Quarter 1 2024 Insights
Global Economy
The optimism surrounding the U.S. equity markets in early 2024 seems to have been largely driven by expectations of rate cuts by the Federal Reserve, which likely buoyed investor confidence in the face of persistent inflation levels above the Fed's target. Additionally, anticipation of a soft landing for the U.S. economy and enthusiasm surrounding developments in generative AI technologies likely contributed to the overall positive sentiment.
In recent months we have seen an alarming re-acceleration in core inflation numbers from the United States. Chart 1 depicts this by showing the 3-month annualised core inflation rate, which is close to 5%. This in itself is not the main concern as opposed to the actual trend of the sticky component of the CPI basket.
Whilst inflation seems to be a persistent problem for the Federal Reserve, it is noteworthy that the U.S. economy has taken a smack to the face with 5% points worth of interest rate hikes and yet nothing material has given way. Continued economic results that are released seems to point to the idea that the U.S. economy could be on its way to some sort of landing that might not be a catastrophe.
U.S. retail sales is one of the key metrics that is indicative of a strong and resilient U.S. economy. In the first quarter of 2024, the retail sales number grew by 0.9% while the year-on-year number came in at over 3.6%.
Retail sales isn’t the only metric to point to. Numerous headlines recently suggested that the U.S. manufacturing sector has been in contraction for 16 consecutive months, as measured by the ISM Manufacturing PMI index (a reading below 50). Although, in March this number showed some signs of optimism, breaching the 50 level.
It is however important to remember that PMI‘s (Purchasing Manager Index) are surveys that are conducted where managers are asked whether they THINK they are doing better or worse than the previous month.
Despite these negative market headlines, if one looks at the actual U.S. Industrial Production numbers (inflation adjusted) which are published every month, we can see that despite the negative PMI manufacturing survey numbers, the industrial segment of the economy held up quite well. Over the past 12 months this number is exactly flat to two decimal points. Again, not bad for a sector that was seemingly in contraction for 16 months.
In the face of this seemingly strong economy, expectations for interest rate cuts were pushed back to the second half of 2024, that is if we even get any cuts. This has caused longer dated bond yields to rise from 3.9% in December to about 4.6% today. At some point this higher discount rate will start to put pressure on equity market valuations, especially those with elevated multiples.
The stronger economic data, coupled with tension in the Middle-East and droughts in certain areas of Africa, led the broad commodity basket to appreciate by more than 10% in U.S. Dollars, driven largely by higher oil prices. Even Cocoa started to trade like a Meme-stock*, rising over 140% this year so far. This could potentially have another knock-on effect on inflation for the Fed to contend with.
Overall, the first three months of the year has been pretty good for investors in equity markets, less so for fixed income investors. Although the market continues to be plagued by uncertainty in terms of political and geopolitical risks, we have yet to see any meaningful pickup in volatility. There is no doubt that these calm times will not last forever, hence the importance of diversification within portfolios.
Financial markets
The first quarter of 2024 started off well for equity markets, with the MSCI All Country World index appreciating by 8.2% in U.S. Dollars. Fixed income investors were not that fortunate, unless they were fully invested in high yield bonds or cash. The U.S. 10-year bond yield rose over 0.8% since the beginning of the year, resulting in bond prices falling.
Growth assets were the major benefactors of this improved sentiment and hope for rate cuts, with major technology companies leading the charge. From chart 4 below we can see that Momentum was the best performing factor by a country mile. It is a strange mix of momentum and large market cap factors that has led to this impressive outperformance. It is noteworthy that this phenomenon has only happened four times in the past 25 years: in 1998; 2000; 2007 and 2020. Instability in markets tend to increase when both factors do well in tandem.
The jump in yields have seemingly gone unnoticed by equity market participants as the bullish narrative proved to be strong enough to propel global equities to new all-time highs. We are however cognisant of the fact that since the start of 2022, the rise in 10-year yields have led to all the significant corrections we have experienced over this period (chart 5).
Commodity prices saw a strong bid in the quarter, especially oil and gold. Due to the geopolitical tensions in the Middle-East, oil was buoyed by possible disruption to trade in the region. The world, and especially the United States, have been less reliant on oil from the Middle-East as the major investment in fracking has paid off.
Gold’s price movement was a bit more unexpected. In a world where real rates (Interest rates that go up while inflation subsides) are heading higher, a piece of gold which does not pay interest should in theory see price declines. However, with China building their foreign gold reserves as they aim to diversify away from the U.S. Dollar, it is providing a solid bid for the precious metal.
Emerging market equities underperformed their developed market peers, with the MSCI EM Index returning 2.4% as investors remained concerned about China’s growth prospects in the absence of any meaningful fiscal stimulus. There appears to be some green shoots emerging from China with some better-than-expected economic activity and some relief being provided by the People’s Bank of China, with a focus on prime rates for home mortgages.
The best performing market for the quarter was however Japan. The MSCI Japan index appreciated by 17.7% for the quarter in local currency terms, despite the Bank of Japan announcing their normalisation of its monetary policy in March. The central bank announced an end to its negative interest rate policy, yield curve control, and its purchases of equity exchange traded funds and real estate investment trusts. This marked the end of an era as well as the end to the lost decades.
Chart 6 serves as a stark reminder of what can happen when market euphoria and unrealistic expectations are priced into equity markets. The chart shows the run-up of Japanese equities in 1990 after a productivity and earnings boom that a lot of investors extrapolated into the future. Imagine being an investor in Japan that had to wait close to 35 years for his investment to finally show a positive price return.
