Keeping You Informed Matters
Economic Review July 2024
Financial markets demonstrated resilience in the second quarter, overcoming macroeconomic concerns with robust earnings that extended beyond AI beneficiaries, supporting stock prices and driving positive returns for risk assets. Investors initially scaled back expectations for central bank rate cuts due to strong April data, but as the quarter progressed, soft-landing hopes revived and economic momentum in Europe remained positive.
But investor attention almost dominated by one stock: Nvidia
The Outlook
In recent reports, we’ve written about stock market performance being dominated by a small number of firms that have ties to artificial intelligence (AI). These Magnificent 7* AI-themed stocks initially moved as a pack, but then started to diverge, both in terms of their operating performance (for example, Apple and Tesla experienced falling revenues in recent quarters) and through their differing share price performances. Gradually, just one stock has come to dominate the attention of most investors and commentators: Nvidia.
*As a reminder, the Magnificent 7 are the following technology stocks: Apple, Microsoft, Amazon, Alphabet, Tesla, Nvidia and Meta Platforms.
This chipmaker has grown sales dramatically: revenue increased by more than 260% over the past year – and its share price nearly tripled. It’s now the largest company in the world, with a stock market capitalisation of over US$3trillion at the time of writing. Nvidia’s stock market capitalisation now exceeds that of the entire British, French or German stock markets. For some context on such a large number, the annual budget for the UK’s National Health Service is less than 8% of this figure. It’s little surprise that the performance of major investing indices, like the US S&P 500 and the MSCI World Index, have been heavily skewed by the rapid rise of the Nvidia ‘stock rocket’.
We invest in portfolios of funds for our clients, and some of these funds contain Nvidia shares (it’s held in portfolios with a ‘growth’ or ‘adventurous’ emphasis) – but managers probably wish they had held more, given its meteoric rise. The critical question for investors, though, is: do Nvidia shares make a good investment now, at today’s price?
There’s a strong theme driving the stock: AI will be an important part of the future, and Nvidia is a key supplier of chips for AI. Profits have been rising strongly, but the share price has been rising faster. So far, so good, but can investors’ expectations go higher still, allowing the shares to rise further? To answer this, we need to understand current expectations.
Investment analysts publish explicit forecasts for sales and profits for the next three years, so we can start with these. After a period of extraordinary growth, Nvidia’s sales are predicted to keep rising, doubling this year, then rising by an additional third, then another 15% in the year after that. For reference, the world economy might usually be predicted to grow by about 5-8% in nominal terms per year. After this explicit forecasting, we then use a method known as a ‘reverse discounted cash flow model’ to work out that the share price is factoring in another 5 years of growth at 15%, with profit margins at record levels for this firm, before some sort of normal long-term growth rate sets in.
Is all this even plausible? Well, yes, it is… though it would be extremely rare for such a big firm to grow so quickly. When one looks back at Nvidia’s history, it’s clear that this is a very cyclical firm, prone to booms and busts in its business, and its share price. For example, after coming to the stock market in 1999, its shares went up by about 15x (15 times) as the internet boom raged, and then crashed by 88% from its 2002 peak; it then rose roughly 11x ahead of the Global Financial Crisis of 2008, before crashing 82% afterwards. There have also been several smaller boom/busts for Nvidia in between these major cycles. But when we try to model the assumptions needed to explain Nvidia’s share price today, there seems to be no allowance for cyclicality.
Therefore, if we model a mild cyclical downturn a few years out, the share price looks unsupportable – modelling a 15% sales drop in 2028/9 leaves the shares at around double any reasonable ‘fair value’ estimate. The shares thus look to be fragile to a business cycle, or to any kind of external shock. Has the microchip cycle been banished, such that we needn’t fear it any longer? Well, there’s certainly been a lot of consolidation amongst chipmakers in recent years, reducing competition. But huge demand for AI-capable chips is luring in new competitors. For example, China’s $47bn ‘Big Fund’ is funding chip competitors, in a drive for national self-sufficiency. Korean chipmaker, SK Hynix, plans to invest $75bn by 2028, with a focus on AI chips. And there are US rivals too, such as AMD. Furthermore, chip demand itself may be cyclical – once the hard work of training a large language model is done, do the model-makers need to regularly buy quite so many chips as they did during the training period? Our best estimate is that chip production may be a less cyclical business than in the past, but that it’s certainly still cyclical. On this basis, Nvidia’s share price looks to be fragile to any cyclical turn.
