Investment update
- The US’s continued economic growth positively impacted global stock markets
- Adjusted expectations for central bank rate cuts led to a decline in global bond prices
- Japan’s stock market was a leading performer in the quarter
Macro overview
In January, the strong stock market rally we saw towards the end of last year took a bit of a breather. The US economy was still creating plenty of jobs and experiencing a persistent rise in the cost of services. As a result, there was a shift in the bond market, as investors adjusted their expectations for how many times central banks might need to lower interest rates in 2024. The strong job market and demand for services suggested that the economy didn’t need as much help from lower interest rates as previously thought.
As we moved into February, things looked up for stocks again. This boost was thanks to the underlying strength of the economy being reflected in solid corporate earnings and positive forecasts from some big names in the technology sector. Companies working with artificial intelligence (AI) shared some optimistic views, which made investors hopeful that demand for the technology powering these AI services will continue to endure and exceed expectations. Although just a handful of technology stocks were the main drivers of the stock market’s performance, sectors such as Healthcare and Industrials also showed impressive growth.
Come early March, Japan’s local index for the Tokyo Stock Exchange, the Nikkei 225, finally exceeded its previous peak set in 1989. The country’s efforts to boost its economy by keeping interest rates very low, through a policy called Yield Curve Control, has continued to show results in early 2024. This approach has not only helped boost the economy and create some modest inflation, but also made Japanese products cheaper abroad, helping exports. Together this has allowed workers in Japan to be awarded their highest pay rises in decades.[1] We believe that the improvements in economic conditions could be self-perpetuating. Investors also stand to benefit from a stronger focus on company governance, through increasing shareholder returns in dividends.
Asset class performance and positioning
We continue to take a balanced approach to portfolio construction. We hold a high proportion of bonds in our portfolios, and we expect these bonds to benefit from the anticipated central bank rate cuts. We believe the first cuts are likely to start around June. This slight delay has given us the chance to thoughtfully increase our investment in stocks, especially in markets we’re particularly optimistic about, like Japan.
Within corporate bonds, we’ve modestly reduced our exposure to interest rate changes. We maintain a strong belief in the relative value of corporate bonds compared to stocks. We note that if the economy keeps improving bonds may not perform as well, but any economic setbacks could lead to the opposite outcome. We continue to see particular value in high-yield bonds, which offer higher interest rates compared to investment-grade bonds. We see this value because we expect corporate default rates to remain low, which makes their higher returns particularly attractive.
We continue to have exposure to investment trusts, particularly those focused on renewable energy. Investor scepticism, partly due to investors waiting for better earnings reports, has weighed down this sector. Nonetheless, the sector continues to deliver appealing prices and, in many cases, high dividend yields hitting double digits.
Impact update
- Artificial Intelligence under scrutiny
- European Union reinforces accountability guardrails
- Met Office announced that 2023 was the warmest year on record globally
This quarter
2024 has certainly hit the ground running. Following on from very high levels of stock market attention on the Magnificent Seven[2] and artificial intelligence (AI) during 2023, the European Union (EU) has now set in legislative ‘stone’ the Artificial Intelligence Act (“the AI Act”).
The AI Act, the first- legal framework of its kind, is designed to manage the risks associated with AI while positioning Europe as a global leader in this area. The regulation was finalised by EU member states in December 2023 and endorsed overwhelmingly by the European Parliament in March. The Act aims to protect fundamental rights, democracy, the rule of law and environmental sustainability from high-risk AI. The regulation categorises AI systems based on their risk levels and potential impacts, reflecting Europe’s proactive approach to digital regulation.
The AI Act is additionally supported by the Digital Services Act (DSA) and the Digital Markets Act (DMA), both of which are aimed at regulating the digital landscape for the benefit of both users and businesses.
Additionally, the EU has moved forward with the Corporate Sustainability Due Diligence Directive (CSDDD). The directive, despite being modified from its initial proposal, requires companies to check their supply chains for environmental and labour malpractice and harm. It will be voted on by the members of European Parliament in April, ahead of the European Parliament elections in June.
However, the EU’s Nature Restoration Law faced unexpected obstacles in March, lacking consensus at the Environment Council meeting. Hailed during 2023 as a game-changer[3], this is a significant hurdle. Despite being approved by the European Parliament, the future of this key piece of environmental legislation is now unclear.
Finally, the Met Office announced that 2023 was the warmest year on record globally, surpassing previous records. The global average temperature for 2023 was 1.46 °C above the pre-industrial baseline and 0.17 °C warmer than the value for 2016.[4]
Future focus
Looking ahead, the European Parliament election in June is set to shed light on the future policy direction within the EU. Among the anticipated decisions post-election is the consideration of a vital new law aimed at banning the sale of products in the EU that are made using forced labour. This draft proposal, approved in March,[5] is now pending final adoption until after the elections.
The introduction of significant regulations such as the AI Act, Digital Services Act and Digital Markets Act is reshaping the operational landscape for big tech and AI in Europe. These laws, designed to enhance consumer protection, are poised to influence not only how tech companies govern themselves and develop products but also how investors view these industries.
In the UK, the investment industry is preparing for compliance with the new Sustainability Disclosure Requirements (SDR) and investment labels regime. As part of the SDR’s package of measures, the industry is also busily getting ready for the new anti-greenwashing rule that comes into force via the SDR on May 31st.
[1] Japanese workers secure biggest pay rise in three decades, Financial Times
[2] Magnificent 7 Stocks: What Are They and How They Dominate the Market, US News
[3] Commission welcomes agreement between European Parliament and Council on Nature Restoration Law, European Commission
[4] 2023 confirmed as world’s hottest year on record, BBC
[5] Deal on EU ban on products made with forced labour, European Parliament
