Welcome back to our bi-weekly market update.

Our aim is to provide you with an overview of current market and financial affairs, digestible to you, in a 5 minute read!

We spoke last week about the challenges that markets, and global economies have been facing, namely, inflation, being a key driver in this. The volatility we have witnessed of late has mainly been in the fixed income sector of the market (government debt and corporate debt), which suggests that parts of the market still find inflation problematic. With economic growth sufficiently strong, it is keeping economies above their inflation targets.

The jury is out as to whether the modest cut in interest rates that we have seen from the federal reserve in the US, Bank of England in the UK and EU, are premature.

Bond yields have traded higher since the Fed’s first cut of the cycle in Q3 2024. This divergence between bond yields and interest rate policy is rare and has kept bonds in the longest running bear market in history – currently at 53 months (in Jan ’25) exceeding the previous record of 16 months set in the early 1980s. It is also the steepest drawdown in history.

The silver lining is that bond bear markets are self-correcting. You might be thinking what does this mean? It means that the main risk when holding a bond is maturity risk and having the ability to withstand the volatility. The beauty of the bond structure is that assuming you can ride it out at maturity you are guaranteed to make money.

• I believe there is an opportunity in inflation linked bonds and building this into your portfolio moving forwards. Structural drivers such as de-globalisation and mounting debt levels suggest that inflation may be problematic for years to come. Inflation linked protection offer positive real yields, meaning they can fully insulate the risk of higher-than-expected inflation and pay a premium above that, making this a powerful wealth protection asset over the longer term.

Recessionary signs witnessed throughout 2024 did not materialise further and a combination of loose fiscal policy and consumer confidence have kept the economy moving in a positive direction. Strategists’ probability of recession over the coming 12 months has fallen from ~60% during 2024 to ~20% today.

This has been a driving factor in keeping bond yields higher than anticipated and supporting enthusiasm for equity markets even at historically high valuations. Maintaining a strong employment market will be a crucial factor in keeping the momentum positive.

There are several attractive long undervalued equity investment opportunities, most notably within inexpensive stock markets such as Japan, the UK, and Emerging Markets, where valuations appeal most. The runway is long and the room for style reversion away from expensive stocks remains significant. US equities have dominated on a global scale of late, but for how much longer?

All eyes on the US

 “The S&P 500 returned +25.0% in 2024 and that follows 2023’s +26.3% for an aggregate +57.9% and an annualised equivalent rate of return of +25.6%. Given those returns are far in excess of the actual earnings growth of the underlying companies, it is argued that it is exceptionally unlikely that the run continues at this pace – but where we have got to today is already exceptional, so anything is possible!

Having provided such outsized returns, with an earnings growth rate below the share price returns, and valuations on most metrics now exceeding historic averages, the US equity market looks increasingly likely to disappoint in future. Goldman Sachs has recently warned about this:” Source: Goldman Sachs

The market concentration of the S&P 500 is a major headwind for the index and something that I believe is not being spoken about enough. The performance is one thing, but it is important to look at where that is being driven from, ultimately it is coming from circa 10 companies within the index, all of which are incredibly interlinked and operate in the tech sector.

If we take the example of Nivida which lost circa 17% of their value last Monday, taking the record for largest stock correction in the US market history; it shows us that diversification has never been more important, with assets such as equity hedges, currency optionality, commercial property and infrastructure all having an increasingly important part to play; alongside equities!

Another key signal, that many investors are starting to act on the US market being overvalued. Berkshire Hathaway (Warren Buffet’s company) has more than doubled their cash position in less than a year. The company has also decided to halt stock buybacks for the first time since 2018. At $325bn, cash now accounts for 28% of Berkshire’s asset value — the highest level since at least 1990. “When stocks are overvalued, Berkshire’s cash piles up because Buffett is finding less and less to buy.” Source: Darren Pollack Fund Manager quoted in Financial Times.

With all this in mind, what should you be prioritising in this market?

• Be acutely aware of where we are in the market cycle – earnings expectations are elevated, and the cost of capital has rapidly increased, this will drive behaviour changes and consequences that materialise with a lagged impact
• Avoid purchasing overvalued assets – they are plentiful and in high demand
• Increase levels of inflation protection, given its structural foundation and severe impact on future wealth
• Prepare for credit conditions to deteriorate – credit conditions have rarely been more favourable, implying the cycle may turn
• Maintain a forward-looking perspective – what has worked well during a low-interest rate environment is unlikely to perform as well under tighter monetary conditions (higher interest rates and less liquidity support from central banks). The road ahead is unlikely to be the road travelled
• Take advantage of valuation dislocations – some less well-loved equity markets trade at reasonable levels and present attractive long-term opportunities even if the short-term seems uncertain and volatile
• Diversify – the most effective way to improve long-term risk-adjusted returns. Successful investment portfolios do not contain a list of assets that all behave in the same way. The future is undeniably uncertain and in the short run it can be surprisingly random – this may cause discomfort at first but can increase wealth over the long run

Anyone still wondering what this means for you and your money?

Please do take this as an opportunity to review your current position and if necessary, make adjustments, a key element of making your money work as hard as you have to earn it, is ensuring you are actively managing your capital and ensuring it remains aligned to your goals and objectives.

If you are unsure on where to start or would like another perspective, please do reach out. As an adviser I see this to be my biggest advantage being outside of your situation, looking in,  it doesn’t mean I always have the correct answer, but I have the ability to give you a different perspective to consider to help you make informed decisions.

From next time, I would like to add another feature to these updates and ask you all what would like to see us focusing upon? As you know I am passionate about opening the conversation around money so please do send in any questions or topics that you want to be covered, and I will be sure to start building these into our features!