Other investments
As the Magnificent 7, and mostly Nvidia, soared, thousands of other US stocks have languished and disappointed investors. Many of them now look sensibly priced. Outside the States, Japanese shares remain in recovery mode, albeit with a weak yen. And in the UK, share prices look seriously cheap, with a gradually recovering economy and a clear catalyst in the form of take-over bids. There were bids during the quarter for Anglo American, Hargreaves Lansdown, Keyword Studios, Alpha Financial Markets, and Britvic.
In June, the French stock market was shocked by Macron’s call for new parliamentary elections, falling 7% quite quickly on the news – a political shock plus weak government finances is a poor mix, as the UK learned in autumn 2022. It’s difficult to predict what happens next, politically or economically, in France (or indeed the impact of this on the EU) – we can imagine a wide variety of possible scenarios. In the meantime, we have modest exposure to French assets and share prices seem broadly sensible.
… and some other news
At the time of writing, US opinion polls, and betting markets, expect Trump to be the next President. If he were to win, his policies would likely include tax cuts for individuals and small businesses (despite the huge US government budget deficit), higher tariffs on Chinese imports, further limits to immigration, easier rules for the energy sector, and an attempt to exert more control over the US Federal Reserve. Overall, these would likely sum to inflationary growth.
In the meantime, the trade war with China continues to escalate, with the US announcing 100% tariffs on Chinese electric vehicles (EVs), and the EU announcing 25+% tariffs on Chinese EVs. As it becomes harder for Chinese firms to export to the USA, exporters are naturally pivoting, seeking out markets in other nations. The Indonesian media reports that its government is currently considering (huge) tariffs on a range of Chinese imports to protect its own industry.
Outlook
No one can predict the next move for Nvidia shares. But by evaluating what expectations are implied in today’s share price, we can see that the shares are a risky proposition, seemingly ignoring the boom/bust history of the firm.
Plenty of fairly priced, or even cheap assets exist elsewhere. Many firms will integrate AI to reduce costs, improve processes or develop new markets. Taking unbalanced investment risks is not required when seeking to benefit from AI.
A possible Trump victory could make investing very difficult indeed. If he were able to pressure the Fed into cutting policy interest rates while running a huge budget deficit, that would be a remarkable double stimulus for the US economy. That could lead to a wild ride for asset markets. Bond markets can be expected to react badly to tax cuts and a bigger deficit.
Those same tax cuts, though, would likely boost riskier, more speculative assets, at least initially. Ultimately, though, too much stimulus should lead to inflation, and a likely crash in the price of those risky assets. Such excitement distracts from prudent long-term investing.
The US/China trade war continues to ratchet up and is now widening out. In the short-term, manufacturing investment is very strong, as each country seeks greater self-sufficiency. But in the long run, global ‘beggar thy neighbour’ policies are not helpful for investors – a famous episode that started in the USA in 1930 brought a lot of pain to companies, workers and investors alike. It seems like bad policy making could be a big threat to investors over the next few years.
Key facts about the world
United Kingdom
- Rishi Sunak announced a general election, despite the fact polls suggested his party trailed Labour by more than 20 points, a lead as large as it was during the 1997 election.
- Inflation hit the Bank of England’s 2% target for the first time since July 2021.
- Despite inflation now being back at target, expectations for the first interest rate cut were pushed back after a higher-than-expected rise in services prices. The probability of a 0.25% cut in August is now less than a third.
