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Client Update - 14th June 2024

After months of anticipation, the European Central Bank (ECB) has finally cut interest rates for the first time in five years. This move, positions the EU as the second major global economy to reduce its lending rate, following Canada's rate cut just a day earlier. The ECB's decision marks significant progress in tackling inflation and has been widely welcomed by both consumers and businesses across the continent. This reduction in interest rates is expected to stimulate economic activity by making borrowing more affordable.

With the ECB taking the lead in cutting rates ahead of the Bank of England (BoE) and the US Federal Reserve (FED), investor attention is now shifting towards these regions. Many are wondering when the UK and US will follow the ECB’s example. Recent positive corporate earnings data and evidence of a mild and controlled economic slowdown further support the anticipation.

In the UK Andrew Bailey, the Governor of the BoE, has said that he is optimistic that inflation is moving in the right direction, with markets currently pricing in a UK rate cut in August this year. Unfortunately, things look less optimistic in the US. While the regions latest CPI print, published on Wednesday, provided reassurance that inflation is slowing, recent jobs data showed higher-than-expected employment growth, complicating the Federal Reserve's position on cutting interest rates. As a result, analysts have gone from anticipating six to seven rate cuts for the US at the start of the year to only one or two, with the first in September, at the earliest.

While there is little doubt that rate cuts in other major regions are coming, the timing remains uncertain. Despite this, we are pleased to report that our investment performance has been strong over the last few months, both in absolute terms and relative to benchmarks. This success has been primarily driven by our investment team’s selections, which have been outperforming in the current environment of slow growth and falling inflation.

Earlier this year, our team made the strategic decision to adjust portfolios away from the expensive US markets, locking in previous gains. We increased portfolio allocations to more attractively valued areas, including Europe, Asia Pacific, and Emerging markets, based on the expectation that these regions would catch up to US valuations. With our increased weighting in Europe, we are well-positioned to benefit from the recent ECB interest rate cut and the subsequent growth it is expected to stimulate in the region. Additionally, through our European fund holdings, our substantial weighting to healthcare company Novo Nordisk has boosted performance as the company continues to outperform expectations, driven by the ongoing success of its weight loss drug.

Similarly, we are well-positioned to benefit from a potential BOE rate cut later this summer. Our investment in UK government bonds (Gilts) across all models are key components of our sovereign debt strategy. The Gilts have provided stability during recent months of uncertainty and hold attractive capital growth potential in a rate cutting environment. Historically, falling interest rates typically result in price appreciation and capital gains for Gilts. Furthermore, in our UK equities portfolio, we have a high proportion of UK smaller companies, which have a strong track record of performing well in periods of falling interest rates. This is due to reduced borrowing costs and boosts to consumer spending and business confidence. Consequently, we are confident in our positioning to benefit from an interest rate cut and have already seen positive returns from these holdings, with small-cap stocks up nearly 8% since April, likely reflecting market expectations of a BoE rate cut.

While we are still very much constructive on fixed income and bonds, we believe our “bond proxy” equity investments such as High Dividend stocks, Utilities, Healthcare and listed Real Estate will produce higher risk adjusted returns. To reflect this constructive view on equities we have increased our ‘Risk On’ level to moderate and increased our equity allocations to these more ‘value’ focussed areas of global equity markets that we believe are most likely to benefit from a falling interest rate environment.

As always, our investment team remains focused on quickly seizing any opportunities that may emerge in the coming months as we await further rate cuts. The team feel well-positioned for this environment but continue to analyse data and monitor political developments as more elections start to take place, to ensure we maintain our strong performance. If you have any questions, please feel free to contact us.

Do have a good weekend.

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