The big headlines

In this regular piece, we summarise the key headlines from the quarter that have impacted investment performance. Feel free to download and share it directly with your clients or read our interpretation below for further commentary.

Our interpretation

David Aujla (DA), who is lead manager of our Summit Growth and Responsible ranges and who co-manages our Model Portfolio Service, alongside MPS Portfolio Manager Ben Gutteridge (BG) and analyst Sarah Fox (SF), share their thoughts on the key developments of the last quarter and how they’re affecting the portfolio management of their respective products.

Earnings momentum – powered by A.I.

SF: “Much has been reported on the topic of AI over the course of the last 18 months. It is the buzz word backed by quite the price action from a handful of very large publicly traded stocks. But does this catch-all phrase signify a technological leap that could just be the most significant opportunity we will see in our lifetimes - and that of our children's lifetime, and their children's lifetime (and so on and so forth…).

“Of course, the other stream of thought is that the explosive growth witnessed in the trends and solutions driven by AI innovation has led to overheating, and risks oversaturation.

“Indeed, there are several factors we can point to that suggest the latter view is a clear contender. The US stock market is highly concentrated in few winners, with the majority of trading hype directly attributable to this thematic, while the Venture Capital community continues to raise material investor capital in AI startups. This rapid growth has led many market participants to question the high valuations of these companies and start floating the “bubble” term.

“On the flip side, what if this is an antiquated way of thinking? Put bluntly, this type of innovation is likely to revolutionize not only the tech sector, but business and society at large, where the benefits will "astound us all" as cited by Amazon's CEO in his recent shareholder letter. Think of a world where productivity is not only improved by AI but is infinite. What does that mean for GDP? The implications for current economic systems and equations are material. However, we have a long way to go until we reach this mountain top, and the rationales for taking positions over shorter-term time frames are much more nuanced, where in depth research and valuation consideration is critical.

“But if we set our minds to think of AI thematically i.e. over the long term - the opportunities here are gargantuan. Maybe it's worth the hype?”

UK recession – past the worst?

DA: “The UK officially entered recession at the end of last quarter, albeit a shallow one. Looking ahead, however, and many forecasts suggest the UK’s economic stagnation may be slowly coming to an end, with lower inflation and anticipated Bank Rate cuts helping to build economic momentum.

“The UK economy entered recession in the second half of 2023, after experiencing two consecutive quarters of negative, albeit shallow, economic activity. 

“Much of the weakness stemmed from a substantial decrease in global exports. Soaring prices of imported raw materials and energy increased the costs of producing goods domestically, making it more difficult to sell higher priced goods abroad. This is just another piece of evidence on how more vulnerable the UK manufacturing sector has become to global shocks.

“In 2023 the UK grew by a mere 0.1%, marking the weakest annual change in real GDP since the financial crisis in 2009, excluding 2020, which was affected by the pandemic.

“2024 got off to a better start. In February, the UK grew by 0.1%, after a 0.3% growth in January. This is fuelling hopes that the economy has turned a corner and is on its way out of a recession. The latest forecasts from the Office for Budget Responsibility (OBR) point to GDP expansion just under 1% and 2% for 2024 and 2025 respectively. Lower inflation and anticipated Bank Rate cuts are expected to help build economic momentum.

“But while this may help the UK move past its worst in the short to medium term, it is important to not overlook the numerous structural challenges such as labour supply shortages, chronic underinvestment and Brexit related uncertainties which continue to plague the economy. The United Kingdom’s long-run prosperity therefore hinges on ambitious reforms.

“As we have stressed before however, the UK equity market is not necessarily the UK economy. Large cap UK stocks (e.g. FTSE 100) generate around 75% of their earnings from overseas sources. By virtue of the translation effect, weakness in sterling – often driven by domestic economic weakness – tends to support UK equity market earnings. While bad news for the UK economy and sterling can be potentially negative for smaller and more domestically oriented UK companies, it can be good news for UK large cap equities.”

Germany – export sickness

BG: “When reflecting on any first quarter ‘German sickness’, our immediate thoughts are not of a struggling German economy but, instead, of Liverpool football fans dealing with the resignation of their idolised German manager, Jurgen Klopp. This alternate direction isn’t just a function of the gravity of the Merseyside news, it reflects an assumption the German economy, the engine of European growth, couldn’t possibly be associated with material weakness. Unfortunately, however, current data paint such a worrying picture.

“The root cause of German ailments stem from the manufacturing and export segments of its economy. Whilst its prowess within these fields are a rich source of national pride and prosperity, its dominance makes the economy particularly sensitive to the ebbs and flows of the manufacturing cycle. In this period of changing consumer habits, from pandemic related goods purchases to post-pandemic services spending, Germany is feeling the pinch. Further to this, a weakened Chinese economy is also weighing on demand for German goods, particularly industrial equipment.

