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[5 min read, open as pdf] Macro factors: growth, inflation and rates
The three key macro drivers that impact markets are Growth (“G”), Inflation (“I”), and interest Rates (“R”) the policy rates set by the Central Bank. Every economic data release is relevant in as much as what it means for the direction of these three key macro drivers. Monitoring these macro factors The chart shows the recent evolution of these three macro factors for the UK. What about other macro factors? Other key macro factors that impact markets include Sovereign Risk (e.g. higher risk premia for Emerging Markets), Credit Risk (higher risk premia for lower quality debt) and Liquidity Risk (higher rewarded return for less liquid investments). Macro factors affect all asset classes Macro factors impact equities and bonds alike. Macro factors impact the risk premia (and hence return expectations) on different asset classes. As these premia shift, so do expected returns. For example, corporate bonds are impacted by interest rates premium, inflation risk premium and credit premium. Small cap equities are impacted by interest rate premium, inflation risk premium, growth premium and liquidity premium. Macro factors are inter-related Macro factors are inter-related. In the text books, when economic growth is strong inflation pressure builds. Interest rates are raised to contain inflation. When interest rates fall, that can stimulate growth. In reality, it can be more complicated (and has been). The relationship between macro factors is key, as a read of the Bank of England’s Monetary Policy Committee minutes will show. Why we believe in an adaptive approach A static-allocation “cruise-control” portfolio had worked well until the bond market dislocation of 2022 driven by the inflation and rate-hike shock. But as markets don’t stand still, nor should portfolios, in our view. We believe in an adaptive approach adaptive approach to navigate market risks, rather than leaving portfolios in cruise-control. This categorically does not mean trying to time the markets. What it does mean is trying to steer away from potential hazards along the way. Conclusion Keeping an eye on the key macro drivers is therefore key to asset allocation decision-making.  [5 min read, read as pdf]
As we look forward to 2025, it is worth revisiting the themes and predictions of our 2024 outlook “turning the corner” to get a sense of what we anticipated at the time, how this informed our recommendations to UK adviser firms’ investment committees. Asset class performance for 2024 is summarised in the chart above. Our 2025 outlook is published separately. Subscribe to our weekly newsletter to get all our insights to your inbox (for UK financial advisers only) Steady as she slows In 2024, we anticipated a gradual deceleration in the U.S. economy, with markets pricing in the likelihood of a slight recession. In the event, the U.S. economy surprised on the upside. Growth forecasts were upgraded from 1.15% at the start of the year to an impressive 2.6% by year-end. This revision supported robust equity market returns and served as a reminder of the resilience of U.S. economic fundamentals. In summary, a resilient US economy defied expectations. What did we recommend to our clients at the outset and during the year? We took a balanced view between accepting concentration risk (traditional S&P 500) and diversified (active, sector exposures). We also recommended clients lean in to broader US equity corporate landscape via 1) Equal Weight and 2) US Small Caps exposures. By contrast, the UK had that shrinking feeling as regards economic growth, and although out of a technical recession, we are not confident of its prospects relative to the US. Pause before pivot At the close of 2023, we were focused on the Federal Reserve’s pause in interest rate hikes, noting that a rate cut was a question of when, not if. While the consensus view was that the first cut would be announced by mid-2024, we anticipated that the timing would hinge on the performance and strength of the U.S. economy. Indeed, the economy’s resilience delayed the start of what we anticipate to be a rate-cutting cycle to September 2024, when the Federal Reserve finally delivered a significant 50-basis-point cut. In fact, the eventual BoE Fed pivot came a month or two later than we had estimated at the start of the year, but we recommended our clients remain dynamic with regards to duration management. We recommended clients go strongly overweight duration in June as a good time to extend duration ahead of BoE cuts, with Fed following suit, and we saw the additional duration deliver returns on the bond side of the portfolio before attention shifted to debt supply and the UK budget later in the year, which led us to recommending to move back to neutral. The importance of portfolio resilience Our focus on resilience proved vital when it came to navigating the key macro factors in 2024: Growth, Inflation and Interest Rates. For Growth, anticipating a soft landing for