What the chart shows

 This week’s chart shows the calendar year returns of nine major asset classes for the last ten years in US dollar terms, giving a clear picture of the volatility within the investment sphere. Asset class fortunes clearly vary each year and there is a number of examples when one year’s star performer may falter the next (see commodities from 2021/22 to 2023), or vice versa, when the class straggler jumps to the front (see US high yield bonds from 2015 to 2016). We can see that no single asset class stays a winner forever – a notion the US equity market has been challenging recently. Only once did an asset class remain on top for two consecutive years – commodities from 2021 to 2022. However, the subsequent plunge in 2023 serves as a stark reminder that trends can change rapidly. 

Why is this important?

The message from this week’s chart is a simple one: no single asset class consistently stays on top. This emphasises the need for diversification, providing a safety net against the unpredictable volatility experienced by individual asset classes each year. It is extremely difficult to select the best performing asset classes every year and winners rarely stay as winners. A key takeaway here is to avoid getting swayed by exciting stories – just because an asset class did well in the past doesn’t guarantee its future success. The best performer of one year can quickly become a laggard the next and short-term predictions often miss the mark. Even asset classes with prolonged success, like US equities, can’t guarantee perpetual dominance. Investors need to be prepared for anything, and we advocate the practice of investing in undervalued asset classes following downturns, weathering temporary setbacks and patiently waiting their comeback. After a highly unusual year in 2023, where economies and equity markets defied widespread pessimism and faced the steepest monetary tightening in 40 years, coupled with returns heavily concentrated in a narrow range of stocks, caution and selectivity are crucial in 2024. Given current valuations and uncertainties, a broad diversification approach will be maintained in portfolios, waiting for valuation opportunities to emerge in preferred assets and markets, remaining wary of extended valuations and excess leverage.

What the chart shows

 This chart shows the inverse of the yield on a 10-year Treasury Inflation Protected Security (TIPS)1 against the US Dollar denominated price of gold per troy ounce since 2000. The chart highlights how historically the 10-year TIPS yield, that is a real yield or net of inflation, has had a close inverse relationship with the price of gold. This correlation has been relatively consistent because higher real yields on bonds diminish the attractiveness of non-interest yielding assets, such as gold, typically used as a defensive asset and as an inflation hedge. Recently however, this relationship has broken down as the rise in real yields has not been followed by a corresponding decline in the price of gold. Remarkably, by the end of November this year, gold had returned 12.4% year-to-date for investors and in fact reached its highest recorded price level.  

Why is this important?

 It is important to consider the factors contributing to the breakdown of this relationship and understand the drivers behind gold’s substantial rally. Firstly, gold has traditionally been regarded as a store of value and safe haven during periods of market turmoil and has thus experienced high demand due to geopolitical instability arising from the conflict in Ukraine, and more recently the Middle East. Another key factor has been the change in markets’ interest rate expectations, with investors now forecasting earlier cuts in 2024, which has caused a weakness in the dollar. This depreciation benefits the dollar-denominated metal as it gives non-US gold buyers higher purchasing power. The final and arguably most significant reason for gold’s surge has been the persistent appetite from central banks. Q3 saw central bank gold purchases reach the second highest level on record, continuing the momentum following a record-breaking year in 2022. This has occurred as central banks, particularly in emerging markets, have sought to reduce their reliance on the dollar following sanctions imposed on dollar-denominated Russian assets. This triggered a shift into alternative stores of value such as gold to mitigate any further ‘dollar weaponisation’ risks. 2024 may also still prove to be a tumultuous year amidst ongoing conflicts, unresolved geopolitical tensions and a busy election calendar which includes the US, UK, Mexico and Taiwan. Alongside lingering recession odds, such risks have supported a perhaps overly elevated price for the precious metal. 

 1TIPS are bonds issued by the U.S government which are linked to the Consumer Price Index (CPI).

What does the chart show?

This chart shows the quarterly inflows of Foreign Direct Investment (FDI) into China since 1998. FDI is a component of a country’s Balance of Payments, representing investments made by foreign entities that involve a lasting interest and a level of control in the host country. This facilitates a country’s economic development by fostering the diffusion of technologies, job creation and the transfer of skills, thereby stimulating growth and enhancing global competitiveness. The chart highlights how the latest figure indicates net inflows turning negative for the first time since China began recording data in 1998, represented by the red bar.

Why is this important?

