Q1 Global Market Insights from the Holden & Partners Investment Team

The first quarter of the year has witnessed mixed fortunes across the globe, with the US market surging ahead while its UK counterpart struggled to keep pace. In the US, the S&P 500 soared by 10.2%, buoyed by a select few stocks and bolstered by the resilience of sectors such as financials and energy.

Conversely, the UK equity market faced headwinds, with the FTSE 100 posting a modest 3.1% gain, trailing behind its US and European counterparts. Amidst this backdrop, monetary policy shifts, particularly in the UK, drew attention, with speculation swirling around potential interest rate cuts. As investors navigate these divergent landscapes, a cautious yet optimistic approach seems prudent, as highlighted by recent portfolio performances.

Summary

US: A robust first quarter for the S&P 500 driven by select stocks, while other sectors show promise amidst evolving market dynamics.

UK: Despite challenges, UK equities display signs of optimism amid monetary policy shifts and fiscal initiatives.

Europe: European markets show promise fuelled by AI-linked companies and impending interest rate cuts.

Asia and Emerging Markets: Japanese equities lead the pack, while China navigates policy adjustments amid global shifts in investor sentiment.

Alternatives: Commodities see varied performances, with oil and gold shining amidst geopolitical tensions and supply concerns.

Sustainability: Insights into air quality concerns and the burgeoning market of Sustainability-Linked Bonds highlight evolving trends in sustainable finance.

Performance: Positive portfolio performance amidst uncertain market conditions underscores the importance of strategic neutrality and measured responses.

US

With the growth style very much in favour in Q1, the S&P 500 returned 10.2% ¹, setting fresh all-time highs in the process. While the ‘Magnificent 7’ ² continues to contribute to the index’s returns (despite poor quarters from Apple and Tesla), we have seen other stocks partaking in the rally helping drive the record highs. The narrow market breadth (when a small selection of stocks drive performance while others do not keep up) had been a concern in 2023, however in recent months we have seen sectors such as financials and energy outperform the index.³

In the fixed income space Treasuries fell over the quarter as yields pushed higher. Hotter inflation figures, a dip in the unemployment rate to 3.8%, and a shift in tone from the Federal Reserve all led to a subdued quarter for the asset class. A stark contrast to the bond rally seen in Q4, when expectations of interest rate cuts were far greater than they are at the time of writing.

The frequency and speed of interest rate cuts for the remainder of 2024 remains unclear. Former Federal Reserve Bank of St. Louis President James Bullard has recently stated that 3 cuts this year is the base case, however a resilient labour market and sticky inflation may change expectations and support the ‘higher for longer’ narrative. On the other hand, rising credit card delinquency and corporate default rates may suggest the effects of high interest rates are beginning to bite.

UK

While global equity markets continued to push higher at the start of the year, the UK equity market has lagged significantly behind. The FTSE 100, a collection of blue-chip UK-listed stocks, gained a paltry 3.1% in the quarter.⁴

This performance lags both US and European peers. This is partly explained by the more value-oriented makeup of the FTSE 100 but also reflects the persistently negative sentiment on the UK economy. In fact, the UK small and mid-cap markets, which are more aligned with the domestic economy, were the few stock markets that fell in February. March provided some optimism for UK equity investors, however, with the FTSE 100 having its best-performing month since November 2022 and surpassing a level last seen in May 2023.⁵

Falling inflation and dovish tones from central banks played a large role in this rally. In particular, comments from Bank of England governor, Andrew Bailey, that “things are moving in the right direction” ⁶ for an interest rate cut pushed the FTSE 100 to its best-performing day since September 2023.⁷ At the time of writing, headline inflation sits at 3.4% while the current bank rate is 5.25%.⁸

While monetary policy gets a lot of attention in the current economic climate, fiscal policy briefly took centre stage last quarter as UK Chancellor of the Exchequer, Jeremy Hunt, set the government’s Spring budget 2024 for the UK economy. An announcement that sticks out from an investment point of view is the British ISA, which aims to promote investment in UK-listed equities. With the rise of passive investing through index funds and exchange-traded funds (ETFs), liquidity flows have become a big driver of price. Following Brexit, the UK has struggled to attract international flows, while a slowing economy has seen domestic flows leave the country, hence British equity underperformance since 2016.⁹ The government recognises this, and the introduction of the British ISA is a move to encourage a healthier UK equity market.

Europe

We mentioned at the end of last year that there may be good times ahead for investors in European shares, citing a deep discount compared to the S&P 500, the fact that 60% of European revenue comes from outside of Europe and that there is less concentration risk.¹⁰ Judging by the Euro Stoxx 50’s first quarter performance, these good times have started. The index, the leading blue-chip stock index for the Eurozone, returned 12.7% over the quarter.¹¹ There’s no doubt the AI theme that has been pushing US mega-cap stocks higher has spilt over into the European market, benefiting companies with links to AI. ASML Holdings and SAP are such companies. Both companies, which returned 31.1%¹² and 29.4%¹³ over the quarter respectively, are top 3 holdings within the Euro Stoxx 50 and undoubtedly helped drive returns this quarter.

European headline inflation dropped further over the quarter and is the lowest among US and UK peers. At the time of writing, headline inflation is 2.4%, just 0.4% from the European Central Bank’s (ECB) target.¹⁴ Practically speaking, this figure is within an acceptable range of between 1% and 3% therefore we should expect the ECB to start cutting interest rates soon.¹⁵ Market consensus is for an interest rate cut in June however with inflationary pressures fading away, there’s an argument that interest rate cuts should start in April.

