Calendar Year 2024 Investment Review

IN BRIEF

• Global Central Banks have started to ease rates
• Corporate earnings and growth remains robust
• Fixed Income provides carry and protection but at elevated volatility
• Geopolitical risks remain ever present
• Base case of no recession in 2025 holds

Market Comment

As we look back on 2024, if we compare what has happened in markets with the consensus view at the start of the year, it’s hard to reconcile what actually transpired. Consensus opinion was for some sort of recession based on rising unemployment and high interest rates designed to bring inflation under control. Base rates in the U.S. were over 5%, while the 10 year treasury was trading at 3.8%, suggesting the market expected dramatic rate cuts to counter the expected fall in growth. It never happened.

Why? Both the U.S. consumer and labour market proved remarkably resilient; U.S. growth held above the long term trend. Another important dynamic was the AI fueled capex boom by corporates, no better illustrated than through Nvidia’s sales revenues - more than doubling in 2024. Consumer confidence in the U.S. has remained, job openings are plentiful (albeit new openings are stabilizing) and real wages have been growing.

The same can’t be said of Europe for a variety of reasons. German manufacturing has been in decline all year driven by the auto sector and cheap imports from China, where there is clearly an oversupply issue. Europe has a much smaller tech sector than the U.S., hence earnings growth lacked the same stimulus. There is political instability and the fiscal situation is fragile, while energy costs remain high relative to the U.S.. Confidence is low and there are few obvious growth drivers. Any positives? Well, equity markets are pricing the lack of growth with valuations at a record discount to the U.S., combined with a historically cheap Euro. The threat of increased tariffs from the U.S. looms; clarity is unlikely to appear until the new U.S. administration is in place. That  means corporate decision making faces uncertainty and capex is being deferred; should worst fears not transpire, it could be there is upside to growth.

Relevant to European activity is the slowing Chinese economy. While stimulus measures have been announced by the authorities, particularly in the embattled property sector, it hasn’t yet translated into a pick-up in demand.

We feel more tangible action needs to be taken; declining property value is a significant factor in consumer confidence and is likely to take a considerable time to turn around. Furthermore, U.S. tariffs are likely to be a bigger issue for China with headlines suggesting 60% as a possibility. We suspect actual will be lower than this.

Within fixed income, although the Fed has indicated that it is on a path to steady rate cuts from high levels, U.S. yield volatility has been high and we close the year with higher yields than when we started. Further rate cuts are likely on the way but at a slower pace and will be data dependent. Much has been written about the concerns over debt issuance to fund the U.S. deficit. While this can have short term impact on bond yields, it is ultimately the economic cycle that drives rates and we believe the path of inflation is still towards the Fed’s target of 2%. This is unlikely to occur in 2025; nevertheless we believe Fed rates will be lower rather than higher in 2025, which is supportive of risk assets. As mentioned, European growth is more challenged and we expect the ECB to continue cutting rates through 2025. That in turn suggests the Euro will remain under pressure vs USD for the foreseeable future.

A word on Japan as the ‘Yen carry trade’ unwind contributed to equity volatility through August. The Bank of Japan has allowed rates to move into positive territory and the yield curve has normalized to upward sloping, potentially signalling the end of deflation for the first time in a generation. This is a positive for the re-balancing of the global economy.

The geopolitical landscape remains a concern with war in the Middle East and Russia/Ukraine both tragic and uncertain. The impact on the global economy has thus far remained relatively muted, with increased oil production in the U.S. keeping a lid on oil prices, indeed falling year on year. Supply chains continue to adjust to the environment and are better placed than in the immediate aftermath of Covid. It is likely that tariff developments will be the driver of further change in 2025.

Key portfolio activity over the year

With fast moving markets and wide performance dispersion, portfolio turnover was in excess of 30%; some being active tactical calls, some being risk re-balancing. The key ones relevant to performance were as follows:

Q1 – added 2% to U.S. equities, thereby moving overweight equity, funded from Core bonds. Trimmed high momentum sectors; tech and healthcare.

Q2 – nuanced changes within fixed income including switching to French government bonds from German to take advantage of higher yield following French election uncertainty. Also reduced U.S. fixed income in favour of Asia/China given the weaker growth outlook.

Q3 - a key period, which witnessed equity volatility following a weak U.S. jobs report and the Yen carry trade unwind. Prior to that event, we reduced the tactical and ‘drifted’ equity overweight to neutral and bought 2% of high yield and the balance in Core bonds. This trade was a combination of a tactical view and careful risk management at the portfolio level. Following the volatility in August, we bought equities back funded from Core bonds.

At the end of the quarter we bought UK gilts funded from U.S. treasuries following the Fed’s rate cut, while the Bank of England held rates.