This presents a troubling picture for a country which has already been plagued by unfavourable data releases over the past year and reflects the deteriorating perception of China held overseas. As geopolitical tensions have escalated and the relationship with the US has soured, companies have been forced to reassess the risk-reward payoff associated with holding capital within China’s borders. As a result, many companies have opted to relocate their operations domestically or to comparable, more stable emerging markets, a strategy referred to as “de-risking”. Furthermore, the Covid-19 pandemic and conflict in Ukraine laid bare many fragilities within supply chains, prompting many companies to evaluate opportunities for diversification and reducing dependencies. China, long labelled the “World’s Factory” owing to its abundant labour force and low production costs, has naturally suffered as foreign investors seek to reduce overreliance on a single country and explore alternative destinations for their investments. An additional contributing factor lies in the unusually wide rate differential between the US and China, creating an incentive for multinational companies to repatriate their earnings, capitalising on the arbitrage opportunity that has emerged.

Foreign companies not only contribute a significant proportion to China’s trade they are also provide a substantial amount of tax revenue and urban employment, particularly crucial during the current period of economic vulnerability. Hence, the downward trend in FDI observed since 2022 is a worrying sign that only compounds China’s existing issues, making it more difficult to achieve their growth targets and fulfil their ambitions of surpassing the US as the world’s largest economy. In response, last week the Ministry of Commerce issued a letter urging local governments to remove discriminatory policies imposed on foreign companies, while this week President Xi Jinping is meeting with President Biden in an effort to stabilise relations. However, there is no ‘quick fix’ to this, and China will likely need to address its own domestic issues before being able to convince investors that it remains an attractive place to do business.

What does the chart show?
 

This week’s chart shows the exchange rate of the Japanese yen against the US dollar (showing JPY per 1 USD). This highlights how the yen has depreciated to its lowest closing level against the dollar since 1990. The yen has also been the worst performer amongst all major currencies in 2023, returning -13.67% so far. This weakening is primarily a result of wide rate differentials relative to the US where treasury yields increased by over 100 basis points year-to-date. This occurs when investors seek higher yields abroad causing the yen to be sold in exchange for foreign currency. Another factor has been the Bank of Japan’s (BoJ) policy decisions regarding yield curve control (YCC) – an ultra-loose monetary policy tool introduced in 2016 to try and stimulate Japan’s stagnating economy. Earlier this week the BoJ loosened this control by shifting from a fixed 1% limit to a more flexible ‘reference point’, permitting the yield to exceed the limit temporarily. Typically, such a change would be anticipated to bolster the yen, however investors had priced in a more dramatic policy adjustment away from the YCC, resulting in a sell-off pushing the yen beyond 150 per dollar. 

Why is this important?

The persistent depreciation of the yen has been beneficial for Japanese companies selling goods internationally, as it improves the competitiveness of their exports. This factor coupled with an accommodating monetary policy has supported the gains in Japanese equities in 2023. The BoJ however will be mindful of the yen weakening excessively which would drive up imports costs and increase inflation, and therefore may be inclined to tighten policy to prevent this. Due to the unconventional nature of the BoJ’s approach to monetary policy, juxtaposing all other major central banks, any tweaks in policy may have significant ramifications on global markets. Since the inception of Japan’s ultra-loose YCC policy, Japanese investors have allocated over $3 trillion abroad in pursuit of higher returns on foreign rates. Therefore, if the BoJ allows domestic yields to push higher, a rapid influx of funds onshore could cause significant disruptions to bond markets overseas where holdings have accumulated. Historically the yen has been considered a ‘safe haven’ currency, a perception which has somewhat broken down recently, but can provide a diversification layer against a potential recession and serves as a hedge for downturns in Japanese equity markets. In addition to monitoring the BoJ’s decisions investors should also pay attention to the strength of the US economy. This will help predict movements in treasury yields and the spread with Japanese government bonds, which will significantly influence the direction of the yen against the dollar. 

What does the chart show?
 
This chart shows the cumulative returns over the past three years of main India, China, Emerging Markets and US equity indices. The trends reveal how, amidst a challenging macro environment with economies recovering from the pandemic and withstanding high interest rates, India has performed best. What is also striking is India’s performance in comparison to Emerging Markets in particular China, who have been dealing with cyclical and structural challenges, including a property crisis, high debts, dwindling consumer sentiment and geopolitical tensions. In contrast, India recently surpassed China as the most populous nation and is predicted to average 6.3% growth until 20281 overtaking China as the global growth engine. Alongside a shift of capital away from China, India has drawn significant inflows due to favourable demographics, an ongoing digital transformation and cost-effective production capabilities attracting industry giants such as Apple and Google to set up camp. Prominent leaders of the democratic world such as US President Biden, UK Prime Minister Sunak and French President Macron have also recognised this evolving power shift and  are keen to deepen ties with India as both a strategic counterbalance to China and economic partner. 

