For this week’s Q&A, Darius McDermott and Juliet Schooling Latter, FundCalibre managing director and research director respectively, review Q1 events and cast an eye on the next quarter. Reflecting on the first quarter of 2024, they delve into various regions and sectors that experienced notable highs. We also discuss the potential for economic recovery in Europe, China’s struggle to regain momentum post-Covid and speculation surrounding interest rate cuts by the Federal Reserve.
Why you should listen to the interview:
With the current geopolitical and economic tensions, the discussion offers various perspectives on where to find investment potential today. Darius and Juliet offer their opinions on a wide variety of topics – including how the bond market looks today – that will keep you listening through to the end of this 18-minute podcast.
This interview was recorded on 15 April 2024. Please note, answers are edited and condensed for clarity. To gain a fuller understanding and clearer context, please listen to the full interview.
Interview highlights:
UK investors drive flows into US funds
Juliet: “US strength has broadened out this year so it’s not just the Magnificent Seven that’s driving stock market gains.”
Darius: “I think it’s the ‘Magnificent Two’ in 2024, Nvidia and Meta being the stronger two of those seven stocks!”
Juliet: “I do feel a little wary of the US at the current levels, particularly as inflation is proving quite stubborn there. One headline that sticks in my mind and raises alarm bells with me is that UK investors added more to US funds in the first quarter than they did in the past nine years combined. That worries me. I know you can’t ignore the US – it’s such a huge proportion of global markets and it could well continue to perform – but I think I’d be taking some profits and moving down the cap scale to the less expensive, smaller cap stocks. They have done a bit better recently, but they’ve been unloved for so long that I think they’ve still got further to go to catch up.”
Darius: “At a headline rate, the US does look expensive on a forward looking PE basis, but it’s not ridiculously expensive, yet we still have a US inverted yield curve. And a US inverted yield curve normally leads to a recession, which we just haven’t had. Growth in the US has also been much stronger than most people predicted, as Juliet said. Also, inflation has been much stronger than people predicted and hence rate cuts in the US which everybody was hoping and expecting at the start of the year, now look at least delayed if at all in 2024. So, that has been a big change in sentiment yet the US stock market has continued to go up. Companies are doing well and growth has been much stronger than people anticipated. I think everything Juliet said about valuations is absolutely relevant and correct, I’m just a little nervous on those valuations as well.”
Japan – dynamic and exciting and full of potential …
Juliet: “Japan is really exciting at the moment I think. We’ve been talking about corporate change in Japan for years and just getting bored with waiting for it to actually happen. Things don’t really move quickly in Japan, but finally they seem to be getting somewhere. The Tokyo Stock Exchange urged companies with book values of less than 1 to improve their valuations, but they’re now widening that, and corporate Japan is coming under increasing pressure to change.
“Added to that, Japan is finally experiencing inflation after decades of deflation. Wages haven’t really increased there in 30 years, but we’re now seeing wage increases of around 5% come through. And so the Bank of Japan has raised rates for the first time since 2007.
“Finally, there’s a lot of domestic money sitting in cash which is starting to move into markets. In January and February, flows into NISAs — their tax-free investment accounts — tripled. All in all, I think it’s looking quite exciting so I remain positive on Japan.
“It has done well over the past year but it’s still got a long way to go to make up for decades of underperformance. If you look back around 20 years, Japanese funds have returned 198% versus 604% in the US so there’s still quite a lot of catching up to be done there. There are likely to be setbacks along the way, but it looks like it’s moving in the right direction.”
… but beware of currency fluctuations
Darius: “But a weak yen could potentially eat into returns for UK investors. If the stock market goes up 1% and the yen decreases 1% versus sterling, you will get zero. But the yen has now been weak, particularly on the interest rate differentials that there are in the developed world versus Japan – actually Japan might raise rates a little bit, we might cut rates a little bit and that really should then give some strength to the yen, which of course then would boost those returns, it’s the opposite relationship. I know the yen has been weak, but there are a number of Japanese funds out there that have given positive returns over a 12 month period in spite of the yen’s weakness as opposed to because of it.”
Improved sentiment in Europe
Juliet: “I think the picture in Europe certainly looks a bit better from here. Inflation fell unexpectedly in March to 2.4% and business activity returned to growth for the first time in 10 months, with growth in services outweighing a pullback in manufacturing. This paves the way for the ECB to reduce interest rates but also European earnings aren’t necessarily dependent upon the European economy with international revenues having increased by over 50% since 2010. This means the health of the US and Asian economies are now quite important too. Sentiment towards European equities has picked up with net inflows into the region, which has been absent for quite some time.”
Is China turning a corner?
Darius: “China has been substantially disappointing following their Covid reopening. There are obviously cultural differences: those of us in the West when we reopened, went out and spent while actually China did the opposite. Chinese people saved more because of everything that they had been through, so the Chinese consumer didn’t spend.
“Can the Chinese government stimulate enough to achieve this sort of growth? I think we would expect some stimulus from the Chinese government and that could lead to a better period for Chinese equities which are cheap on all-known bases; cheap versus their own history, cheap versus other emerging markets, certainly versus the likes of the US, for example, which is trading on a premium to its historic long-term average, while China is trading at a discount.
“Whether you want to invest there, of course is a secondary question. It’s something we look at and talk about a lot. There’s no doubt it’s cheap versus its own long term history, it could have a period of recovery, sure.”
Juliet: “It’s still got the headwinds of the property market decline and geopolitical tensions there. But yes, as Darius says, it’s certainly cheap so I think we are quite divided managers. We speak to a fairly divided community too, some are overweight China because it’s cheap and there are others who continue to avoid it.”
Sentiment is high but geopolitical tensions persist
Juliet: “Markets have been really strong in the first quarter and the global sector is up almost 7% and the US up over 9% which naturally makes me a little more cautious. The dangers that we face at the beginning of the year persist, with Ukraine and general geopolitical tensions. I do wonder if we are due for a pullback at some point. Having said that, the UK is only up 2.5% and UK Smaller Companies continue to lag to that. I’d be tempted to perhaps recycle some profits from the US into the unloved UK.”
Darius: “I think economies have been stronger than people expected and that has implications around the rate cycle. There was some bad inflation data out of the US last week, which has been just a bit more persistent, but at 3-3.5%, it’s not disastrous. Stock markets have continued to be positive this year. I just think that the electoral cycle and rates and inflation will continue to be a dominating macro effect with, of course, all the uncertainty that’s coming out of the Middle East at the moment so, I think I’m broadly neutral for the rest of the year, given that there’s been a strong start. But do still watch conflict in the Middle East, that could have bad outcomes for markets if there was to be a dramatic increase in tensions and more parties entering into that dispute.”
Conclusion: Amidst a turbulent political backdrop, both Juliet and Darius highlight opportunities in smaller cap stocks and Japan. Overall, while markets remain strong, geopolitical uncertainties persist, warranting caution.
