Quarterly Rebalance Commentary

Overview

The summer months tend to be a calm period for markets, but 2024 has somewhat bucked that trend.

The three months since the last rebalance have seen turbulent economic data, volatile equity markets and, with the return of rate cuts, a day in the sun for fixed income assets. We discuss the events in more detail below – but from a portfolio sense, we’ve been expecting something like this for about a year, so already had positions in place.

US interest rates became the driving force behind much of the activity seen across the globe, as Jerome Powell and the Fed (a good band name?) began talking about a rate cutting cycle. With the US economy not particularly showing signs of broad stress, this reinforced the narrative around a soft landing.

In such a world, investors began looking outside of the winners of the past year – the long-awaited market rotation. This is a world in which the Magnificent 7 begin to share the spotlight with some of the unloved sectors of the market – healthcare, banks and smaller cap companies. The optimal version of that world – which we saw for most of July – is one where the large tech names move sideways, while everything else rallies. Markets remain positive, but led by new champions…

However, a very strange Friday in early August demonstrated the other version of the rotation. Equity markets around the world had their worst days since 2008. In fact, Japanese markets – catching up with events on Monday morning – had their worst day since 1987.

There were plenty of different reasons ascribed to the panic: weak US economic data, the reversal of the Yen carry trade, Bank of Japan rate rises, AI “bubble” and even some obscure views around the impact of algorithmic trading on a quiet summer’s day. Whatever the underlying cause (likely a combination of all of the above), within a couple of weeks, everything was back to normal! Which in itself, isn’t that normal!

We’ve positioned portfolios to weather such short-term storms, as well as for the hopefully benign broadening out seen in markets over the last three months. Our fixed income allocations provided the cool calming counterpoint to the otherwise heated equity market environment, while our more diversified equity holdings also offered protection and upside.

Core investment views

After more than a decade of lurching from one financial crisis to another, the markets are gradually remembering that economic cycles are normal.

And in those cycles – the same way that an aeroplane isn’t always ascending and descending – the economic world spends most of the time between extremes. There will be a mixture of good and bad data, and of policy responses; but only rarely will these result in large market shifts.

That’s where we are at the moment – a Holding Pattern.

Over the next 12 months, we expect:

• Economic growth to be positive but slowing as the lagged impact of rate rises comes through. We wouldn’t be surprised to see US GDP growth at 2%, rather than 2.3%, for example.
• Inflation to keep falling, but only because interest rates don’t. We’ve consistently said that central banks are going to make sure that inflation is crushed, before they start to really cut interest rates. And the end destination for rates isn’t zero.
• Our quantitative signals suggest that only small tactical deviations from neutral are appropriate, as we’d expect in the middle part of a cycle. A slight underweight to expensive concentrated equity markets (predominantly avoiding the US), and a small overweight in fixed income to take advantage of high yields in a defensive asset class.

Tactical Asset Allocation

As the markets adjust to a more normal economic cycle, traditional relationships should reassert themselves. Indices will become less concentrated, as the spotlight moves away from recent winners to either cheaper quality companies, or cheaper high-growth companies.

We will see markets begin to favour assets which can weather a more volatile growth and inflation environment. We want to hold the right equities – with robust earnings, strong balance sheets, able to deal with a higher interest rate environment than the last two decades.

Asset allocation changes

This quarter we have completed the transition to the 2024 Strategic Asset Allocations. Additionally, we made a few tactical changes to portfolios this quarter:

• A small reduction to the government bond overweight
• A reduction to the Put-Selling position
• A further trim to the AT1s position as prices continued their recovery back to their highest in nearly three years
• A minor trim to the Climate Transition Leaders position.

Manager changes

There were no manager changes made this quarter.

Please note: All of the comments in this document refer to the models we run on the 7IM platform, but the models are also available on a range of other platforms. As much as possible, we try to replicate the models we run of the 7IM platform across all platforms, but due to differing security availability, not all of the points outlined in this document may be relevant across these platforms. If you are unsure whether certain changes apply to models on a specific platform, please reach out to a member of the team.