A Frothy Cappucino…

As we close the door on February, things are certainly feeling a little frothy in a number of markets just now.  US equity markets continue to drive higher, led by the phenomenal returns from the technology sector in the all-encompassing Artificial Intelligence space, the US 500 has hit multiple new highs in February and there seems like no end is in sight……watch out for phrases such as it’s different today!!.

With our feet firmly on the ground though, we see many valuation models continue to notch up and most are well above historical norms (>1 SD). With the latest earnings season now behind us, the star performers (you know the ones) with the exception of TSLA, continued to post huge profits, none more so than Nvidia which added a further $277 Bn (yes, you heard right, that’s two hundred & seventy seven with nine zero’s behind it) to its market capitalisation on the back of the statement that it expects revenue streams to continue to grow. Seriously, in February 2020 the shareprice for Nvidia was a respectable $67.94 per share, while today it is trading at $797.82 per share, that’s a compounded annual growth of ca. 85% per year over the last four years. …nose bleed alert!!

In contrast, participants on the fixed income side are indeed having a rougher time of it. Treasury yields swung from 4% in December, to 3.94% in January to a whopping 4.26% today driven by the disconnect between the markets and the message from the FED. J Powell stated explicitly that the FED would be data driven and the markets simply ignored his message, and proceeded to price in a seven point rate cut in 2024. This has now been re-calibrated at break-neck speed, to three rate cuts in 2024. In previous notes, I mentioned to expect rates to commence being reduced in the second half of 2024 and indeed, this now appears more plausible.

As ever, the best advice for long term investors, is just to hold on for the ride. Despite nosebleed valuations, missing out on rallies like we’ve seen in the last 6 weeks is the opportunity cost that can destroy long term returns remembering that the greatest returns throughout the year occur over a handful of days only and are best availed of when investors stay in the market. Trying to time a dip or a peak is a gamble & inevitably leads to missing out on the best days for returns. Statistically, this behaviour has significant negative impacts on portfolios.

On the macroeconomics side of the equation, we see that EU annual inflation[1] dropped slightly from 2.9% to 2.8% in February which was mirrored in Ireland with a decrease from 3.2% to 2.7%. Underneath this drop, we see that In Ireland, the biggest contributors to the rates included price increases for food, utilities, recreation and hotels. Italy showed the lowest inflation at 0.9% while Estonia the highest at 5.0% for the same period.

Some of the headline data which we track is shown in the table below.

Reinforcing the message last month; the current US & ECB  interest rate policies continue to have the desired effect on the rate of inflation.  With the 2% sweet spot in sight, it is now time to start thinking about reducing those higher rates to avoid either economy tipping into full recession. The balance faced by the Central bankers here is too much rate reduction, too quickly, and they will be cognisant of the eighties when just such a move tipped the US into prolonged recession. The challenge then is to achieve that “soft” landing where inflation peels back to 2% without the economy tipping into recession…..a bit like steering an oil tanker into a parking spot at your local supermarket.

Sticking with inflation, Europe should be content, and the US irked by the slow pace of its reduction. I would suggest that Europe is experiencing the greater rate reduction as several economies are close to or in technical recession, despite the bloc having registered a 0.1% increase in Q4 2023.  Germany, the EU’s largest economy saw its GDP shrink by 0.3% in the final quarter of 2023 which for the industrial powerhouse of Europe is somewhat worrying.

Like European Central Bank rates, US rates have remained unchanged, and I would suggest this will be the case for a few months more yet. Core inflation is stubborn to get down and a cool hand by Central bankers is required to steer the trading blocs gently towards that all important soft landing where inflation reaches its target of 2% while high employment remains.

So, while great for investment portfolio’s yearly performance, the market froth is a sign of pent-up energy amongst investors to continue to re-allocate their capital, something which must be viewed with a note of caution. So, with the transformative change in the risk-free rate now firmly planted at stage two, we continue to see Short dated bonds paying a higher yield than the average dividend yields for stocks, (4.67% versus 1.5% in the US and 2.06% globally) and that being the case, any future yield drops in bonds, should produce a capital return for short dated bond portfolios.  These two features highlight the comeback of the 60/40 portfolio where now both equities & bonds will deliver reasonable returns for the foreseeable future.

Turning to oil now, we see the price jump from $78 to $81 per barrel bringing us back to the average price per barrel of €82 through 2023. The global threats including the war in Ukraine, Israel’s invasion into the Gaza strip, trouble in the Red sea shipping lanes and all that that brings, still remain. We continue to see US and UK navy tactical bombardments of Houthi rebel positions to protect those valuable shipping lanes, but we move into the warmer season in the northern hemisphere, consumption should be lower and it might give time to resolve issues in that region of the world.

