Portfolio Perspectives, March 2024

Resilience and the prospect of rate cuts

Equity markets made further progress in February as the theme of resilient economic performance with the prospect of declining interest rates dominated investors thinking. The US economy continued to show momentum and there were further upgrades to growth forecasts for 2024. From the rest of the world, the news is ‘less bad’ and there was hope for some policy developments from China. Comments from central banks were more helpful with ECB President Lagarde and Fed Chair Powell reaffirming that we are close to the start of interest rate cuts.

Growth has been at or ahead of forecast across the globe, but outside of the US not been strong enough to prompt upward revisions. In the euro area, beats are coming through in the PMIs and latterly in Retail Sales. In China, it is external demand which is delivering the surprise with consumption growth still in the doldrums. At the National People’s Congress, the economic growth target was maintained at 5% but no central policies were revealed to achieve this growth rate. Inflation data reports were a negative, with CPI higher in both the euro area and US – but not by enough to eliminate the potential for interest rate cuts.

In February there was a revival in the Asian markets driven by a combination of stabilisation in China, Japan not changing monetary policy and the upward move in the semi-conductor sector. However, all regions were positive in the month. Market performance was led by the cyclical sectors (Industrials, Consumer Discretionary) following the better growth data. IT was also strong as exceptional results from Nvidia pushed the Semi-Conductor sector higher. The defensive sectors were laggards, in particular those most sensitive to bond yields (Utilities and Property).

Post the fourth quarter earnings season, there were only modest changes to 2024 forecasts. Global earnings are expected to grow by 10% in 2024. Given that some sectors suffered an earnings recession in 2023, it is not hard to get earnings growth from this base. However, global earnings growth is forecast to accelerate in 2025 which, given we have no sectors in earnings distress in 2024, looks ambitious.

Of late, the growth data has been at or better than expected and that is probably reflected in the recent equity market moves and sector rankings. However, there are some glitches on the horizon. We have the downward move in the ISMs in the US and the jobs release was mixed - the unemployment rate is rising despite the robust payrolls number. China has not announced any major policy initiative to get the economy back towards its 5% growth rate. The good growth news may not continue and thus a modest underweight in equities remains the preference.

Bernard Swords,
Chief Investment Officer

Another incremental increase to duration

Our constructive duration view continues this month, with another incremental increase to duration. As discussed last month, yield levels, central bank messaging and inflation data, continue to support this view. On inflation, US inflation releases did show core inflation measuring higher than expected however, core CPI is declining and that is the important thing.

Outside of the aforementioned supports for the constructive view, a key factor which is supportive of our duration view is the repricing of market central bank expectations. As indicated in our Chart of the week, the market expectation for cuts has now moved in line with central bank projections. This indicates that yield and bond prices are less vulnerable to negative performance pullbacks going forward, absent a change in central bank rhetoric.

Another factor which supports the move to incrementally increase duration is the correlation between government bonds and corporate bonds. Historically, government bond performance and corporate bond performance has been negatively correlated. In times of economic stress, investors will flock to the safety of ‘safe haven’ government bonds, whilst in times of high economic growth corporate bonds will outperform due to an improved earnings outlook. In recent years, this relationship broke down as unprecedented central bank tightening and inflation dynamics overwhelmed economic considerations. However, as we move towards a more normalised inflationary and economic environment, the typical relationship should resume once more.

As we cover in more detail below, we have increased portfolio duration, bringing the portfolios more in line with the overall duration of the Bloomberg Euro Aggregate Index.

Elizabeth Geoghegan,
Head of Fixed Income Strategy

Adjusting our cyclical holdings

Last month we outlined how we have gradually increased the duration profile of our fixed income assets, moving to a more neutral standpoint in our flagship portfolios. In March, we continued incrementally increasing the maturity profile, rolling a shorter maturity German bund into longer maturity Netherland government bonds.

Within the equity portion of our flagship portfolios, we are adjusting our cyclical holdings – switching Capital One into Ashtead Group plc. Capital One is in the process of acquiring Discover Financial. While this is an attractive proposition, it is going to be time consuming, carry significant regulatory risk and result in a large increase in the number of Capital One shares with associated execution risk. Given the likely overhang on the share price over the coming year, we view this as a good time to rotate the asset.

We are reinvesting the proceeds into Ashtead Group plc, a UK-listed equipment rental business with a long track record of outperformance. Approximately 40% of revenue is derived from construction industry end markets (directly) with the balance driven by a diverse range of end markets. We favour the stock given:

• Ashtead’s absolute and relative share price performance is highly correlated to cyclical indicators. These indicators are currently trending upwards and near moving into growth territory.
• There is the current tailwind of US industrial reshoring which creates a large visible multi-year pipeline of potential demand.
• Ashtead had a profit warning in November 2023 due to reduced demand from film and TV industry strikes, and lower than usual hurricane related demand. These idiosyncratic events and the low expectations for near-term growth appear to present an opportunity to add a high-quality franchise on average multiples of low expectations.
  

In adding Ashtead Group plc.to flagship portfolios, we maintain our cyclical exposure within equity portfolios but with a higher  quality business – higher profitability, lower financial leverage, less regulatory risk, at a time when Capital One will be undergoing a major transaction.  

Sarah Quirke,
Head of Investment Solutions