Welcome to our ‘May 2024 Insights’ report where we provide you with the means to keep informed of the latest economic and investment market conditions. In this report, we set out our views on the current environment and the challenges and opportunities that lie ahead for investors over the next twelve months. We aim to keep you updated on such matters leading to better investment decisions and by extension more acceptable returns on employed capital.

Are we there yet?

The fourth year of a US Presidential cycle has historically been positive for equity markets. The incumbent usually aims to boost economic growth to secure a favourable election result. Certainly, President Biden is trying to pull out all the stops this year and until recently, it has worked. In our March 2024 insights, we reported US GDP was forecast to grow +3.0% year/year in real terms in Q1 2024 and by a booming +6% per annum after accounting for inflation. However, more recent data suggest growth may be slowing, while inflation remains sticky. Despite a constructive growth outlook, global equity markets stumbled in April. This followed a sustained advance in which optimism built on positive price momentum and improving fundamentals moved markets off their bottom.

Although market shocks from war and geopolitical crises tend to temporarily affect long-term market growth, investors are often inclined to sell because of immediate uncertainty, hoping to reinvest in the market after the crisis has passed. Selling is counterproductive, locking in otherwise temporary losses and degrading the ability to participate in the next market recovery. After a healthy correction, catalysed by events in the Middle East, many managers believe markets still have greater performance potential than global bonds, and recommend staying the course with an equity preference. While rate cuts by the Federal Reserve look likely to be delayed, we expect policy easing this year to support equity markets with healthy earnings growth.

In a recent Note by Franklin Templeton, one of the world’s largest investment managers, they highlighted a number of key takeaways, which is a common view held by many managers. Specifically:

  • Growth is more constructive: Leading economic indicators continue to improve globally, and consumers are remarkably resilient.
  • Inflation risks evolving: Significant progress has been made, although it has been bumpy, and inflation is still above targeted levels. U.S. consumer prices increased less than expected in April, suggesting that inflation resumed its downward trend at the start of the second quarter in a boost to financial market expectations for a late Summer interest rate cut.
  • Policy easing cycles to begin soon: Inflation progress allows policymakers leeway to balance growth and inflation objectives. Central banks remain cautious and will seek data that confirms disinflation before acting. In the West, some are likely to start cutting rates soon, but with a greater divergence of outcomes likely.
  • Allocation toward risk: An improving macro environment is typically associated with strong markets, which causes managers to maintain a tilt toward riskier assets. Policy changes may balance growth and inflation surprises, but the collective mix remains constructive.
  • More attractive yields for bonds: Higher yields more recently have been boosting the return potential from global bonds, especially lower-risk government bonds. Easing cycles are likely to begin this year, and we find market expectations to be fair.

Outside the US, economic conditions have improved, though remain below trend. Europe, the UK and Japan have avoided recession while growth in India and China remain resilient. The global composite PMI, which includes manufacturing and services sectors, registered its fifth consecutive month of expansion in April which was its strongest growth in nine months. However, inflationary pressures have also risen internationally, and remain above central bank target levels.

Sell In May?

We have a macro environment of low but improving growth internationally, initial signs of slowing growth in the US, and inflation rates that remain stubbornly high everywhere.

Despite the stock market correction in April, the FTSE World Equity Index has shrugged off the rising risks of stagflation and rallied +8% year-to-date in euro terms. Bonds, a poor inflation hedge, continue to struggle. The US dollar has added +2% versus the Euro while commodity prices have performed well in recent months. Commodities have historically outperformed equities and bonds during stagflationary periods. West Texas Intermediate crude oil has rallied +19% in the first four months of 2024. Agricultural and soft commodities have added +23% and industrial metals have gained +15%. We expect stock market volatility to pick up in the second half of the year as the US presidential election comes into focus.

The bull market in equities may continue, though it is prudent to be vigilant and prepared for market nervousness until later in the year. “Sell in May, go away, and come back on St. Ledger’s Day”, is sage advice as we navigate the months ahead.

Equities

Fed Chair Powell will likely maintain a tight monetary policy and keep interest rates ‘higher-for-longer’ until inflation falls back towards his 2% target, or until financial markets suffer increased volatility and a material correction.

Bonds

The Federal Reserve left interest rates unchanged in April at 5.25%-5.50%. Jerome Powell communicated his preference to see more progress towards his 2% inflation goal before considering a rate cut. He also announced a reduction in the pace at which the Fed balance sheet would be run down, from $60 billion/month to $25 billion/month. Net-net, it was a mildly dovish policy update.

There is an ongoing debate regarding the restrictiveness of US monetary policy today. Real interest rates (10-year nominal rates adjusted for inflation) are less than 1.0%, suggesting monetary policy may still be relatively loose. However, the TIPS (Treasury Inflation-Protected Securities) yield is significantly higher at 2.3%. While the real interest rate is a theoretical construct representing the cost of borrowing in real terms, adjusted for inflation, the TIPS yield reflects the market’s expectations of future inflation and the risk premium associated with inflation-indexed securities.