Portfolio commentary
Adobe, a leading provider of cloud-based creative digital media solutions, has been one of the top-performing investments over the past year. Despite initial concerns in early 2023 regarding the impact of generative AI, the market quickly warmed up to Adobe as it introduced its Firefly product, leading to an impressive 84% surge in the stock price from mid-May through January's end. Since the company’s latest earnings results and lower than expected forward guidance in this quarter, the share took back some of its gains. While there is some concern about emerging competitive threats such as OpenAI's new text-to-video creation tool, Sora, we remain confident that the company would be able to utilise the availability of next generation AI tools to enhance their own product suite.
NVIDIA was once again the best performing company in our core portfolio delivering an 82% year-to-date return, on the back of a +239% return in 2023. Nvidia continues to defy gravity as the narrative around the company gains evermore momentum. Dan Ives from Wedbush Securities coined Nvidia the “God Father of AI” as the company continues to play a crucial part in building the infrastructure for Artificial Intelligence for years to come. Although we own the company in our portfolios due to exceptional profitability and balance sheet strength, coupled with a moat as deep as the Mariana Trench*, we are fully aware of the expectations heading into its earnings release for the first quarter of 2024 on the 22nd of May.
Zoetis delivered another strong performance in 2023 thanks to their diverse portfolio across markets. The company did however see a modest slowdown in veterinary visits in 2023, but the company is beginning to scale biologic drugs for pain in dogs and cats. These drugs are said to be highly differentiated and should have higher profit margins than their peers. The Wall Street Journal (WSJ) reported a detailed safety concern associated with the use of Zoetis’ arthritis drugs for animals. The WSJ reported earlier that “thousands of reports of side effects” from the use of Zoetis’ drugs Librela and Solensia have spurred reviews from health regulators in the U.S. and Europe. “The medicines are safe and effective, and have low rates of adverse events”, the company said in an emailed statement. The market’s movement seems to be overdone as no new incremental data has actually been made public by this article.
Apple was one of the laggards in the quarter as the company faces challenges, which included weaker iPhone sales, market erosion in China and mounting regulatory pressure stemming from Europe, and even the U.S. Justice department, regarding its App Store fees. A stunning fact, Alphabet pays over $10 billion in annual payments to secure its place as a preferred search engine on Apple iPhones. To put this into perspective – this amount is enough to cover almost all of Apple’s research and development costs for a year. The share price is down over 10% year-to-date, trailing the market by quite a margin. It remains a great business with a sticky customer base, but Cupertino will have to find a way to re-ignite growth in the coming quarters with many analysts pointing to their September event to unveil some sort of AI channel.
Microsoft's remarkable growth story persists unabated, buoyed predominantly by the stellar performance of its Azure cloud platform and associated cloud services. The company's strategic focus on expanding its cloud offerings has proven to be a masterstroke, driving robust revenue streams and bolstering its market position.
Ferrari announced the arrival of Lewis Hamilton as their main driver from 2025 onwards on a multi-year contract. The champion Formula One driver Lewis Hamilton is parting ways with the Mercedes-Benz team after 11 years.
Nike has seen some strong performance in its revenue streams linked to its direct-to-consumer channels. It has however been susceptible to a prolonged period of increased costs. Nike CEO John Donahoe blamed remote work for the company's innovation slowdown and lack of fresh products. Donahoe said the Nike employees worked from home for 2.5 years and “it's really hard to do bold, disruptive innovation, to develop a boldly disruptive shoe on Zoom.” The company announced that they will continue to invest in China as they see it as their main growth driver for the future. The company is also investing in hyper-localizing its storytelling and brand through Icon Shanghai, which plans to be a creative studio program aimed at translating global messaging into locally resonant content, responding rapidly to the dynamic Chinese market.
Our multi-asset portfolios performed well, despite yields that moved higher. Our portfolios have a relative healthy weight to high yield bonds, liquid alternatives and commodities, which provided some uncorrelated returns to the traditional bonds and equities, which are typically correlated in regimes of high inflation.
Global hedge fund performances in the first quarter were the best in more than 3 years, driven by an unusual combination of higher-than-normal returns from both equity-oriented funds and trend/macro funds. Managed Futures and Global Macro funds' strong performance benefited from long positions in U.S. and Japanese equity markets, dollar longs against several crosses, and long positions in surging agricultural commodities.
The hedge fund industry was well positioned in the quarter for a stronger than expected global economy and rising inflation pressures (particularly in the U.S.). Fund positioning remains well below previous peaks in equity risk and conservative across cyclical sectors, U.S. bonds and gold. While many investors are already close to their maximum positioning, many hedge fund managers look in a position to reinforce recent market moves by increasing positions.
Our infrastructure exposure outperformed the benchmark due to our allocation to Pacer’s U.S. Infrastructure Development ETF that provides our clients with exposure to companies that stand to benefit from a potential increase in infrastructure spending in the United States, including those involved in the production of raw materials, heavy equipment, engineering, and construction.
In our listed private equity managers basket, Apollo Global Management and KKR were the two standout performers, both appreciating by more than 22% in U.S. Dollar terms, after strong results from both companies. Apollo’s profit soared by more than 31% as interest rates buoyed their credit and insurance businesses. The company is also active in the market trying to buy Paramount Global for $26bn. Paramount Global is the holding company of CBS and Nickelodeon.
*A meme stock refers to the shares of a company that have gained viral popularity due to heightened social sentiment. Typically associated with high levels of volatility.
*The Mariana Trench is an oceanic trench located in the western Pacific Ocean, about 200 kilometers east of the Mariana Islands; it is the deepest oceanic trench on Earth
Source: FactSet Research Systems
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