Why is this important?

The past decade has been disheartening for emerging market investors and therefore the ability to identify promising markets like India has proven to be essential. The question is whether the superior returns gained by investors in India are sustainable or if current valuations already reflect the optimistic outlook going forward. The Nifty 50 (benchmark Indian stock market index) is currently trading at around a 22x P/E ratio compared to the CSI 300 (benchmark Chinese stock market index) trading around 12x, so in terms of value India may not be as favourable. Furthermore, enduring structural problems such as extreme wealth inequality, corporate corruption and low literacy rates may provide headwinds to sustaining the high growth levels predicted. However, in a global environment characterised by dim growth prospects across the board and pervasive instabilities, an economy as stable and continuously expanding as India should not be underestimated. With the size of and scale of India’s consumer base, potential for innovation and further development, the country emerges as an appealing contender to weather a challenging macro environment and potential external shocks. While risks of short-term price corrections cannot be ruled out, the investment proposition for India primarily rests in the long term. 

What does the chart show?
 
This chart shows the difference in 30-day volatility between the iShares 20+ Year Treasury Bond ETF (Exchange Traded Fund) and the SPDR S&P 500 Trust ETF. ETFs are funds traded on stock exchanges and typically hold a range of holdings in a specific asset class with the aim of tracking their overall price movements. In the chart we can see the volatility spread between bond and equity ETFs reaching its highest ever positive level indicating that long term treasuries are at their most volatile in relation to equities. Typically, we would expect to see lower levels of volatility in government bonds compared to equities, highlighted by the negative average long term spread, as these securities tend to provide more predictable returns for investors and therefore more stability in supply and demand dynamics. Equities on the other hand are more exposed to investor sentiment, economic conditions and business cycles, leading to more volatile price movements.

 Why is this important?

 This is significant for investors as the typical risk reduction benefits that bonds traditionally offer in portfolios are compromised due to large swings in prices. Investors have been on high alert, interpreting statements from the Federal Reserve, and swiftly reacting to economic data releases in an attempt to anticipate the trajectory of interest rates. Additionally growing fears regarding the escalation of the ongoing conflict in the Middle East have caused geopolitical tensions to teeter on the edge. These factors are collectively contributing to consistent inflows and outflows in treasuries resulting in the recent dramatic price fluctuations. Given the unlikelihood of a swift resolution for these uncertainties in the short term, we can expect to see this volatility persisting for the time being, elevating risk in portfolios. Diversification is critical to help manage risk – by investing in a range of asset classes and investment styles, investors can spread their risk and reduce volatility whilst minimising drawdowns. Building in additional diversification levers to further smooth the investment journey is an approach that we have always adhered to and have implemented successfully over the decades.

What does the chart show?
 
This chart shows the yields on treasuries reaching their highest levels since the Global Financial Crisis, fuelled by dramatic sell offs in the past couple weeks. US government-issued debt securities are typically regarded as safe-haven assets with reliable returns, however in recent years this has not been the case. In the past couple of years, central banks have responded to inflationary pressures with an unprecedented series of rate hikes, leading to a dramatic surge in yields. Yields move inversely with prices, so these yield spikes have coincided with steep drops in prices, damaging portfolios containing fixed income assets. Despite the anticipation of a reversal of this trend and promising returns in 2023, the resilience of economies, ongoing debt issuance, and a growing deterioration of confidence in US fiscal responsibility have resulted in a continual rise in yields. Most recently the US payrolls released on Friday (6 October) reported 336,000 additional Nonfarm jobs in September, more than doubling expectations. In response, yields on 30-year treasuries surpassed 5% for the first time in 16 years, as investors were yet again taken off guard by the strength of the economy amidst a high interest rate environment. 

 Why is this important?

