Q4 2024 Investment update...

Transcript

Tom Merchant:

Hi, good day. Thanks all very much for joining us at this Q4 investment update. My name’s Tom Merchant. I’m a partner and business development manager, and I’m delighted to be joined by Charlie Ambler today, our co-chief investment officer. Hi, Charlie.

Charles Ambler:

Hi, Tom.

Tom Merchant:

Hi. So Q4, I think unsurprisingly, those of you listening in wouldn’t be shocked to know that majority of the focus around the headlines, and frankly a lot of our clients, were focused on the U.S. elections, and that Trump winning for a second time and it being announced. Now, was this a surprise? I’d be really interested from your take on it in terms of how did the investment markets react, and was this a shock, and did they act accordingly?

Charles Ambler:

Yeah, it was a surprise in the sense that it was a very balanced election going into it. In the buildup, especially the weeks preceding, Trump seemed to take a bit of a lead in the polls. Now the efficacy and accuracy of those polls could be debated, but it felt like markets were beginning to believe that Trump could get a second term as we headed towards the election day.

On the results, the U.S. market reacted very positively, especially in the more domestically focused stocks, some of the smaller names. Bond markets also initially reacted quite positively.

However, since then some of the mood’s changed. I think there’s been a fair amount of taking stock. We’ve obviously since had his inauguration, but it wasn’t in Q4. It was at the start of January.

But what’s become quite apparent is, Trump feels a lot more empowered this time round, is already putting through a number of policies, is touting tariffs to a much greater extent. And we are entering a world of quite considerable uncertainty regarding political impact on markets.

Tom Merchant:

Fine. And then away from the U.S., if you would, and I’m quite keen to talk a little bit around how we’re feeling about going forward, but just looking backwards for now. Did the rest of the world react positively? Were equity markets in general up? How were they behaving in Q4?

Charles Ambler:

Yeah, it was a mixed bag. I think the countries which were impacted most negatively were the ones that were in the eyeline for tariffs, especially from the Trump administration. China was one of the places, which following the end of Q3 at the end of September, there was a very strong rally in China based on the potential for significant stimulus. That had sort of faded towards the start of the election. And then once the results were announced, there was another nail in that that led to a pretty muted growth in emerging markets.

I think global growth is definitely under threat from tariffs. However, a lot of the Trump policies that we’d expect to see come through potentially are quite market friendly. So it really is a two-sided coin when it comes to his presidency over the next four years, especially in regards to deregulation and being quite a pro-growth, pro-capitalist type president.

Tom Merchant:

Fine. And while it seems like a bit of a redundant thing to say based on market cap and how much U.S. has dominated the investment markets going forward, but is it safe to say they are still the number one driver in terms of how investments and equities are behaving at present in terms of what’s happening over there?

Charles Ambler:

Yeah, absolutely. If you take the contribution to returns from either the MSCI World or just the specific S&P 500, you are still heavily led by what’s considered the Magnificent Seven.

There were some similar warning shots over the last quarter. News of DeepSeek, Chinese-led AI tech, was definitely a well-timed shot at the Magnificent Seven oligopoly, or the AI oligopoly, that we’ve seen over the last 18 months to two years. It brings into question the profitability, I think, of the amount of CapEx that’s been going on in these companies.

A question that probably won’t be answered in the near term, but if you’ve been investing a lot in data centres and infrastructure based on a assumption that they’re going to be highly profitable in the future, particularly a sort of scarce resource, and someone announces that they’ve got technology that doesn’t require that level of infrastructure, you could see why it would be a concern for those companies.

Tom Merchant:

Definitely. And full marks for using oligopoly in a sentence, that’s probably the first time I’ve ever come across that outside of a book.

Right. That’s really interesting, Charlie. And so that’s a main look at what’s going on in the investment markets.

But if we go on the other side of the coin, or the other side of traditional investing coin if you like, and look at bonds and debt, which traditionally has been the uncorrelated asset class to be in to balance out the equity side, but as we both know this quarter in 2022 and such like was really detrimental in that field. So can you maybe cover off a little bit what happened in the bond market globally and whether the effects of the equity market was still correlated to it, or was it behaving slightly differently?