Asia and Emerging Markets

The Japanese Nikkei 225, an equity index comprised of Japan’s top 225 companies listed on the Tokyo Stock Exchange, took the top spot as the best-performing market among major developed countries over the quarter. An improving corporate governance landscape and a weak Japanese Yen were drivers of the approximately 20.6% return over the quarter.¹⁶ Of note was the weak Japanese Yen versus the US Dollar, a reflection of the real interest rate differential emerging from contrasting monetary policies. The differential tightened slightly in the quarter as the Bank of Japan (BoJ) exited its historic negative interest rate policy in the wake of the 5.3% Shunto wage round and inflation above the 2% target.¹⁷ Despite this, the Yen continued to weaken following the BoJ’s announcement to increase interest rates as investors concluded the policy change did little to erode the disadvantage suffered by Yen holders.

In China, the People’s Bank of China (PBOC) took various measures to stabilise markets and boost the economy. These include a 0.5% cut in the reserve requirement ratio and a historic 0.25% cut in the 5-year loan prime rate.¹⁸ The policies boosted market sentiment as reflected in the recent uplift in the Shanghai Composite Stock Market Index which at one point in the quarter was down 9.2%. The index finished the quarter up approximately 2.2% however this lags its peers.¹⁹

China has been out of favour with investors recently on the back of a property crisis and a deflationary environment. A beneficiary of this cold shoulder from investors is India, which saw its weighting in the MSCI Emerging Markets Index reach its highest level over the quarter bringing the India-China gap to a record low.²⁰ India has been the fastest-growing economy for the past decade boosted by robust consumption and increases in government spending, particularly on infrastructure.²¹ Also, its large and growing working-age population means it’s well-placed to achieve domestic growth goals and benefit from global efforts to diversify supply chains.²²

Alternatives

The S&P GSCI, an index of physical commodities across the energy, agriculture and livestock, and metals industries, brushed off a down year with a 10% return over the quarter.²³ A big driver of these returns was oil which has been experiencing market tightness following OPEC+ supply restrictions. Drone strikes on Russian energy plants and uncertainty in the Middle East have also contributed to Brent Crude’s approximately 13.1% gain over the quarter.²⁴

Gold continued to shine, reaching new all-time highs, and breaking out of a 4-year range.²⁵ There’s no doubt falling interest rate expectations played a key role in this move higher but geopolitics and central bank buying also played a role worth mentioning. Following strict US sanctions on Russia and Iran, other nations worldwide, particularly the BRICS countries (Brazil, Russia, India, China, and South Africa), have started to wean themselves off US Dollar dependence by diversifying away from US Treasury bonds into gold, oil and other strategic reserves.²⁶

Finally, a commodity that has been catching market participants’ eyes recently is Cocoa which has seen a price increase of approximately 240% over the year.²⁷ Dependent on production from a small part of the world, West Africa, poor weather conditions and ageing trees that require more fertilisers and pesticides have hampered production. While this price increase has less of an impact on our daily lives compared to if wheat or soybean prices increased by 240%, it does highlight the fragility of soft commodity supply that is susceptible to weather volatility.

Sustainability

A report carried out by a Swiss air quality technology company, IQAir, found that only 10 countries met the WHO’s (World Health Organisation) air quality guideline for fine particulate matter (PM2.5).²⁸ While the nose can filter most other larger particles, these particles are so small they can travel deep into our lungs, potentially entering the bloodstream. While it is perhaps something that goes unnoticed, air pollution poses a great threat to public health globally, and accounts for an estimated 7 million premature deaths every year.²⁹ Finland, Estonia, Puerto Rico, Australia, New Zealand, Bermuda, Grenada, Iceland, Mauritius and French Polynesia met these standards, with the UK exceeding the guidelines by 1 to 2 times. For reference, Bangladesh, Pakistan and India exceeded the WHO guideline by over 10 times.

Having emerged in 2019, Sustainabilty-Linked Bonds are a relatively new and increasingly popular market for finance. Their characteristics are altered, e.g., a step up in coupon/interest rate, should a predefined sustainability objective not be met, e.g. a 10% reduction in greenhouse gas emissions by 2030. These are popular among issuers as the proceeds do not need to be earmarked for specific projects as is the case with Green Bonds, but instead can be used for general purposes. Research from the Climate Bonds Initiative looking at the $279bn issuance (as of Nov. 2023) found that only 14% of Sustainability-Linked Bonds are aligned with the Paris Agreement target of limiting global warming to well below 2°C.³⁰ Unambitious targets and poor reporting quality are two big problems that are seen; however, we should see these issues alleviated as the market matures and we see clearer guidance around structuring and disclosure.

Performance

There is no disguising the fact that the last couple of years have been testing, so it is pleasing to see that the positive performance that we saw in Q4 has continued into this year. All our portfolios were in positive territory over the first three months with many beating their respective benchmarks. The narrative that central banks will cut rates later this year is still a driving force in returns, especially in asset classes that are negatively impacted by higher rates. Our internal view is that the market is over optimistic about the number of cuts there will be and the chance of none is increasing. As such the changes made at the beginning of the year put our portfolios in as neutral position as possible. Being more boring has become our mantra of late and being slow and judged in response to volatile markets an even more important part of what we already do. This isn’t to say that we won’t make changes when we think they are appropriate but not being rash and reacting too quickly has paid off in markets like these. The decision to do nothing is as much a decision to do something.