Europe
- Macron announced shock snap parliamentary elections after huge gains for right-wing parties in the European parliament elections. Ahead of the first round of voting the CAC 40 index (a stock market index tracking the 40 largest shares listed on the Paris Stock Exchange) fell to a 5-month low, losing around 6.5% from the date of the announcement, with French stocks suffering their worst quarter in 2-years.
- The European Central Bank cut interest rates by 0.25%, the first cut in 5-years. Market reaction to the news was muted, with the Stoxx Europe 600 index (a stock index representing European stocks across 17 European countries) rising by 0.7% on the day.
- Bulgaria and Romania failed the economic test required to join the Euro, after concerns around the two country’s high inflation and weak institutions.
Asia
- India is set to see billions of dollars of inflows after its sovereign debt was included within JP Morgan’s emerging market debt index. Around 28 government bonds, worth £312bn will give India a 10% share of the index.
- An intensifying dispute between China and the Philippines over the Thomas Shoal reef and the beached Sierra Madre, means this has now become the most dangerous flashpoint in the Indo-Pacific region.
- The EU imposed tariffs of up to 48% on Chinese electric cars, risking a potential trade war with the Chinese Communist Party according to warnings from the German government.
North America
- Donald Trump was found guilty on all counts in his ‘hush money’ trial – becoming the first former US president to be convicted of a crime.
- US stocks closed the first half of 2024 up 14%, with five stocks driving most of the gains. Microsoft, Meta, Apple and Amazon accounting for 29% of the increase and Nvidia accounting for 31% alone.
- The US remains on course for one interest rate cut this year after the Fed’s preferred inflation metric fell to 2.6%, only slightly above target.
South America
- Brazil’s ruling party has filed a lawsuit against the head of the country’s central bank, accusing him of political bias and for cutting rates too slowly, gradually coming down from 13.75% to 10.5% in the last year.
- Argentina will now have to pay four hedge funds £1.1bn after a London court rejected the country’s appeal in a dispute over its GDP-linked securities.
- Increasing Chinese economic clout in South America means there is now bilateral support for the ‘Americas Act’ in the US which would offer incentives to Latin American countries if they ‘nearshored’ production away from China.
Africa
- Ghana agreed a deal with bond holders that will wipe nearly 40% off the value of £10.1bn worth of the country’s bonds. abrdn, Neuberger Berman, Greylock Capital Management, Amundi and others will give up £3.6bn of their original claim.
- The currency and equity markets of South Africa strengthened as Cyril Ramaphosa was sworn in as the President through a power-sharing agreement with the Democratic Alliance.
- Angola, the continent’s second largest oil producer, agreed a deal with China Development Bank to ease its debt crunch whilst avoiding a wider debt restructuring. Angola is Beijing’s biggest borrower in Africa and owes around £13.2bn.
Q2 2024 Performance Review
Unconstrained strategies
Key facts
Bonds stable despite inflation concerns
US mega-cap tech/AI leads equities
Strong performance in Asian equities
UK mid-sized companies outperform
Global small caps struggle
Shift in Japanese equity strategy
Adjusted renewable infrastructure exposure
Summary
Bonds had a somewhat benign outcome over the quarter, driven by changing inflation outlooks. In April, concerns over resilient US inflation reduced rate cut expectations from six to one, causing yields to rise and prices to fall. This trend reversed in June, helping the L&G All Stocks Index Linked Gilt fund (-1.3%) and Amundi UK Government Bond ETF (-0.9%) recover from larger losses. The more defensive M&G UK Inflation Linked Bond fund (+0.5%) and Vontobel 24 Sustainable Short Term Bond fund (+1.1%) remained steady. Corporate bond funds were neutral, reacting to earnings expectations rather than inflation and interest rates.