The TIPS yield is approaching the October 2023 cycle highs, indicating a higher cost of capital. Yet economic growth and stock market barometers suggest that monetary policy is not tight enough. Overall, there is some uncertainty around how tight monetary policy is. While the Fed has tightened aggressively, there are differing views on whether their current stance is tight enough to bring down inflation without derailing the economy. The data and economic outlook will likely determine whether further tightening is needed. While the Fed controls the short end of the yield curve, the bond market determines longer-term rates. The 10-year yield is slowly adjusting to a more inflationary world. The trend higher in 10-year yields should continue.

Alternatives

Annualised performance data in euros, 30th April 2024

In stagflationary times, commodities perform best. Apart from natural gas, of which the United States is an abundant producer, commodities are accelerating higher in 2024. Industrial metals, precious metals, agricultural commodities and energy have rallied double-digit percentages in the first four months of the year. The Goldman Sachs Commodities Index has now returned +13% year-to-date.

Crude oil has rallied +19% year-to-date. Investing in energy as an inflation hedge presents a compelling opportunity for those looking to protect portfolios against the erosive effects of rising prices. Energy stocks have historically served as a reliable hedge against inflation, with the sector demonstrating resilience and potential for growth in inflationary times. The energy sector, particularly oil and gas, has faced challenges in capital investment over the past decade, leading to supply constraints and reduced refining capacity. The ongoing transition away from fossil fuels to alternative energy sources is expected to accelerate long-term demand for metals, mining, and natural resources, creating opportunities for investors in the energy sector. This shift in energy sources could further enhance the value proposition of energy investments as an inflation hedge in our view.

In the years ahead, investing in natural resources should offer the opportunity to capitalise on the sector’s historical performance, supply-demand dynamics, transition to alternative energy sources, resilience, and portfolio diversification benefits. By strategically allocating capital to energy opportunities, investors can potentially safeguard their portfolios against the impact of rising inflation and position themselves for long-term growth in a changing economic landscape.

Sector In Focus – Alternative Energy

It is clear that clean energy — which eliminates or substantially reduces carbon dioxide emissions — is a better alternative for the environment than fossil fuels.

Governments are taking action to reduce carbon dioxide emissions and clean energy technology is advancing rapidly. The European Commission wants 32% of all energy production to be renewable by 2030 among its members. In 2017 it was just 18%. In Europe, the share of energy consumed in the EU during 2022 generated from renewable sources was 23%. This increased from 21.9% in 2021.

Today a greater share of European households and businesses get their power from wind and solar than coal. Energy generated from wind and solar power is cheaper to generate than fossil fuels (IRENA, Renewable Power Generation Costs in 2020), even without subsidies. Meeting EU emissions-cutting goals will require an even faster expansion of renewable sources, requiring a power sector based 70% on renewables by 2030. More reliable and affordable than ever, Investment Managers believe clean energy’s potential to provide energy security, combined with enhanced government support, may spur significant opportunities for investors. While the environment for clean energy was already poised for success, the Inflation Reduction Act in the US has underscored this tipping point. The Clean Energy and Inflation Reduction Act is a landmark U.S. legislation aimed at combatting climate change by investing heavily in renewable energy and reducing greenhouse gas emissions. It includes substantial incentives for clean energy technologies, such as solar and wind power, electric vehicles, and energy-efficient infrastructure, while also introducing measures to lower healthcare costs and reduce the federal deficit. Investors should be ready for further focus on bolstering global clean energy manufacturing, decarbonisation, and incentives for consumers to make energy efficient choices.

In the ever-evolving landscape of the global economy, the renewable energy sector stands at the forefront of innovation and sustainability. Over the past decade, alternative energy funds have emerged as a very attractive option for investors seeking long-term growth in an asset class often described as embryonic, attracting investors keen on aligning their portfolios with environmentally conscious practices. However, the sector has not been immune to economic variables with the surge in interest rates in 2022 casting a shadow over its growth trajectory. This sector tends to be Interest Rate sensitive.

As central banks worldwide embarked on a path of tightening monetary policy, the alternative energy sector has experienced its share of challenges. Rising interest rates have introduced headwinds, dampening the appeal of these funds for investors who had flocked to them during times of accommodative monetary policies. Yet, amidst the concerns and uncertainties the current environment, characterised by a more accommodative Interest Rate environment we anticipate a shift in the appeal that could re-instate this sector as a very attractive investment option.

Within Insight Private Clients, we have a number of investment options which provide exposure to this sector. Please feel free to reach out to us to explore how these investments can benefit your portfolio.