Welcome to our Quarterly Investment Overview
I promise to keep this shorter than my usual Quarterly Updates for I have covered much ground in the first few months of this year. I will therefore attempt to cover the main dynamics and views in bullet point form, under each of our investment partners’ names.
We’ve experienced a positive and relatively smooth growth trajectory, especially for riskier assets so far in 2024. All this changed last week however, when we had the double whammy of weaker rhetoric around interest rates and the elevation of the conflict between Israel and Iran. The markets didn’t like it and profits were taken with AI stocks being hit badly. Nvidia fell 10% alone last Friday.
In contrast, by Monday of this week, the FTSE 100 reached a record high, helped by a rise in oil company share prices.
Our agenda this week covers comments from our selected investment partners:
- LGT Wealth Management (LGT)
- Foresight
- Legal and General Investment Management (LGIM)
- JPMorgan
- Our Summary
LGT Wealth Management
I caught up with Phoebe Stone, the Head of Sustainability for LGT Wealth Management. As you know from a recent Market Commentary, I articulated LGT’s ESG (Environmental, Social Governance) considerations when building a portfolio, but this time the focus was how such assets are likely to fair. We also spoke about investment markets in the wider context.
Sustainable
- Headwind conversations are having to be had with investors because of the pull-back from governments in terms of their commitment, particularly to the challenges around net zero emissions. It was agreed that the importance of Sustainable action hasn’t changed but the financial realities of what political parties were committing has. Phoebe stated that we shouldn’t underestimate the increased commitment of medium to large corporates which rarely makes the headlines.
- The politicisation of all things carbon is not helping matters and this is expected to build this year as we move into elections, both here and in the US.
- Phoebe reiterated how they are continuously refining their thematic exposures and what meets their criteria.
- We spoke about how some of the developing countries are the market leaders in Sustainability, with India and China being ‘light years’ ahead of most countries in the developed world.
- Some of the themes are solar and wind power projects in the north of India, waste management potential with improved technologies and education, and precision farming using AI and robotics.
Markets in general
- Phoebe highlighted the difference in performance between two of the Magnificent Seven stocks in the first quarter; Nvidia and Tesla. She highlighted the danger of too high a stock concentration. Something which played out last week, reinforcing Blue Sky’s action at lowering our AI exposure.
- Phoebe was pleased that the outlook for interest rates have moderated because they thought markets were getting ahead of themselves. A steadier growth pattern is much more desirable.
- At the start of the year, the markets were predicting US interest rates would fall seven times. Now it appears as though this could be two to three times and later in the year. It could be that with an improved outlook across Europe, they may well be the first to cut rates.
- LGT have upgraded their outlook on Emerging Markets, although the recent views on interest rates may slow this recovery with the dollar strengthening. Many emerging market economies rely on imports from the US. Phoebe was keen to say though that many emerging markets have weakened their dependency on the US dollar.
- Their outlook on Asia is much improved, particularly with a growing middle class. Phoebe highlighted the strength of Chinese technology companies but these have largely been overlooked due to Chinese domestic problems. China used to have weak foreign investment and a strong domestic market however, this is currently the other way around, on a relative basis, despite recent pullbacks by foreign companies. Stimuli is unfolding but China has some way to go and they would like to see the economy improve across many sectors.
Foresight
As you may well be aware, Foresight is a specialist in Infrastructure with a strong emphasis on environmental principles and renewable energy. I caught up with Mike Parsons and Nick Brown this month to ascertain their latest thinking.
Infrastructure funds have struggled, from the time of the Liz Truss debacle, but performed strongly from the end of October 2023 through to the end of the year. However, stickier interest rates have not been their friend. We disinvested from Infrastructure within our in-house actively managed portfolios last year, but we are mindful of reinvesting when interest rates start to fall as we think this is likely to be a sweet spot for this asset class.
- With bond yields remaining high and interest rates being elevated, investors have not largely wanted to take the risk of benefiting from a good infrastructure yield.
- They have started to see some hedge funds stepping in and Investment Trusts capturing the immense discounts on offer.
- Fundamentally, the underlying businesses are strong but as they invest in physical assets they have been ‘hit’ by high interest rates.
- Some great things about infrastructure funds are that they are not adversely influenced by weak consumer confidence, their earnings are strong, on the whole, they are index-linked and many of their contracts are backed by the government.