Charles Ambler:

Yeah, of course. So the bond market is slightly less dominated by the United States. It is still a major player of the Fed and their cuts and decisions to cut do impact global bond markets, especially emerging. But there is a more even spread.

So I’ll touch off geographically how it played out. A few weeks after Trump’s election was announced, the Fed came out and basically implied that his term was most likely to be more inflationary in the States, and that would therefore be offset by a less dovish approach from the Fed, so less rate cuts.

The market, the equity market, reacted quite poorly to this. They had a bad December. This was because prior to Trump’s election there was a real feeling that the next growth engine for equities or for risk assets would be this falling rate environment.

Part of the reason why you’ve seen a failing in the correlation, or the low correlation, of the two assets is the fact that inflation remains quite high. Historically, the two asset classes, equities and bonds, have a good level of low correlation when inflation is low. What we saw in 2022 was inflation spiked. Interest rates are the way to curb that inflation, but they also caused higher rates called taper growth.

Now what we saw with the last few months is, because inflation remains above target, especially in the United States, when we have CPI prints or inflation prints that seem sticky, you get a Fed that comes out and says, “Well, we’re not going to be able to cut, I’m afraid. We’re most likely going to have to hold.”

Now equity markets respond badly to that, because they’re hoping rate cuts will drive future growth from here. And that’s led to this increased correlation over the last three years. That is not to say that every single move is in lock step. There are moments where they do their own thing. But what we’re seeing is in the broad risk on risk off moments, bonds and equities do remain much higher correlation than we’ve seen, say maybe, in the 2010s.

Tom Merchant:

And just on that as well, I take it the tariffs, that’s not going to be helpful for an inflationary environment in the U.S., because presumably things are going to get more expensive. Is that partly the reason why they were behaving the way they were?

Charles Ambler:

Yeah, Trump has a lot of policies. I think if you distil them down into the four main ones, deregulation, tariffs, his approach to immigration, and then his views surrounding tax and tax cuts. The deregulation and tax cuts generally pro-growth. The tariffs and his approach to immigration would certainly be more inflationary and quite sapping on growth, sometimes described as stagflationary, if you will, sort of low growth, higher inflation type policies.

The big question mark here is what actually he implements. We’ve seen a huge range of numbers and outcomes tabled against different countries when it comes to tariffs. We’ve already seen some growing back from those numbers. We wouldn’t expect any tariffs to be final. So even if he announces something against, say, China, if they retaliated, there would be likely some sort of agreement come to which wouldn’t be overly detrimental to markets. Bear in mind that throughout Donald Trump’s first term as president, he used the S&P 500 as a real bellwether for how well his term was going.

Now, if we were to suggest when he might be more comfortable hurting the stock market in favour of gaining some wins with his core base, it’s probably earlier in his presidency. He feels certainly quite empowered. Right now he’s got the Senate. There will be midterms. There will be changes to that power structure in the States during his four years. So we would expect potentially to see a higher level of disruption in the nearer term. But as you come towards the end of the term of presidency, he would probably be looking more pro-business, pro-growth and to see numbers coming through in the stock markets.

Tom Merchant:

Fine. And then so at the start, you mentioned the U.S. had a pretty strong quarter. So were we… We’ll look at what we’ve done portfolios at the end of the quarter and what we’re doing heading into this, but what did we do in portfolios in Q4?

Charles Ambler:

I wouldn’t say we are not very maximalist in our changes, we are much more gradualist. We’ve continued to make changes in portfolios that we’ve been implementing throughout the year. We’ve chosen to accelerate them as we come into this new year. But during the last quarter, there wasn’t a wholesale changes around the presidency for example, in part because we were fairly well positioned for it.

Our general view is that there is strong scope for a broadening out in the equity markets, be that further down the U.S. market cap, so less Mag 7 dominated or more globally, so ex-U.S. There are certainly significant points towards opportunities further afield. We’ve seen market breadth in the last two years being very tight.