“The label ‘Sick man of Europe’ isn’t just a function of German struggles however, it also has much to do with the relative improvements across Europe’s remaining states. The pain and effort from nations such as Spain, Italy, Greece and Ireland, to improve their competitiveness, have brought much reward for their respective economies, helping to tackle record levels of unemployment. This ‘peripheral’ momentum will be further supported by less conservative fiscal policy and larger (relative) disbursements from the EU Recovery and Resilience Facility (RRF). Such a transition is to be applauded and sets these respective economies and markets on a far better course into the future.

“Of course, not all is lost for Germany, should the manufacturing sector enjoy a recovery, and there are signs such an outcome is unfolding, then the German economy will surely thrive. Should the manufacturing renaissance prove fleeting, however, then the ‘Sick man of Europe’ moniker may yet endure.”

The US still out in front

DA: “Economic data released over the period was largely positive, with all three major indices (S&P 500, Dow Jones Industrial Average and Nasdaq Composite) registering gains. Cooling but stubborn inflationary data, coupled with impressive employment figures, seems to justify the US Federal Reserve’s insistence that it’s still too soon to cut interest rates. 

“Recent inflation and growth data in the US have been more robust than the market anticipated. Monetary policy easing expectations have therefore been tempered in recent months, fewer interest rate cuts are now priced than were originally expected. Under three cuts are expected for 2024, a noticeable decline from the seven cuts (of 0.25 percentage points) expected at the start of the year. 

“Even though inflationary pressures have eased considerably from the post-pandemic highs, the latest readings continue to put Fed policymakers on a difficult journey. In February, the Personal Consumption Expenditures (PCE) price index, the Federal Reserve’s preferred inflation gauge, increased by 2.5% year on year, a faster pace than January’s 2.4% rise.

“While higher energy prices and supply-chain related disruptions remain key drivers, it is the resilience of the US economy which continues to mostly limit the extent of the normalisation process in inflation. 

“US GDP growth has been exceptionally strong in recent years. Economic output has expanded by 2.5% in 2023, an acceleration from 1.9% in 2022. The Atlanta Fed is currently estimating US GDP to rise at a 3.2% rate in the first quarter of 2024. These are growth rates far above what Fed officials regard as the ‘non-inflationary growth rate’ of 1.8%. 

“Consumer spending, which accounts for more than two-thirds of US economic activity, has been the key force behind these figures. Tightness in the US labour market which has pushed up wages, coupled with very generous pandemic related fiscal stimulus (most of which ended into household’s pockets), are credited with sustaining consumer strength.

“Even though the resilience of the US economy has reduced the risks of a recession scenario, it has also inevitably tempered any sense of urgency for Fed officials to loosen financial conditions. 

“We remail of the opinion that the path for interest rates is lower, albeit with some volatility. We also retain the view that 2024 will likely be the year when the Fed begins to cut interest rates. With this said, so long as the aforementioned dynamics remain at play, concerns around interest rates remaining “higher for longer” cannot be said to be entirely unfounded.”

Chinese market – signs of life?

BG: “Some of my fondest early childhood memories are that of being duped by my dad into vacating some of the very best hiding places, by the lure of £5 notes he had dropped, not so discreetly, in open spaces. This, as I would so often (re)learn, was a classic ‘Value Trap’ as, upon immediate capture, would not only have to surrender the £5 but also suffer some teasing having fallen for such an obvious trick.

“I would not pretend to suggest these (multiple) occurrences have somehow moulded my investment approach, but I do often think of this analogy when staring at a high-risk high-reward ‘trade’ – just as it is with China today. I’m afraid I just cannot get comfortable with the idea there is ‘asymmetry’ in taking a position in Chinese equities at this time, and squirm a little at those who suggest all the bad news is ‘in the price’. Geopolitics, a real-estate collapse, a global recession and erratic economic policy are just some of the known risks that could drag Chinese earnings, sentiment and share prices plundering through recent lows. Conversely, however, one might suggest that such is the depths of pessimism toward the asset class that it might only take an amelioration in the situation (rather than improvement) to gives share price some relief. Indeed, I believe we saw exactly that in Q1 this year. It appears, in the face of ongoing economic decline, authorities may have reached a pain threshold that now compels them to respond, which is exactly what we’ve just seen in the shape of cuts to interest rates, easing bank lending standards and increased government financing of social housing programmes. It was of little surprise to this author (and many others) that the scale of stimulus fell far short of previous efforts, however, it was also clear authorities will no longer sit on their hands whilst the economy falters. Perhaps the ‘big bang’ stimulus may have to wait for global recession, or ‘Trump tarriffs’, in which case there may be more pain to endure for Chinese equity holders between now and then, but Q1 was a reminder that only modest amounts of stimulus can do quite a bit for such lowly rated share prices.”