We then spoke about their Sustainable themes fund:
- It is an impact fund and one we are following closely. We may consider moving this into our own internal Global Themes portfolio. One of the areas they are focusing on is agricultural production as it is a huge emitter of carbon dioxide. Vertical and controlled farming is one such consideration.
- Like Phoebe at LGT, Mike and Nick spoke about negative rhetoric and how ESG has been politicised but it’s offering good value for the medium-term with corporates committing a lot of capital into the green energy space.
- The oil and gas sector and share prices have been doing well which has delayed investment.
- It was felt that the real estate sector is the most likely sector to respond quickly to a lowering of interest rates.
- Foresight have made changes to their mandate and have removed their 4% income target. With rates likely to remain higher than was the case, which gives them a greater remit for investment, especially with bond yields being high.
Legal & General Investment Management
We spoke to Francis Chua, a Fund Manager within the asset allocation team. In summary:
- They are concerned about deteriorating earnings (corporate profitability) and are wondering how long it will take interest rates to pivot. If it takes too long, then they can see earnings becoming weaker and some volatility in markets.
- On saying this, they can see central banks having greater flexibility. As a result, they are cautiously optimistic.
- There are many variables to consider, stickier than expected inflation, geopolitics, and a higher oil price. They would also be concerned if interest rates were cut too quickly. Of course, the twist is, if interest rates remain elevated.
- In their view, the US markets have responded too quickly. They don’t believe we are at the start of a new market cycle but are in a late cycle rally and what we’ve seen is euphoria driven by tech stocks.
- They, like Foresight and LGT, have a positive view on Infrastructure, particularly with huge discounts on offer but were careful in their outlook just now, in light of the possibility of sticker interest rates.
- They like bonds with inflation falling but prefer a basket of international bonds.
- They are neutral on Asia with no regional preference. They are encouraged by the property sector restructuring in China and the additional stimuli from the Chinese government but need to see sentiment improving before committing more capital to the region.
- On emerging markets, they cited that the strength of the US dollar cannot be underestimated because a lot of commodities are priced in dollars. Commodity prices overall have come down, although the price of oil has risen. Emerging markets are attracting money from investors selling out of the US.
- At this juncture with interest rates high, they don’t favour the small-cap sector as too much volatility is likely.
- They do see UK equities being beneficiaries of improved growth and expect legislation for large pension schemes to be required to invest more capital in UK equities.
JPMorgan
I ran through JPMorgan’s latest market overview and the upshot is as follows:
- It should not be overlooked that consumers are getting a real income and wealth boost as inflation falls.
- Manufacturing confidence and activity is also improving.
- Despite cooling wages, US inflation has remained sticky which has brought into question the speed of rate cuts.
- The Bank of England is wrestling with falling headline inflation and sticky wage growth.
- Many markets have priced a benign economic outlook.
- The US is vulnerable to single stock stories as we have seen over the last week or so.
- Over-optimism isn’t so prevalent in Europe and emerging markets, thus offer good value.
- More complex portfolio construction is required in a more complex world.
- They are pro-risk but with an emphasis on an exposure to Europe and emerging markets. They have a positive outlook for assets overall, although as we’ve seen there may be periods of short-term consolidation in stocks.
- They expect moderate economic growth, declining inflation, and loose central bank policy this year.
Summary
We have experienced some volatility of late, but after the stellar rise in values in some sectors, particularly technology, this is no surprise. Interestingly enough, so-called ‘Big Tech’ soared post-market last night. Alphabet Inc rose 12% as it declared its first ever dividend and boosted its share buyback by $70 billion. Microsoft also trounced its earnings estimates according to Bloomberg. Both companies saw a surge in cloud revenue fuelled by AI demand.
In general, markets have held up well, but it is very clear that there is dispersion in performance by asset class and geography, reinforcing our strategy of combining passive, lower cost index trackers and active management.
The investment houses we engaged with are, I think it’s fair to say, cautiously optimistic. The views range from a late cycle rally to a new economic boom. Could we have both I wonder?
Of course, if economies are too strong, central banks will struggle to bring down interest rates in any meaningful way. Maybe, that is something we are just going to have to live with… our new norm perhaps.
Thanks for staying the course for this quarterly update.
Have a great weekend!
Gary and the Blue Sky Investment Team
Risk warning
Please Note: This communication should not be read as giving specific advice regarding your personal circumstances. This would only be given following detailed assessment of your individual needs. The value of investments may fall as well as rise; you may get back less than invested. Past performance is not necessarily a guide to future returns.