New highs but less froth
US equities have risen by around 7% so far this year and now exceed their 2021 peak by a similar amount. In many ways, US market dynamics look healthier than they did back then. The very strong performance of the “Magnificent 7” has led to some concern that the market is experiencing another tech bubble. However, for the most part, these huge companies have the earnings growth to justify their performance and their valuations are not extreme. The rally has also been broadening out in recent months. Since October, the other 493 companies in the S&P500 have risen by just over 20%. It’s a very different picture to 2021, when a wave of retail money inflated the share prices of companies with little prospect of profitability, as well as SPACs, meme stock and cryptocurrencies. Investing at all-time highs often feels uncomfortable. However, historical data suggests that record highs in the US market have generally not been associated with lower future returns, as we explore here.
The Nikkei regains its 1989 peak
After 34 years, Japan’s Nikkei index is also making new highs. Japanese stocks are up by almost 20% in 2024 and 45% over the past twelve months (in yen terms). Despite the very strong recent performance, the longer-term track record remains underwhelming. In the time it has taken the Nikkei to get back to its 1989 peak, the S&P500 has risen 14-fold and even the FTSE100 has more than tripled. There is reason to be more optimistic about the future, however. After decades of flirting with deflation, Japan’s inflation rate has been above 2% for almost two years now, encouraging businesses and consumers to spend. Meanwhile, corporate balance sheets are healthy, earnings are growing, and valuations look attractive. This suggests the relatively strong performance could continue, even if markets pause for breath in the short term.
UK Budget may offer little room for manoeuvre
Polling data suggests that last November’s Autumn Statement, which included a two-percentage point cut to the rate of National Insurance contributions, did not result in much political benefit for the Conservative party. It is still widely expected that the upcoming Budget will include “giveaways” designed to boost the party’s electoral appeal. However, the Chancellor may struggle to deliver tax cuts worth significantly more than last November’s, given that UK growth remains weak and public finances have not been moving in his favour. Tax cuts could also complicate efforts to bring down inflation. Even before any additional fiscal stimulus, the Bank of England expects inflation to rise in the second half of the year, after returning to target in the first half. This suggests that UK interest rate cuts could be limited. Schroders’ economists expect the UK Base Rate to end 2024 at 4.5%.
Positioning
Our overall equity exposure is broadly in line with our long-term strategic targets. Japanese equities remain a core overweight position and have boosted performance this year. We have also been increasing our exposure to US equities, given the resilience of the US economy, improving consumer confidence and a positive outlook for corporate earnings. We remain overweight fixed income, with a focus on shorter-duration bonds with less interest rate risk. We still see appeal in alternatives, which can provide valuable diversification benefits, but we have been trimming our exposure to take advantage of more attractive opportunities in equities and fixed income. High levels of inflation in the UK have made meeting inflation-plus return targets more challenging in the near term. Despite this, we remain confident in the ability to meet inflation-plus targets over the longer term.
Key
🟢 Positive
⚪ Neutral
🔴 Negative
Outlook
| Economics | Global growth continues to be resilient, driven by consumer demand in developed markets. However, the full impact of rate increases to date have not been felt and risks remain.We continue to expect inflation to moderate, though it remains above central bank targets for now.Interest rates have likely peaked but hopes of imminent rate cuts may be premature. |
| Valuations | After rallying strongly towards the end of 2023, global shares look somewhat expensive compared to their long-term average.Government bonds also rallied late in 2023 and yields fell. However, bonds still offer relatively attractive levels of income and could help to protect portfolios if economic growth slows more meaningfully.Valuations of both equities and credit remain vulnerable to a meaningful deterioration in corporate earnings. |
| Sentiment | Investor sentiment improved significantly in the final months of 2023 and remains optimistic.Consumer confidence remains weak compared to history, though is showing signs of recovery in the US.With sentiment at bullish levels, markets are more vulnerable to a pullback. Higher bond yields, a pickup in inflation and geopolitical escalation could all stoke market fear in the near term. |
| Risks | Persistently elevated levels of inflation, which would warrant continued hawkish central bank policy.Escalation in geopolitical tension e.g. Middle East, Russia/Ukraine, US/China.Labour market weakness and falling consumer demand could challenge the developed market growth outlook.Potential spillover effect from slowing growth in China on the global economy. |
Asset Classes
| Asset classes | Current positioning | Current views |
| Equities | ⚪ | Falling inflation and a peak in interest rates have prompted us to add to equities. However, elevated valuations and buoyant market sentiment mean we have a neutral stance entering 2024. |
| Bonds | 🟢 | Overweight fixed income given more attractive valuations and defensive characteristics. |
| Alternatives | ⚪ | Higher interest rates require greater selectivity in alternatives. Commodities remain attractive as an inflation hedge, but we are neutral on alternatives overall. |
| Cash | 🔴 | Cash has a poor track record of preserving real wealth over the long term. However, available rates are higher than in the past and holding some cash allows us to take advantage of tactical opportunities quickly. |
Terms
Spread: the difference in yield between a non-government and government fixed income security.
Duration: approximate percentage change in the price of a bond for a 1% change in yield.
This article is issued by Cazenove Capital which is part of the Schroders Group and a trading name of Schroder & Co. Limited, 1 London Wall Place, London EC2Y 5AU. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority.
