The global growth cycle hit its lowest point in 2023 and is now picking up. Earnings estimates have been edging higher, with increasing contributions from sectors and markets that have lagged over the past twelve months.
Although central banks are hesitant to lower interest rates at this moment, they are conveying more accommodative signals to the market, which maintains the prevailing “risk-on” sentiment.
From a market perspective, the main equity indices continue to trend higher. Upside market participation is broadening while credit spreads remain tight. Cyclicals vs. defensives are exceeding expectations, whilst the recent pick-up in commodities and outperformance of TIPS over US Treasuries point towards a “reflationary” message. The best performing sector in Q1 was not tech – in fact, energy, industrials and financials all produced better returns as the overheated tech sector traded sideways in March, and the dispersion of returns within the tech heavyweights widened considerably.
For fixed income investors it was a more challenging period. Stickier inflation prints, resilient economic activity, and the Federal Reserve (Fed) backpedalling somewhat on its dovish December tone combined to drive negative returns for bonds.
The shift in the macro backdrop was also reflected in market expectations for interest rate cuts, where the implied number of US rate cuts for 2024 reduced from seven at the end of 2023, to no more than three rate cuts in total, starting in the summer. Today’s market pricing is now broadly in line with the Fed’s latest dot plot. As prospects for aggressive rate cuts faded, the yield of the Bloomberg Global Aggregate Index increased by 28 basis points (bps) over the quarter, which led to negative returns of -2.1%.
The US dollar rallied throughout the quarter, gaining around 2% and erasing half of the losses from Q4 of 2023. It was supported by the continued strength of the US economy, higher & more attractive relative cash and bond yields for a longer period, and the weakness of the Japanese yen which fell to a 34 year low relative to the greenback.
Despite the backdrop of higher bond yields and a stronger dollar, gold rallied to a new all-time high at the end of March, with strong sovereign fund buying. Oil also performed strongly, with prices up 17% so far this year and well above $80 barrel again. OPEC remains committed to production cuts and geopolitical tensions have threatened supply. Meanwhile, global demand forecasts are being raised and inflation is rebounding. Even as non-OPEC production hits record highs, oil prices continue to firm as concerns increase over supply ceilings in some of the largest producing nations.
Asset Allocation
During the quarter we increased our weighting to global equities across our models, reduced exposure to fixed income (trimming US government bond holdings after a strong 4 month run) and added to our alternatives exposure through a systematic trading fund.
Corporate earnings continue to show signs of resilience and the expected broadening of global growth in 2024, and an upturn in global trade, should support earnings prospects in select non-US markets. Cheaper valuations and the shrinking of the economic growth gap relative to the US are making regions such as Europe more attractive to global investors, whilst the prospect of a smoother transition to lower growth as a result of rate increases has diminished the potential return for government bonds in the medium term.
In conjunction with the increase to our equity exposure, we also made changes to the stock and sector weightings in our models & portfolios during February. This was implemented to align the largest stock positions more closely to their importance & contribution to the global equity index, and to weight the remaining high conviction ideas appropriately so that our tracking error to the benchmark is reduced overall.
There has been no change to the initial stock screening and selection process that drives the research process, and we remain committed to the high-conviction approach to stock selection that has been in use at Martello since inception. We believe this new approach will reduce our volatility relative to the global equity benchmark whilst still allowing the opportunity for portfolios to out-perform the ARC indices through stock selection.
Equities
Contribution to performance was shared across both the US and European equity lists during the quarter, with a broad range of sectors also involved. We see this as a positive outcome, as the concentration risk of a narrow segment of the market is replaced with a wider focus on earnings growth and valuation across more sectors and regions.
In Europe, strong contributors included SAP (+29% in $ terms), ASML (+31%) and Stellantis (+24%) – respectively enterprise software, semi-conductor manufacturing equipment and automobiles (traditional and EVs). In the US returns were equally as broad – American Express (+22%), Berkshire Hathaway (+18%), Garmin (+16%), Exxon (+18%) and Amazon (+19%).
New additions to the models during the quarter include: Novo Nordisk, Netflix and United Health, whilst exposure to Alphabet, Amazon, Visa and Monolithic Power Systems (high performance, semi-conductor based electronic power solutions) were all increased.
Overall, the earnings reports during the quarter were very encouraging, and spanned defensive, growth and more cyclical companies. There was a strong focus on financial strength, top and bottom line growth, and returning excess profits to shareholders via buybacks and enhanced/special dividends, where appropriate. We would argue that the financial health of the companies we invest in is as strong as we can recall and has recovered strongly from the lows of the post-Covid period.
Fixed Interest & Bonds
As mentioned, we trimmed exposure to US government bonds during the period, reducing weightings in the 7-10 and 1-3 year ETFs where held in the Cautious, Balanced and Growth models. 10 year bond yields have crept higher since they touched 3.81% in early February as US economic data continues to remain firm and the timing of a first rate cut from the Fed is pushed out, possibly to the second half of 2024. This resulted in a negative return of -2.1% for the USD global aggregate bond index for the quarter.
