most argue that an ageing population will save more and put downward pressure on yields. This is really just speculation. We have come through a period of very unusual bond markets; we do know that governments are generally running higher budget deficits. We can only say that bond markets are investable and that medium duration looks the least risky.
Equities
Equity performance over the past year
14/09/2023 – 17/09/2024, local pricing
Against this background of very substantial rises in interest rates, the overall movement in equities has been surprisingly positive. One would have expected that a scene of higher interest rates and higher inflation would have had more effect. It is true that company profitability has been stronger than would have been expected – this has been particularly the case for some of the large technology stocks and some drug companies.
Markets are currently taking a rather rosy view of the world but later 2024 may well see some switch to longer-term concerns that we have outlined above. Indeed, in August they suffered the largest drop in months on the belief that the economy was in worse shape than had been thought after a surprisingly low set of jobs figures in the US. At the same time, some investors reckon the gains in tech companies may be on the back of unsustainably positive expectations for artificial intelligence.
Euro cash
We have now seen two interest cuts in 2024 – the first cuts in five years. Rates remain however at levels last seen in 2001, and with yields on short government bonds sitting above inflation, deposit rates remain attractive.
Property
Property in general has longer cycles than the equity market which can make it useful as diversifier. We believe European property has a positive long-term outlook as it is coming from a period of rental weakness, although there may be short-term declines as interest rates rise and while the prospect of a recession remains.
Commodities
Commodity performance over past year against equities
18/09/2023 – 17/09/2024, US dollars
The oil price as of late has been difficult to predict – fears about the war in Gaza initially led to concerns that that might put pressure on supply in the Middle East, however this failed to materialise and prices haven’t seen the gains predicted.
Most developed economies are driving to ensure access to secure energy supplies and improve energy self-sufficiency. There is no guarantee however that this will dampen oil price volatility, and the volatility of commodities in general means that investment is best left to serious risk-takers.
Hedge funds
Hedge fund performance over past year against equities
01/09/2023 – 31/08/2023, US dollars, hedge funds priced monthly
Hedge funds can make an appropriate investment because of their defensive qualities in a market downturn but generally incur high management fees and tend to underperform during bull markets.
Currency funds
These funds have shown gains and losses recently. They are useful as a diversifier because of the relative independence from other securities but can experience significant volatility over the short term.
Multi-asset funds
There is little useful information with which to assess these funds for their performance, but many have struggled to deliver on their stated investment objectives (typically cash plus four to five per cent, or two thirds of equity performance). Because of the very wide range of investments they hold, they provide useful diversification, and the ability to dynamically shift asset allocation can provide some protection in times of equity market corrections. The higher returns now available on cash and bonds, many of which can be accessed in a low- cost manner means we are advising clients to reduce their exposure to multi-asset funds, many of which have high active manager fees, and would not be including them in new investment portfolios at this time.
Credit (Senior loans, High Yield & Emerging Market Debt)
We remain positive on credit as a diversifying strategic allocation within portfolios, and many credit investments are currently offering a relatively high and attractive premium over cash. Given the extend of the recent upward movements in bond yields and the current stage in the economic cycle, we would have a slight preference for Emerging Market Debt over High Yield Debt or Senior Loans at this time.