Tom Merchant:

Sorry, further can you describe what you mean by that in terms of market breadth being tight? Sorry.

Charles Ambler:

So market breadth is effectively the number of winners versus the number of losers. And what we’ve seen is the number of winners is effectively seven. It’s not seven, but amongst the 500 main stocks in the States, seven of them have driven the bulk of the returns. We would expect to see that number shift. The earnings growth, which is expected from those seven companies versus the other 493. The gap is narrowing significantly.

Equally, I mentioned DeepSeek earlier and the ability for AI to be a lot cheaper potentially for companies to implement. One of the things that has been very noticeable since the announcement of ChatGPT and the AI revolution is that the main companies that are winning at the moment are the suppliers of AI. And what we’ve not seen is a lot of people winning in the sense of using AI. We’re not seeing more traditional companies implementing higher productivity because of its adoption. Part of that is potentially the costs associated with it, and the costs associated with it are a double-edged sword. If the higher costs means increased profitability for those suppliers and lower potential profitability for those users.

Now technology like DeepSeek might bring… It’s an open source platform. It gives you the opportunity to adopt part of it or all of it, effectively for free, or to build on it. It is not tumbling down of moats that these companies have, but it is certainly a warning shot. And it does suggest that bottlenecks naturally get unclogged, because when you have this supernormal profitability, there is a huge incentive to go after it.

Tom Merchant:

So based on us being gradualist, what themes are we carrying on with then in terms of what are we taking from last year and taking into this year? And have we deviated at all from any of them?

Charles Ambler:

Yeah, exactly. So in the equity book, it’s certainly a more broadening out as I mentioned. That is not a new theme. In the alternatives book, we remain very pro areas that benefit from higher volatility or a desynchronization in interest rate policy, so macro hedge funds that make returns by playing relative value trades against different interest rate environments.

The fixed income book is probably the one that we’ve made the biggest change over the last few quarters, or two quarters. Previously, we were much more United States orientated and slightly longer duration. Since the inauguration of Trump, and some of the more recent data, especially on inflation, we’ve shifted more towards the UK and opened our first direct exposition in the Eurozone for government debt.

As I mentioned, a higher inflation environment typically leads to a higher stock and bond correlation. In areas like the Eurozone where inflation is coming down a bit quicker, and actually already within the target range, we feel that there’s that opportunity for it to become a diversifier once again and for that correlation to break down.

Tom Merchant:

Interesting, fair. And then if you could summarise your thoughts then in terms of, in short or long form as you like really, how did we feel about Q4 for us as a business and performance wise, and how are we feeling going forward? Do we have a degree of confidence heading into the rest of 2025 around the markets, or are we cautiously keeping some powder dry?

Charles Ambler:

No, we are fully invested. Our view is that what has happened over the last six months has increased maybe the likelihood of these fat tails. But they’re both upside and downside. However, the base load in fundamentals at the moment is very strong. The U.S. corporate health is good. Consumers still have unstretched balance sheets. They’ve been deleveraging, especially when it comes to stuff like mortgages.

There is a lot of opportunity out there to make money. But the flip side of that is that valuations remain quite high. We have been building up what we’d consider resilience in the portfolio. We would hope to make a solid return next year rather than targeting a stellar return. Because we feel that the opportunity for there to be a misstep, either by a policy or a crack in the system because of this increased rates environment that we’ve had, has increased. But it’s definitely not made it into our base case.

As I think you’ve probably heard in previous conversations, we believe that diversification is a great way of maintaining a high gross risk. So the portfolio maintains a lot of opportunities to make money, but it keeps quite a low net risk. So when you combine them all together, you can keep the volatility of portfolios low. So when maybe something’s winning or losing, there is other things offsetting it.

Tom Merchant:

Fine. Brilliant. Great. Well, Charlie, thank you so much for your time, and thank you all for listening out there. Obviously, if you have any questions, as always, please do get in touch with us or your advisers, and we’d, obviously, be delighted to speak further. But until next time, thank you all very much.

Charles Ambler:

Thank you very much. Cheers.