the US economy, we highlighted the potential outperformance of cyclical sectors, and momentum, yield and size factors. In the event, momentum emerged as the best-performing factor, with yield and size also delivering strong returns. For Rates, we adjusted duration exposure mid-year to capture the effect of falling policy rates, aligning portfolios with a changing interest rate environment. For Inflation, which remained above target, the inclusion of liquid real assets (but to a lesser extent than in 2022) and shorter duration inflation-linked bonds, ensured continued portfolio resilience. We continue to emphasise the importance of a diversified alternatives exposure from a correlation perspective, not just in name. Our recommendation to consider Private Market Managers and Gold & Precious Metals paid off during the year – as these were the best performing asset classes for the year, outperforming world and US equities. Political and Geopolitical risks In a year of elections, we saw a change in government in the UK and in the US following Trump’s Presidential win. Both have a greater impact on bond yields and currency dynamics than equity markets, in our view. Geopolitical risks remain elevated with the Russia-Ukraine war continuing to grind, escalating conflict and contagion in the Middle East – all at tragic human cost. Conclusion Markets did indeed turn a corner in 2024, with economic growth, earnings and equity market returns outperforming expectations. With 2024 in the rear-view mirror, it’s time to look ahead to 2025. Our 2025 outlook is published separately. Henry Cobbe, CFA Head of Research, Elston Consulting UK equities have lagged global markets. Henry Cobbe argues that the remaining case for owning them is as for diversification, not for growth.
Read the quote in the Trustnet article  [5 min read, open as pdf]
 [3 min read, open as pdf ]
 Central Banks' policy rates are expected to pivot towards cuts in 2024 with a material impact on asset class perspectives.
Read the full article in FT Adviser  [5 min read, open as pdf]
 Wealth Manager's Ross Miller chats to Elston Consulting's Henry Cobbe. They discuss the return of yield and how it plays out across equities, bonds and alternatives.
Listen to the podcast  [5min read, open as pdf]
 [5 min read]
1. Yield is back: for equities, bonds and alternatives - the yield drought is over 2. Selectivity matters more: within and across asset classes 3. Inflation is getting stickier: getting past the peak, but still a problem Read the summary article Find out more:
 [5 min, open as pdf]
 [5 min read, open as pdf]
With low growth, soaring inflation and spiking interest rates, advisers need to rethink the definition of risk. Focus on volatility is focus on the “wrong problem”. Instead, advisers should focus on preserving purchasing power (mitigate inflation risk) to protect client outcomes. That requires a fundamental rethink around traditional definitions of risk, asset allocation and diversification. For full article including charts, open as pdf  [5 min read, open as pdf]
Each quarter we are publishing the Top 5 holdings of our Elston Smart-Beta UK Dividend Index. These are the UK’s largest dividend payers as a proportion of the total dividend pool. For full report open as pdf  [5 min read, open as pdf]
Inflation hits 40 year high UK inflation figures came out today with a print of +9.0%yy (April), from +7.0% (March) and slightly below +9.1%yy consensus estimate. This is the highest level in 40 years, putting renewed focus on the “cost of living crisis”. Rising energy and food costs are the primary drivers, linked to the sanctions regime and the Russia/Ukraine war. The Bank of England has been “behind the curve” as regards to inflation risk. A look at inflation guidance contained in recent Monetary Policy Committee (MPC) minutes shows. Near-term inflation guidance has consistently under-estimated inflation since August 2021 – rising from “above 2%”, to 4%, 6%, 8%,, 9% and now 10%. Read full article with charts  [5 min read, open as pdf]
In a recent CPD webinar, Elston’s Henry Cobbe interviewed Patrick Minford, Professor of Applied Economics at Cardiff University and economic adviser to Margaret Thatcher in the late 1970s and early 1980s to ask about the fight with inflation in the 1970s and any comparisons for today. While it is tempting to look for similarities with the energy shock and period of sustained inflation that the UK suffered in the late 1970s and early 1980s, Professor Minford highlighted some significant differences. The lower risk of a wage-price spiral, central bank independence and a track record of manging inflation means lower risk of inflation getting out of control in the long-term. But the short- to medium-term remains under pressure. In Minford’s opinion, the risk to the growth is the bigger risk: and this would be the right time for HM Treasury to worry less about debt ratios, and turn on Government spending taps. Read full article, open as pdf Watch the CPD webinar (50mins) |
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