Q4 – there were further re-balancing trades ahead of the U.S. election to reduce risk. Following the election and in light of the new business friendly Republican win, we moved back overweight equities, with a bias to the U.S.. The overweight to high yield was reduced and Core bonds were re-positioned by reducing long duration treasuries in favour of securitised, specifically Mortgage Backed Securities.

Year end high-level positioning

We enter the new year with a moderately pro-cyclical position; 1-2% overweight equities and 4% overweight high yield – split equally between Europe and the U.S.. Geographically, we are overweight the U.S. equity market vs Europe, based on the relative growth trajectory. The danger of being too underweight Europe is that low growth is consensus and the Euro is at historically low levels; any piece of good news could trigger a rebound.

At the sector level, our key overweights are technology, financials and consumer staples – a spread of secular growth, cyclicality and quality. Underweights include materials and energy.

Within fixed income, we are underweight Core bonds in favour of high yield and neutral duration at around 6.5 years, with a bias to European duration, given the weaker growth outlook. That means that we are balancing a pro-cyclical overall position with some defence in fixed income should growth disappoint.

For portfolios with hedge funds, we are positioned in line with the strategic allocation and have a slight bias to relative value and global macro.

Returns

Staying fully invested and pro-cyclical throughout the year has served portfolios well. While longer duration U.S. Core fixed income was a headwind in absolute terms, when paired with U.S. equities to balance risks, returns have been strong. Alpha (or excess return relative to benchmark) was principally driven by an overweight to U.S. equities for most of the year as well as the high yield position, funded from Core bonds. Tactical trading and rebalancing was also additive, most notably over the summer period (see case study). Relative sector positioning was a small contributor to returns; more important this year was being fully exposed to the tech related sectors and ‘Mag 7’ - our portfolios were. This year demonstrated why it can be dangerous to take too much tracking error (deviation from the strategic allocation); dispersion of return has been very high as evidenced by Morningstar median manager data.

Outlook

Uncertainties abound both from geopolitical risk and the incoming U.S. administration. These factors aside, we feel that the economic backdrop to markets is positive. Global growth remains positive yet at the same time moderating inflation gives Central Banks the scope to reduce rates from restrictive levels, which is a positive for risk assets. Valuations within U.S. equities and credit markets are relatively full but we believe with good reason given the economics. We expect continued corporate earnings growth to support progress in equity markets and we expect fixed income to provide returns broadly around yield levels but with the potential for capital gains should we see growth slow more than the market is expecting. We don’t expect returns in 2025 to match those of 2024 but we do believe that a fully invested approach will offer superior returns to holding cash. Indeed, investors across retail and institutional markets hold substantial amounts of cash, which we expect to be deployed and that is a healthy technical consideration.

Case study:

The importance of multi-asset investing and tight risk management for compounding wealth

The post Covid period characterized by rising inflation and interest rates proved challenging for multi-asset investing and the traditional benefits of negative correlation between equities and bonds evaporated i.e when one asset class loses value, the other gains. The starting point of that period is relevant; interest rates were at zero or even in negative territory in order to stimulate growth. 2024 was the year that negative correlation returned and it marked what we think is now the top of the interest rate cycle.

To illustrate the point, the below is a chart of how the main asset classes performed in July/early August when markets were caught out by a particularly weak U.S. labor report and concerns grew that interest rates were too high. In early July, we sold equities from an overweight position as we thought markets had run too far, too fast. We bought some high yield fixed income, yielding around 7.5%, which we felt would offer returns similar to equities over the forward 12 months. And we added to Core investment grade bonds in preference to holding cash.

As you can see, equities then drew down and Core bonds rose in value - a c.10% performance differential in just 3 weeks. Had one instead just moved to cash, yes one would have avoided the equity drawdown but cash does not offer the opportunity for capital gain, which longer maturity bonds do.

Following the drawdown in equities, we found that portfolios had ‘drifted’ underweight equities. That was not a position we wanted to maintain as we felt that market fundamentals relative to our base case had not changed. We therefore bought back equities funded from Core bonds, which had risen and locked in the relative out-performance because equities rapidly recovered thereafter.

We believe negative correlation will remain a feature of markets going forwards now that rates have substantially normalized and are above the level that central banks would deem “neutral’’ – technically that is defined as the rate that allows for trend growth; neither stimulative or contractionary. Most of the time equities and bonds positively correlate because over a cycle they tend to both produce positive returns but bouts of volatility and drawdowns in equities are quite normal. By holding a portfolio comprised of longer duration bonds combined with equities, one can increase the opportunity to smooth returns over time and to take advantage of these market opportunities.

For illustrative purposes only. Estimates, forecasts and comparisons are as of the dates stated in the material.

Indices are not investment products and may not be considered for investment.

Past performance is not a guarantee of future returns and investors may get back less than the amount invested.