Setting macroeconomics aside, what does all this mean for investors?

Well, year to date, we see a rally in global markets which have delivered about 7.5% increases but with valuations of fPE ratios notching up to 17.83. The biggest contributor is the top ten companies contributing to the US500 with 9% driven in no small part by the technology sector, followed closely by the Japanese rally of 8.7% (I’ll get to this in a moment) and then Euro equities 4.1%. However frothy I deem the US markets, the fear gauge as measured by the volatility index continues to bound around the 13 to 15 range; well below the standard of 20 points which is attributed to volatile markets (last seen in October 2023).

Returning to the Japanese equities story, for the past two years they have been trading at well below (>1-2 SD) their long term average and have now broken free in 2024 delivering a whopping 8.7%  year to date. So, what’s driving this?…well since 2020, both the Euro and Dollar both strengthened against the Japanese Yen, by 36% in Euro terms and 28% in US Dollar terms. Weaker Yen means cheaper exports and that, coupled with significant corporate board room changes at Japan’s biggest companies has led to a resurgence in interest in Japanese companies which are already amongst the best in the world.

In addition, Japan is now making moves to slowly increase its interest rate (Currently -0.1%) to combat rising inflation. That being the case, the Yen will strengthen, so those who bought Japanese assets for relatively cheap Yen, will now also benefit if indeed interest rates do in fact increase. Hence the flood of global capital eastwards.  Don’t forget that Japan is the thirds largest economy in the world, something to be admired of the Samuri warriors…

Looking forward, we are seeing forward price / earnings ratios (one of our measures of value) for global equities continue to increase from long term averages with global equities now trading at 17.83 times (increased from January), European equities at 13 times, with Japanese equities trading at 14.92 (increased from 13.8 in January) and US equities now trading at 20.4 times their forecast earnings.

The long-term forecast for growth in global stocks has reduced slightly to 10.3% with another slight reduction in the average yield of 2.06% from 2.1% in January. This reduces the equity risk premium which is the Forecast growth – the risk-free rate, to ca. 5.7%. However, conditions continue to still drive fund flows into the money markets which are currently yielding ca. 3.98% and remain a valuable component of many portfolios.

As always, we take the long view on Investments and are happy with globally diversified portfolios. In today’s (relatively) normal interest rate environment, we see slightly less fair value across global equities with (fPE’s at 17.8) in comparison with early 2023, where valuations averaged 16.6 times earnings. While the markets have roared so far this year, I would suggest again that as the Central bank’s Monetary policies unfold throughout the course of the year, we can expect to see increased volatility in those capital markets. During these times, it is important to remind ourselves of our investment objective which as always, guides our asset allocation.

For regular long term investors, our view is to continue to buy into the market and for lump sum investors, while the conservative portion of portfolios can be bought quickly, a multi-stage approach to the purchase of the equities portion, might be a prudent option.

Our view, on global bonds has also remained as per last month. With, the US 2 year treasury now yielding 4.67%, which is attractive when compared to the average dividend yield of 2.06% for risk assets and slightly more attractive than some money market funds which are paying the 3.98% yield but with the advantage of higher liquidity. Therefore, with bond yields at current levels, and interest rates probably plateaued but set to change, this asset class continues to look a more attractive investment, than in recent years.

Our cautious view on lower volatility portfolios continues to be implemented through the use of money market funds, currently yielding ca. 3.98% and a small allocation to hedge fund positions to exploit market inefficiencies; all in all, providing some degree of protection in the current volatile climate.

My favoured image this month comes from Vanguard,  courtesy of  Standard Life & depicts the progress in market returns despite the global trauma experienced…Enjoy!

[1] Measured by the Harmonised index of Consumer Prices,

Sources: Central Banks: Federal Reserve, ECB, CBOI, Sharepad®. Euro Inflation is measured by the Harmonised Indices of Consumer Prices (HICP).  Periodic Market updates & reading materials  from Vanguard, Bloomberg, Ruffer, Davy Select & others depending on subject matter. All views and details contained are for information purposes only, are subject to change & are not advice. We recommend you seek independent clarification for your particular circumstances. Lifetime Financial Planning makes no representations as to the accuracy, completeness nor suitability of any of the information contained within and will not be held liable for any errors, omissions or any losses arising from its use.