In equities, US mega-cap tech/AI related companies, led by Nvidia, dictated market direction in Q2. The Natixis LS US Equity Leaders fund (+4.9%) performed well due to this exposure, while the Xtrackers S&P 500 Equal Weight ETF (-2.6%) reflected broader market struggles. Fidelity Asia (+7.5%) saw solid performance from regional growth companies, building on first-quarter gains. In the UK, investor interest is returning to undervalued regions, with the R&M UK Recovery fund (+5.8%) and Montanaro UK Income fund (+4.8%) performing well. However, global small and mid-sized companies, like those in the American Century Global Small Cap fund (-0.6%) and Regnan Global Equity Impact Solutions fund (-14.6%), struggled. The Regnan fund faced headwinds in its specialist European growth companies, leading to a review of its continued inclusion.
We adjusted our Japanese exposure, selling the Lindsell Train Japanese Equity fund (-5.9%) in favour of the more dynamic Zennor Japan fund, which focuses on growth opportunities in smaller and mid-sized companies.
In alternative assets, we reduced exposure to Downing Renewables & Infrastructure Trust (+3.3%) in the Cautious and Balanced mandates due to liquidity concerns and introduced the Gravis UK Infrastructure fund, which invests in more liquid assets. This move aims to maintain renewable energy sector exposure and capitalise on long-term growth opportunities. The Gravis fund is expected to further benefit from renewed interest in the broader UK market, offering a strong recovery play over the coming years.
| SECTOR | Q2 2024 | 1 year to 30/06/24 | 1 year to 30/06/23 | 1 year to 30/06/22 | 1 year to 30/06/21 | 1 year to 30/06/20 | 5 years (annualised) |
|---|---|---|---|---|---|---|---|
| IA UK Index Linked Gilts | -1.8% | -0.0% | -16.8% | -20.2% | -4.3% | 11.2% | -6.7% |
| IA £ Corporate Bond | 0.1% | 10.5% | -4.8% | -13.1% | 3.5% | 5.7% | 0.0% |
| IA Property | 0.8% | -1.0% | -12.1% | 11.1% | 1.1% | -4.3% | -1.3% |
| IA UK Equity Income | 4.6% | 14.6% | 4.0% | -0.6% | 25.4% | -13.7% | 5.1% |
| IA UK Smaller Companies | 7.3% | 14.0% | -5.7% | -22.6% | 50.8% | -6.4% | 3.3% |
| IA North America | 1.7% | 21.3% | 11.9% | -3.7% | 27.3% | 8.5% | 12.5% |
| IA Europe Excluding UK | -0.7% | 11.7% | 18.6% | -12.5% | 23.8% | -1.0 | 7.7% |
| IA Japan | -3.6% | 10.1% | 12.4% | -11.8% | 13.1% | 7.9% | 5.9% |
| IA Asia Pacific Excluding Japan | 5.3% | 10.0% | -3.1% | -10.8% | 26.9% | 2.6% | 4.4% |
| IA Global Emerging Markets | 4.1% | 11.5% | -0.3% | -17.3% | 28.3% | -3.3% | 2.7% |
Source: Morningstar in GBP. Net income reinvested. Past performance is not a reliable indicator of future results.
The positioning of our Unconstrained strategies
Cautious
Growth
Balanced
Adventurous
Q2 2024 Performance Review
Ethical strategies
Key facts
Ethical bond funds neutral as inflation expectations volatile
Mixed results from global equities, with Emerging Markets performing well
Increased investor interest and strong performance in UK equities
Adjustment to renewable energy infrastructure exposure
New anti-greenwashing rules introduced
Summary
Performance from the ethical bond funds was broadly neutral this quarter. Having been marginally weaker in April due to more resilient inflation data, the funds recovered into June ranging from -0.6% for the Liontrust Sustainable Future Corporate Bond fund, to +1.1% for the Vontobel 24 Sustainable Short Term Bond fund.
