Darius McDermott, managing director of Chelsea Financial Services and adviser to the VT Chelsea Managed Funds range, considers whether th US Federal reserve has been judged to have left a rate rise too late for the markets and outlines how the investment team have been mitigating the risks.
I’m sure most of you would’ve heard about the game of chicken, in which two people drive two very fast cars towards each other from opposite ends of a long, straight road. If one of them swerves before the other, they are called a chicken. Of course, if neither swerves, they will crash.
It has felt a little bit like this for financial markets during the first half of 2024. Despite geopolitical uncertainty, markets have continued to grind ever higher, with mega-cap technology stocks, such as Nvidia, leading the way – while others like utilities and gold also registered strong returns. This was off the back of strong economic indicators – while the threat of recession began to diminish.
But the sloth-like Fed pivot (and its impact) has always been an overhanging factor for markets. While other central banks in Canada, Europe and the UK have started to make their move, the US Federal Reserve – with inflation remaining sticky in the world’s largest economy – has held firm.
It has been a tough balancing act – if the Fed moves too soon inflation will be stuck above their target. By contrast, the risk of leaving it too long will threaten economic growth and jobs – potentially resulting in recession.
It appears things may have come to a head in early August, as disappointing jobs data from the US acted as a catalyst for a sell-off, with investors fearing that the Federal Reserve has left the rate move for too long. This came in tandem with the unwinding of the carry trade in Japan – with significant volatility in the Nikkei 225.
Stock markets were already worried about high borrowing costs and unsettled by signs that a long-running rally in share prices, fuelled in part by optimism over artificial intelligence (AI), might be running out of steam. The UK, Europe and Asia also saw markets tumble in what appeared to be a very sharp correction. The VIX index reaching its highest level (65) on Monday (August 5) since the height of Covid in March 2020 as global equities fell sharply*. For clarity, anything above 30 is considered to signal heightened volatility from increased uncertainty, risk and investor fear. It has since fallen back to 22.7 but spent the first seven months of 2024 at an average of 14**.
US government bonds, energy and bond proxies offer balance to VT funds
We were fortunate that we had already started to reduce the level of risk within our fund range by adding some US government bonds. This was due to a combination of concerns (valuations, rates and geopolitics) but was principally down to the growing tensions in the Middle East between Israel and Iran. Simply put, if we see some sort of attack we want exposure to US government bonds because they are the biggest risk-off asset you can have.
We’ve looked to tap into the strong commodities rally in 2024 by adding the BlackRock World Mining Trust. Demand for the likes of copper has reached record highs (it has risen over 20% since mid-February 2024***). The energy transition to a lower carbon world cannot happen without an increased use of metals – the likes of electric vehicles are dependent on this (all electrification needs mining). We also need to consider the importance of metals for the likes of AI. AI can’t commoditise commodities and if you want more AI you need more data centres (computing power) and that requires more commodities.
For the past 12 months, credit spreads have been reasonably stable. They have continued to tick marginally lower in 2024 as it has become increasingly clear that the major economies will experience a soft landing (avoid a deep recession).
While the tightening of credit spreads has not resulted in us reducing our bond exposure, we have looked to specialist investment trusts as an alternative bond proxy. Examples include GCP, a debt investment trust which lends and Assura, a specialist property company that buys GP surgeries. Not only do they offer an alternative route to bonds, but we can access these investment trusts at attractive discounts.
A move to value
We have steadily increased our weightings across the funds to value in the past quarter. Although we’re still overweight to growth – which benefited the fund’s performance last year – we were conscious that we were running a considerable growth style risk.
We’ve also increased our exposure to the UK as it continues to be undervalued and unloved. A fund we like here is Man GLG Income. Unlike many of its peers, the UK benefits from a stable political climate and is still trading very cheaply versus its long-term history. From a valuation perspective, this comes in stark contrast to the US and, to some degree, Europe.
Balance has been my core message in 2024 and it is no different today as there are so many different directions for markets to travel down. Take small-caps as an example – yes, they are attractively valued if we just bumble along in a typical rate-cutting cycle from here. But if central banks have to cut aggressively, the macro and liquidity challenges change the complexion quickly. That is why diversification is the key to navigating the current market backdrop.
*Source: CNBC
**Source: Macrotrends, at 7 August 2024
***Source: Credendo, 27 May 2024
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Darius’s views are his own and do not constitute financial advice.
Valu-Trac Investment Management Limited is the authorised corporate director (ACD) and investment manager of the VT Chelsea Managed Funds. Valu-Trac is authorised and regulated by the Financial Conduct Authority (FCA). Valu-Trac’s FCA registration is 145168. Chelsea Portfolio Management Services Limited will be the investment adviser for the VT Chelsea Managed Funds.
Main image: sharon-mccutcheon-8lnbXtxFGZw-unsplash
