Q1 2024 – Gold Spikes & UK Companies Carry On

Sluggish

In a global context, UK equities remained sluggish in Q1 2024, with domestic indices showing low single-digit changes compared to high single-digit or low double-digit gains for indices in the US, Japan, and China. Unusually, these equity market gains came despite higher US and UK 10-year bond yields, which rose by about 60 bps.

Cut Alone

While central banks have stuck to the narrative that policy rates have peaked, a stronger than expected US economy and an emerging Chinese manufacturing recovery have pushed expected rate cuts well into the second half of the year. If 2023 was the year markets adopted the idea of a US soft landing, 2024 could be the year of the no-landing hypothesis. With robust US GDP and jobs data, there is waning economic justification for rate cuts, and the question for the Bank of England and the ECB (where there is an economic case to cut) is whether they are prepared to lead the Fed.

Not So Precious Debt

A Fed rate cut in an election year with an economy growing at +3% pa and creating over 300,000 jobs monthly looks like a political act. Doubt regarding central bank independence increases fears of US Treasury debt monetisation. Such is the scale of the looming sovereign debt pile that these concerns have pushed precious metal prices higher. The gold price moved to an all-time high, up 13% in the period to $2,300/oz, and unlike other recent all-time high assaults, this one happened with a firm Dollar (the DXY was up 4%), meaning that for the first time in a while, dollar-based investors have seen a positive return on gold. The mere suggestion from the Fed that it was raising its 2% inflation target (even a tad) could send the gold price on a rerun of its 1970s flight path when it went up ten-fold.

Elevated Inflation

Other commodity prices have also strengthened during the period. Oil is up 16%, with Brent Crude close to its 12-month high and above $90. Copper and other industrial metals have also risen, and a few soft commodities have spiked. Cocoa prices have nearly doubled YTD. While containable, these price moves come when retail inflation appears stubbornly sticky. We might not be heading for a 1970s-style double-headed surge, but fears of sustainably higher inflation persist.

Debt Debt Everywhere

Despite delayed rate cuts, yield curves are normalising as longer-duration yields increase, and bond wonks debate whether this implies a bull or bear steepening. The outcome will be determined by whether we can manage a manufacturing-led reflation (China’s recovery persists) before the long and variable lags of “higher for longer” start to break things. One doesn’t have to look far to find swathes of debt that require refinancing; Thames Water is just one example.

From Concentrate

However, for equities, the high level of market concentration remains a feature, particularly the dominance of the Magnificent Seven AI Big Tech goliaths. A robust, fiscally stimulated US economy and growing evidence of a technological paradigm shift continued to pull markets higher from the top, albeit with less force. Although we have previously commented on this bubble-like trend, it is now becoming more widely debated.

AI Winners

Financial markets overestimate the impact of technological change in the short term but underestimate its impact over the longer term. AI will be no different from the internet, the transistor, electricity, or the steam engine before it. Owning big telecom infrastructure companies in the early 2000s wiped many investors out. In contrast, those businesses that thrived on cheap and abundant connectivity over the following twenty years delivered spectacular returns to investors in Google, Facebook and Amazon. Similarly, we have yet to see the long-term winners of this technology cycle.

Paradigm Shifts

Knowing you are in a bubble is tricky until it is too late. Today’s tech titans have sounder financials than most of their dot-com equivalents, suggesting the AI bubble could still be in its formative stages. But era-defining bubbles, like those seen in 1929, 1973, and 2000 only collapse after they have sucked in all market participants. While we tell ourselves that we are not going to get sucked in, the dominance of passive index-tracking investing does it automatically. While some suggest catalysts that might change this long-term trend, they are only evident in hindsight; timing is impossible to judge. However, history indicates that a dispersal of returns to smaller companies and a multi-year shift to active and value styles all follow a period of concentration.

Carry On Buybacks

Although long-term equity market trends change slowly (at least initially), some encouraging early signs are present. In Q1 2024, flows to UK equity funds remained negative but at a declining rate that was more than offset by increasing share buyback and M&A activity. Notably, February witnessed the first net inflow into UK Small-Cap Funds for over two and a half years. One swallow doesn’t make a Summer, but the idea that the UK is overdue an increased capital allocation is gaining wider traction. As UK-listed companies continue to retire their lowly valued equity through record levels of share buybacks and agree to offers at attractive valuation premia, the price action on increased capital flows to the lower echelons of this market will be dramatic.

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