In comparison to this return, both our active bond funds produced positive returns during the period – Waverton Global Strategic (+0.86%) and Vontobel 24 Strategic Income (+2.78%). This highlights the need for active management across the wide spectrum of the fixed income/bond market, and also that ongoing corporate health has contributed to further spread tightening in the credit and high yield markets where both funds have exposure.
Alternatives
Both of our alternative funds produced useful, uncorrelated returns during Q1, exceeding the benchmarks for cash/bond market performance. Jupiter Merian Absolute Return was ahead +3.33% in USD whilst the newly added Kelper BH-DG Systematic Trading fund returned +4.12%. The latter trades medium term trends across a wide range of asset classes, including equities, FX, bonds and the commodity markets. Strong contributions year to date have from it’s exposure to Japanese equities and also Cocoa, which has benefitted from interrupted supply due to heavy rains in West Africa.
Outlook
2024 has started off positively for investors, notwithstanding the negative contribution from government bond markets as they wait to benefit from interest rate cuts. The positive take on this is that this asset class is more attractively priced than at the end of 2023 and stands to provide protection to portfolios should there be a growth or geo-political shock that upsets current risk appetite.
The current high level of investor sentiment is in fact one of the main risks to further market progress in the near term as there are signs of ‘over exuberance’ and stretched valuations in certain areas which could deflate steadily or which could correct sharply. The recent move higher in bond yields and the delay to monetary easing may also divert liquidity away from equity markets, at least until signals become clearer on the timing of rate cuts.
That said, global economic momentum is improving and pointing towards a ‘no-landing’, positive reflationary pathway ahead. Financial conditions are on the ‘easy side’ and have continued to ease since the start of the year.
Central banks are expected to cut rates in the second half of the year and resilient corporate earnings have supported equity prices through the first quarter, when rate cuts had been anticipated to begin. Absolute valuations have improved recently, and stripping out tech and communication service stocks, forward PE ratios are at or below their historical averages, especially in non-US markets.
Given the evidence of improving market breadth, and likely further positive revisions to earnings starting this month, we are optimistic that the good start to 2024 can continue. Furthermore, we expect that the laggards of 2023 will contribute to this performance as the year develops.
A positive start to 2024 – Q1 commentary
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The global growth cycle hit its lowest point in 2023 and is now picking up. Earnings estimates have been edging higher, with increasing contributions from sectors and markets that have lagged over the past twelve months.
Although central banks are hesitant to lower interest rates at this moment, they are conveying more accommodative signals to the market, which maintains the prevailing “risk-on” sentiment.
From a market perspective, the main equity indices continue to trend higher. Upside market participation is broadening while credit spreads remain tight. Cyclicals vs. defensives are exceeding expectations, whilst the recent pick-up in commodities and outperformance of TIPS over US Treasuries point towards a “reflationary” message. The best performing sector in Q1 was not tech – in fact, energy, industrials and financials all produced better returns as the overheated tech sector traded sideways in March, and the dispersion of returns within the tech heavyweights widened considerably.
For fixed income investors it was a more challenging period. Stickier inflation prints, resilient economic activity, and the Federal Reserve (Fed) backpedalling somewhat on its dovish December tone combined to drive negative returns for bonds.
The shift in the macro backdrop was also reflected in market expectations for interest rate cuts, where the implied number of US rate cuts for 2024 reduced from seven at the end of 2023, to no more than three rate cuts in total, starting in the summer. Today’s market pricing is now broadly in line with the Fed’s latest dot plot. As prospects for aggressive rate cuts faded, the yield of the Bloomberg Global Aggregate Index increased by 28 basis points (bps) over the quarter, which led to negative returns of -2.1%.
The US dollar rallied throughout the quarter, gaining around 2% and erasing half of the losses from Q4 of 2023. It was supported by the continued strength of the US economy, higher & more attractive relative cash and bond yields for a longer period, and the weakness of the Japanese yen which fell to a 34 year low relative to the greenback.
Despite the backdrop of higher bond yields and a stronger dollar, gold rallied to a new all-time high at the end of March, with strong sovereign fund buying. Oil also performed strongly, with prices up 17% so far this year and well above $80 barrel again. OPEC remains committed to production cuts and geopolitical tensions have threatened supply. Meanwhile, global demand forecasts are being raised and inflation is rebounding. Even as non-OPEC production hits record highs, oil prices continue to firm as concerns increase over supply ceilings in some of the largest producing nations.
Asset Allocation
During the quarter we increased our weighting to global equities across our models, reduced exposure to fixed income (trimming US government bond holdings after a strong 4 month run) and added to our alternatives exposure through a systematic trading fund.
