Portfolio Review – August 2024

Portfolio Review – August 2024 – Issue 23

This is the latest One Four Nine Portfolio Management (OFNPM) portfolio review providing investors and advisers with an easy to digest overview of what’s happening in the markets globally, alongside comparisons of OFNPM’s portfolio performance each quarter and throughout the year.

Chief Investment Officer’s comments

In the last review, we wrote, “Inflation and central banks’ response to inflation via monetary policy is still the single largest determinant of short-term returns in markets. It has been the key overriding theme since late 2021 and it shows no sign of abating as a determinant of short-term noise in markets”. This is still the case, although we have moved into a new phase, one of lower inflation, with less risk to the upside, allowing central banks to consider rate cuts.

Inflation in most developed jurisdictions is now close to or at target. In the UK inflation at the start of the year was at 4.0% and has now fallen to 2.2%, and has been as low as 2%, the Bank of England target. In Europe, inflation is also now at 2.2% and has been close to the European Central Bank’s (ECB) target for most of the year. In the US there are signs that inflation is now reaching target levels, having stubbornly been above 3% for over a year. US Consumer Price Index (CPI) fell to 2.5% in August, the first time it had been below 3% since March of 2021. The Federal Reserve’s favoured measure of inflation, the Personal Consumption Expenditures (PCE) Index fell to 2.5% in July.

Central Banks in general have welcomed this fall in inflation but have remained wary of a re-ignition for most of the year. In particular, the Federal Reserve has been the most hawkish of the central banks citing a tight labour market, strong wage growth and sticky, yet low inflation as reasons for not pursuing more accommodative interest rate policies. However recently, with better than expected inflation data, the Fed has softened its language around interest policy. At its Jackson Hole symposium in mid-August, Jerome Powell, the Federal Reserve Chair, prepared the market for a cut in US interest rates as early as the September meeting, the last meeting before the General Election in November.

While the Fed does not see inflation as entirely defeated, they see much less risk to the downside of more accommodative monetary policy. If the Fed do cut rates in September they will be one of the last central banks to initiate a rate cutting cycle. Globally central banks have already started to ease monetary policy this year as they see the risk of domestic inflation easing. The table below shows a selection of central banks cutting rates this year already.

Source: Morningstar

The Swiss National Bank (SNB) was the first central bank to cut rates in March and has added a further cut since. Of the large central banks, the ECB cut rates in June, while the Bank of England surprised markets somewhat by cutting rates by 25 basis points at its August meeting. Some central banks (SNB, Sweden and Canada) have now cut rates more than once. It is clear that we are now at the start of a global rate easing cycle, but the depth and length of it will be dictated by how inflation is kept under control.

A notable exception to rate easing has been the Bank of Japan (BOJ) which has enacted two rate rises this year to take their rate from -0.1% to 0.25%. This spooked markets for a short period of time in early August but was calmed quickly by the BOJ itself as it gave guidance that they did not see this as a prolonged rate hiking cycle. Still it is unusual as the BOJ policy rate has not been above 0.5% since 1996.

Central banks are clearly turning their attention away from inflation risk and towards economic growth risks. The UK was in a technical recession last year and while the Eurozone avoided such a title they had three out of four quarters in 2023 where the economy was stagnant. Growth in the US in contrast has been steady throughout the higher interest rate cycle and this has been part of the reason why the Fed has been reticent to cut rates. The US is starting to show clear signs of slowing economic growth and this coupled with an easing of tight labour market conditions has allowed room for the Fed to think about accommodative action.

Markets, both bond and equity, have been very focused on the number and timing of rate cuts, although market expectations have been wide of the mark about both at certain times in the past year. Markets have been volatile, especially the bond market on the back of this. Hopefully, now we have our first rate cuts, markets can end their obsession with rates and inflation and focus on growth as a driver of market returns, with fixed income retreating to a more predictable dull market, providing diversification and stability, as it should.

We do not expect rates to head back towards the “emergency” levels of 2008 to 2021 but nor do we know how far they will fall and when this rate cutting cycle will end. Central Banks will want to keep some rate powder dry for the next existential crisis they may face, whatever that may be. We do think however that this rate easing cycle will be shallower than previous cycles. This would be further reinforced if economies are growing. There will be no need to cut so drastically if economies are growing (or even stagnating with high leverage levels and high rates).

Market performance

Markets have generally been benign in the three months to the end of August apart from a very short-lived period of equity market volatility in early August derived from some extraordinary movements in the Japanese stock market which were soon reversed.

There has been little difference in return from equity market regions, sovereign bonds and investment-grade credit. In almost all asset classes we have been able to derive solid positive returns. There has been some volatility in currency markets, but in general, this has not detracted significantly from returns enjoyed by a Sterling investor.

Yields globally fell over the quarter across the whole yield curve. Returns from bond markets have been positive and long-duration plays have outperformed short-duration ones. Yield curves remain inverted, but the strength of this inversion has continued to diminish. Gilts returned 3.8% over the three months to August while short-duration gilts returned 2.2%. Global government bonds, when hedging out the currency risk, returned 3.8% as well. Our US treasury position, which is currency hedged, returned 4.4% over the three months. Cash over the same period returned 1.3%.

Sterling investment grade credit produced positive performance over the quarter as spreads stabilised and widened slightly. Short-dated (1-5 year) sterling credit gained 2.3% over the quarter which was a very similar return to short-dated Gilts. The broad investment grade sterling credit index gained 2.9%, behind gilts, due to the shorter duration nature of investment grade credit compared to sovereign debt.