We continued to adjust the renewable infrastructure assets, further reducing the Downing Renewables & Infrastructure Trust (+3.3%) and introducing the Gravis UK Infrastructure fund towards the end of the quarter. Downing is being reduced due to liquidity concerns, rather than for performance reasons, and we wish to maintain exposure to the renewable energy sector where we see long-term growth opportunities. The Gravis fund invests in a more liquid pool of assets and with the return of interest to the broader UK market, should offer a strong recovery play over the coming years. Gold continued to perform well, as reflected by the Royal Mint Responsibly Sourced Gold ETC (+5.2%), with the Trojan Ethical fund (+1.9) also benefiting from its underlying position in the yellow metal.
The UK equity selections performed well, with the abrdn UK Ethical Equity fund (+7.5%) the standout return, while collectively Aegon Ethical Equity, CT Responsible UK Income and Montanaro UK Income all returned over 4%. The FTSE All Share index of UK companies was positive, up 2.6% over the quarter in comparison. Interest is slowly returning to the wider UK market driven by the prospect of political stability, mergers and acquisitions, and increased share buybacks.
In global equities, the fortunes of our selections have been more mixed. The Janus Henderson Global Sustainable Equity fund (+4.2%) continues its strong start to the year, as does the Vanguard ESG Emerging Markets All Cap Equity Index fund (+5.0%). Emerging markets such as South Korea and Taiwan due to their technology sectors, and India which continues to see strong economic growth, were key drivers. However, the Regnan Global Equity Impact Solutions fund (-14.6%) struggled. The Regnan fund, with concentrated positions in specialist smaller European growth companies, has faced several headwinds to both its style and sector focus, which leaves it under review for its continued use in strategies. We are aware that many of the companies held are deeply out of favour currently, with potential for longer-term recovery from here.
Otherwise, recent regulatory changes with new anti-greenwashing rules aim to clarify fund marketing and descriptions, benefiting investors in responsible, sustainable, and ethical investments as the fund universe expands.
| SECTOR | Q2 2024 | 1 year to 30/06/24 | 1 year to 30/06/23 | 1 year to 30/06/22 | 1 year to 30/06/21 | 1 year to 30/06/20 | 5 years (annualised) |
|---|---|---|---|---|---|---|---|
| Global Sustainable | 1.9% | 17.8% | 10.5% | -5.8% | 21.3% | 4.9% | 9.3% |
| UK ESG Enhanced | 4.3% | 14.0% | 9.2% | -0.9% | 20.5% | -14.0% | 5.0% |
| US ESG Enhanced | 3.7% | 24.9% | 13.7% | -1.5% | 27.2% | 11.8% | 14.8% |
| Developed Market Europe Sustainable | 0.5% | 12.6% | 14.8% | -10.3% | 23.9% | 2.3% | 8.0% |
| Emerging Market ESG Enhanced | 2.8% | 10.1% | -4.5% | -15.2% | 19.9% | -3.1% | 0.7% |
| UK Corporate Bond Sustainable | -0.5% | 10.5% | -8.3% | -15.1% | 1.9% | 7.0% | -1.3% |
| Global Corporate Bond Sustainable | -0.4% | 4.9% | -2.8% | -5.7% | -6.0% | 9.5% | -0.2% |
| Global Green Bond | -1.3% | 3.4% | -4.6% | -11.6% | -6.0% | 5.5% | -2.9% |
| Global Renewable Energy | 0.8% | 1.6% | 5.9% | 0.5% | 37.0% | -0.9% | 8.0% |
Source: Morningstar sustainable indices in GBP. Net income reinvested. Past performance is not a reliable indicator of future results
The positioning of our Ethical strategies
Cautious
Growth
Balanced
Adventurous
Disclaimer
Opinions constitute our judgment as of this date and are subject to change without warning. The value of investments, and the income from them, can go down as well as up, and you may not recover the amount of your original investment. Past performance is not a reliable indicator of future results and forecasts are not a reliable indicator of future performance. Where an investment involves exposure to a foreign currency, changes in rates of exchange may cause the value of the investment, and the income from it, to go up or down. The information in this document is not intended as an offer or solicitation to buy or sell securities or any other investment, nor does it constitute a personal recommendation.