There is life beyond the Magnificent Seven

Global equities last week gained a further 1% or so in both local currency and sterling terms, bringing their gains year-to-date on both measures to around 6.5%. With performance diverging significantly across regions, we thought it worth focusing this investment update on the key issues facing the major markets over the coming year.

Japan led last’s week’s gains with a rise of 2.4% and the key but flawed Nikkei 225 index this morning broke above 40,000 for the first time. We are reasonably positive on Japan, both as a result of the return to inflation after three decades of deflation and the increasing focus by companies on delivering returns to shareholders. Even so, the strong gains of late have in part just been driven by renewed weakness in the yen and the performance in sterling terms has not been quite so impressive.

US equities also fared relatively well last week with a gain of 1.3%. All the focus remains on the Magnificent Seven tech stocks which have driven the lion’s share of the gains so far this year. But with a lot of good news now priced in (and the news from the chip manufacturer Nvidia has undeniably been exceptionally good), other much cheaper areas of the US market should not be forgotten. With recession now looking increasingly unlikely, small and mid-cap stocks, which have been shunned recently, look well placed. Indeed, small cap led last week’s increase with a rise of 3%.

On the macro front, the focus last week was very much on whether the Fed’s favoured core inflation measure would echo the worse than expected consumer price numbers already reported. In the event, it did – although no more than expected. Prices rose a relatively large 0.4% over the month but the year-on-year gain edged lower to 2.8%.

This week, attention will be on the employment data on Friday, following last month’s blow-out report, and on the Fed Chair’s mid-week testimony to Congress. Powell, however, is unlikely to say much to alter the market’s belief that rates will start to be reduced in June, with three 0.25% cuts by year-end. This is a far cry from the seven cuts the market was anticipating in early January and looks much more plausible, not least because it is in line with the Fed’s last forecast back in December.

UK equities have lagged recently and were down fractionally over the past week. The UK has been held back of late by its lack of tech stocks and relatively high exposure to the defensive sectors and commodity-related equities, both of which have been underperforming.

However, we retain our positive view. The UK is looking ever cheaper relative to elsewhere, with its price/earnings ratio now close to 40% lower than the rest of the world. The domestic economic outlook is also looking rather better and small and mid-cap stocks are best placed to benefit.

All eyes this week will be on the Budget but in truth it will be of marginal importance for the stock market. The Chancellor’s room for manoeuvre is severely limited with the OBR, the official budget watchdog, now saying there is only some £13bn to play with if the government sticks to its fiscal rules which require government debt to be falling in five years’ time. This compares with a leeway of £30bn ahead of the Autumn Statement.

Tax cuts are a political necessity but look set to be limited to a 1p or maybe 2p cut in national insurance or basic income tax rates. Most probably, this will be partly financed by small tax rises elsewhere or possibly by tightening further the already implausibly tight government spending plans.

More important for the economy, and possibly also the government’s political fortunes, should be the marked fall in inflation to 2% or below that should be seen over coming months. This drop should not only help a return to modest positive growth this year but also ensure that interest rates start to be reduced in the summer.

European equities have also been a laggard of late and we remain relatively unenthused. Like in the UK, the economy has been flatlining, but the market is not as cheap and it is more cyclical which doesn’t help in a sluggish growth environment. Last week’s inflation numbers also came in higher than expected and the ECB is likely to reinforce on Thursday the market’s belief that rates are unlikely to be cut before June.

This just leaves emerging markets, which we believe are well placed to outperform. China had until recently been the main drag on performance but over the last month has actually been the best performing major market, gaining 9%. This bounce is down to the recent action by the authorities to support the market and the fact that Chinese equities had simply become excessively cheap and the pessimism on the economy overdone.

Today sees the opening of the two-week long National People’s Congress which will be analysed intently for indications as to the extent and type of further stimulus measures. Very likely, there will be no policy bazooka announced but further smaller targeted measures at boosting the economy, with the growth target for this year likely to be kept close to last year’s 5%. If so, this should be sufficient to allow Chinese equities to claw back a further part of their underperformance.

Still, emerging markets are much more than just China and the outlook here too is positive. The region is ahead of developed markets in terms of cutting rates, growth momentum is moving in its favour and valuations are relatively cheap. At a country level, India remains a source of strong growth, Korea and Taiwan provide alternative sources of tech exposure than the US, and countries such as Mexico and Vietnam are beneficiaries of companies re-shoring away from China.

All said and done, despite appearances to the contrary, there are good opportunities out there beyond the Magnificent Seven (or to be more accurate the Magnificent Six given Tesla’s poor performance of late). We believe a sizeable exposure to such areas is crucial to reduce risk given the very optimistic AI-related expectations now priced into these stocks. It is all too easy to forget following their stellar gains over the past 16 months that over the previous 12 months they lost close to 50% of their value.

Rupert Thompson – Chief Economist