Yield compression has been a direct consequence of the market’s reevaluation of the future path of interest rates given lower inflation and the beginning of rate cuts by most central banks.

Equity returns were not dissimilar from bond returns over the three months to August. The MSCI World in sterling terms gained 3.3%. There was little style difference over this period with growth stocks (3.1%) slightly underperforming value stocks (3.5%). Small-cap stocks once again underperformed their large-cap counterparts returning just 2.0% over the period.

There was some regional variation, over the three months to August although it was not large. The UK market gained 2.5%, while the US gained 4.0% in Sterling terms. Japan, despite the volatility in August, returned 2.3% while Asia Pacific (3.1%) and Emerging (2.6%) were slightly ahead. Europe was the laggard of global equities returning just 0.1% over the quarter.

Across most regions, stocks continued to re-rate as price-to-earnings (PE) ratios climbed. The exception was Japan where the return from changing valuations was negative. While expanding valuations is a worry, there was some good earnings growth to underpin these. In the US, Japan, Asia and Emerging markets we experienced positive earnings growth from underlying companies. Only in the UK and Europe did we see declines in earnings. Of the developed regions the UK has been the worst performer in terms of earnings growth for some time. As long as earnings continue to fall there is little hope that UK stocks will re-rate substantially and returns from the region will be depressed.

Portfolio performance

There was little difference in returns between bonds and equities over the three months to 31st of August 2024. Moreover, there was only a very small difference between active funds and passive funds over the same period. Our Active Non-Equities (Cash, bonds and multi-asset funds) returned 2.77%, while their passive equivalents returned 2.81%. Our active equities averaged 2.88% over the three months while their passive equivalents underperformed slightly returning 2.51%. This meant there were only small differences across risk profiles and portfolio solutions during the three months to the end of August.

Defensive portfolios

Source: Morningstar

All portfolios delivered strong returns over the quarter. This was mainly due to the strength of bond markets over the quarter. The small weight to equities in portfolios meant that active portfolios did not benefit from the slight outperformance of active equities over passives. A higher cash allocation was a slight drag on portfolios relative to more risky versions although this was very small. Sustainable portfolios had a very slight edge due to sustainable equity funds outperforming more general equity funds.

Cautious portfolios

Source: Morningstar

All portfolios delivered strong returns over the quarter. This was mainly due to the strength of bond markets over the quarter. Active portfolios benefited from the slight outperformance of active equities over passives, although the differences were small. A higher cash allocation was a slight drag on portfolios relative to more risky versions although again this was very small. Sustainable portfolios had a very slight edge due to sustainable equity funds outperforming more general equity funds. Income portfolios offered slightly better returns due to their low cash weight. Most portfolios slightly underperformed their relative IA sector.

Balanced portfolios

Source: Morningstar

All portfolios delivered strong returns over the quarter as both bond and equity markets delivered strong returns. Active portfolios benefited from the slight outperformance of active equities over passives. Sustainable portfolios had a very slight edge due to sustainable equity funds outperforming more general equity funds. Income portfolios offered slightly better returns due to their low cash weight and some better equity performance. Most portfolios slightly outperformed their relative IA sector apart from the passive portfolios.

Growth portfolios

Source: Morningstar

All portfolios delivered strong returns over the quarter as equity markets delivered strong returns. Active portfolios benefited from the slight outperformance of active equities over passives. Sustainable portfolios had a very slight edge due to sustainable equity funds outperforming more general equity funds. Income portfolios offered slightly better returns due to better equity fund performance. All portfolios outperformed their relative IA sector.

Adventurous portfolios

Source: Morningstar

All portfolios delivered strong returns over the quarter as equity markets delivered strong returns. Active portfolios benefited from the slight outperformance of active equities over passives. Sustainable portfolios had better returns due to sustainable equity funds outperforming more general equity funds and their passive equivalents.

Portfolio outlook

We last made significant changes to our portfolios in late January. Across all portfolios, we added to our sovereign debt position by reducing cash and investment-grade credit. Within sovereigns we moved from our short duration position to an average duration position splitting our sovereign exposure between UK government bonds and currency hedged US treasuries. While we expected no rate cuts till the second half of 2024 we wished to be positioned for potential positive returns from any cuts should we have been wrong on this call. Portfolios are positioned for a slow rate cutting cycle over the next three to five years. We should benefit from both rate cuts and the diversification that average duration sovereign debt will afford us should economies slow and enter recession.

We remain committed to our equity growth bias within portfolios, not least because the majority of our funds have continued to report that their underlying holdings have on average grown their earnings over the year. We invest for the long-term growth in earnings rather than try to trade the valuation cycle.

Find out how One Four Nine Portfolio Management invest here.

Dr Bevan Blair,

Chief Investment Officer,

One Four Nine Portfolio Management

London, Friday 20 September 2024.

All investment views are presented for information only and are not a personal recommendation to buy or sell. Past performance is not a reliable indicator of future returns, investing involves risk and the value of investments, and the income from them, may fall as well as rise and are not guaranteed. Investors may not get back the original amount invested.

All data is at 31 August 2024. One Four Nine Models are benchmarked against UK CPI and any other benchmark has been displayed for comparative purposes only and is not a benchmark for the Models. Performance figures are net of underlying fund fees and include One Four Nine Portfolio Management’s Management Fee of 0.20%. All model portfolio performance data is sourced from One Four Nine Portfolio Management. All other data is from Bloomberg and Morningstar.

This service is intended for use by investment professionals only. This document does not constitute personal advice. If you are in doubt as to the suitability of an investment, please contact your adviser.

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