Corporate earnings continue to show signs of resilience and the expected broadening of global growth in 2024, and an upturn in global trade, should support earnings prospects in select non-US markets. Cheaper valuations and the shrinking of the economic growth gap relative to the US are making regions such as Europe more attractive to global investors, whilst the prospect of a smoother transition to lower growth as a result of rate increases has diminished the potential return for government bonds in the medium term.
In conjunction with the increase to our equity exposure, we also made changes to the stock and sector weightings in our models & portfolios during February. This was implemented to align the largest stock positions more closely to their importance & contribution to the global equity index, and to weight the remaining high conviction ideas appropriately so that our tracking error to the benchmark is reduced overall.
There has been no change to the initial stock screening and selection process that drives the research process, and we remain committed to the high-conviction approach to stock selection that has been in use at Martello since inception. We believe this new approach will reduce our volatility relative to the global equity benchmark whilst still allowing the opportunity for portfolios to out-perform the ARC indices through stock selection.
Equities
Contribution to performance was shared across both the US and European equity lists during the quarter, with a broad range of sectors also involved. We see this as a positive outcome, as the concentration risk of a narrow segment of the market is replaced with a wider focus on earnings growth and valuation across more sectors and regions.
In Europe, strong contributors included SAP (+29% in $ terms), ASML (+31%) and Stellantis (+24%) – respectively enterprise software, semi-conductor manufacturing equipment and automobiles (traditional and EVs). In the US returns were equally as broad – American Express (+22%), Berkshire Hathaway (+18%), Garmin (+16%), Exxon (+18%) and Amazon (+19%).
New additions to the models during the quarter include: Novo Nordisk, Netflix and United Health, whilst exposure to Alphabet, Amazon, Visa and Monolithic Power Systems (high performance, semi-conductor based electronic power solutions) were all increased.
Overall, the earnings reports during the quarter were very encouraging, and spanned defensive, growth and more cyclical companies. There was a strong focus on financial strength, top and bottom line growth, and returning excess profits to shareholders via buybacks and enhanced/special dividends, where appropriate. We would argue that the financial health of the companies we invest in is as strong as we can recall and has recovered strongly from the lows of the post-Covid period.
Fixed Interest & Bonds
As mentioned, we trimmed exposure to US government bonds during the period, reducing weightings in the 7-10 and 1-3 year ETFs where held in the Cautious, Balanced and Growth models. 10 year bond yields have crept higher since they touched 3.81% in early February as US economic data continues to remain firm and the timing of a first rate cut from the Fed is pushed out, possibly to the second half of 2024. This resulted in a negative return of -2.1% for the USD global aggregate bond index for the quarter.
In comparison to this return, both our active bond funds produced positive returns during the period – Waverton Global Strategic (+0.86%) and Vontobel 24 Strategic Income (+2.78%). This highlights the need for active management across the wide spectrum of the fixed income/bond market, and also that ongoing corporate health has contributed to further spread tightening in the credit and high yield markets where both funds have exposure.
Alternatives
Both of our alternative funds produced useful, uncorrelated returns during Q1, exceeding the benchmarks for cash/bond market performance. Jupiter Merian Absolute Return was ahead +3.33% in USD whilst the newly added Kelper BH-DG Systematic Trading fund returned +4.12%. The latter trades medium term trends across a wide range of asset classes, including equities, FX, bonds and the commodity markets. Strong contributions year to date have from it’s exposure to Japanese equities and also Cocoa, which has benefitted from interrupted supply due to heavy rains in West Africa.
Outlook
2024 has started off positively for investors, notwithstanding the negative contribution from government bond markets as they wait to benefit from interest rate cuts. The positive take on this is that this asset class is more attractively priced than at the end of 2023 and stands to provide protection to portfolios should there be a growth or geo-political shock that upsets current risk appetite.
The current high level of investor sentiment is in fact one of the main risks to further market progress in the near term as there are signs of ‘over exuberance’ and stretched valuations in certain areas which could deflate steadily or which could correct sharply. The recent move higher in bond yields and the delay to monetary easing may also divert liquidity away from equity markets, at least until signals become clearer on the timing of rate cuts.
That said, global economic momentum is improving and pointing towards a ‘no-landing’, positive reflationary pathway ahead. Financial conditions are on the ‘easy side’ and have continued to ease since the start of the year.
Central banks are expected to cut rates in the second half of the year and resilient corporate earnings have supported equity prices through the first quarter, when rate cuts had been anticipated to begin. Absolute valuations have improved recently, and stripping out tech and communication service stocks, forward PE ratios are at or below their historical averages, especially in non-US markets.
Given the evidence of improving market breadth, and likely further positive revisions to earnings starting this month, we are optimistic that the good start to 2024 can continue. Furthermore, we expect that the laggards of 2023 will contribute to this performance as the year develops.
Gary Hill
Investment Director