 Rising yields pose not only a threat to portfolios containing fixed income assets by reducing their value, but also significantly tighten financial conditions. Given that banks hold large proportions of government debt, a devaluation of these assets imposes substantial strain on their balance sheets, limiting their capacity to lend, and in turn exerting pressure on the broader economy. Therefore, the recent surge in yields will prompt the Federal Reserve to consider whether additional rate hikes are required given the risks that emerge if conditions tighten excessively, and a recession is triggered. This was echoed by hawkish Fed member Loretta Mester who stated these moves were “certainly going to feed into” Fed rate decisions. The rise in long term bond yields in recent weeks does however now present attractive valuations for investors, given the extent to which bond prices have fallen, with real rates now also very much in positive territory. As a result, in addition to increasing exposure to safe-haven government bonds in short maturities in recent months, we are actively seeking opportunities to extend duration as we enter the latter stages of the rate cycle. The focus is now on the upcoming CPI report, due to be issued this week, to gauge what decision the Fed may take at their next meeting in November.   

What does the chart show?
 
This chart shows the discounts of specialist or alternative asset (Association of Investment Companies property, private equity, and infrastructure) investment trusts’ share price to their Net Asset Value (NAV) since 2015. NAV represents the total underlying value of all fund assets per share. Investors gain exposure to these assets by purchasing shares of these investment trusts traded on the stock market, leaving the share price susceptible to the same supply and demand dynamics as traditional stocks, resulting in prices fluctuating either above (premium) or below (discount) the NAV. In the chart we can see investment trusts’ average discounts in specialist assets have widened to their highest levels not seen since the onset of the COVID-19 pandemic, suggesting weak market appetite. 

Why is this important?

Against a backdrop of economic uncertainty and rising interest rates, alternative assets like property, infrastructure, and private equity have performed poorly due to their sensitivity to higher rates. As alternatives are often considered risky investments, higher rates have caused investors to rotate into “safer” assets such as government bonds which now offer attractive yields. The key question for investors now is whether these significant discounts offer interesting valuation opportunities, especially given interest rates are approaching peak levels. While share prices tend to be volatile in the short-term, sometimes creating deep discounts, these have historically corrected themselves over time. However, dangers also arise where investors believe that managers are being overly optimistic when calculating their NAV and discounts then become embedded in investor expectations, leaving room for these to widen further. Long-term investors can reap benefits from riding out temporary volatility, waiting for the economic outlook and consumer sentiment to improve. Due to their inflation-linkage and low correlation with equity markets, asset classes such as property and infrastructure could also provide protection for investors if inflation does not return to low target levels.  As always, investors should not purely rely on discounts as a guarantee of capital returns; they should also ensure that the underlying holdings in the trusts they invest in are of high quality. Given expectations of increased market turbulence, alternatives continue to offer diversification benefits at attractive valuations. Discounted NAVs in private equity continue to appear overly pessimistic, while secular trends in infrastructure support our outlook for both asset classes.

What does the chart show?
 

This chart shows a comparison between the trends in year-on-year Consumer Price Index (CPI) from 1966-1980 and 2013-2023, highlighting the striking similarity in the two periods. Not only are the trends eerily reminiscent of the 1970s, but many of the challenges central banks have been faced with are also alike. The pandemic and Russia’s invasion of Ukraine bear resemblances to the Yom Kippur War in 1973, as in both instances exogenous shocks caused widespread supply constraints and subsequent inflationary pressures. The chart also illustrates how after an initial decrease in inflation after 1975, there was a significant rebound in prices, predominately driven by a surge in the oil price. Given the recent uptick in inflation following a rise in oil prices, this is a situation that the Federal Reserve (Fed) hopes to avert this time around. The first worrying signs that the trend is being followed were seen in the slight uptick in inflation earlier this month, a reversal also driven by oil price rises.

Why is this important?

Federal Reserve Chair, Jay Powell, has already faced the consequences of not learning from previous mistakes, after judging the early inflationary pressures as ‘transitory’ and merely a product of exogenous shocks. Former chair, Arthur Burns (1970-78) made the same error, pointing to cost-push shocks as the culprit for high inflation, highlighting how in both cases, the damaging lagged effects of ultra-loose monetary policy were ignored. The consequence of the substantial rebound of inflation in the late ‘70s, was a painful correction period which necessitated unprecedented rises in interest rates implemented by the infamous Paul Volcker, resulting in severe back-to-back recessions. There has however, been an important paradigm shift in the monetary framework used today compared to the 1970s. Previously, monetary supply was used as the main instrument of policy alongside non-monetary actions such as taxation and implementing wage or price controls, while the Federal Funds Rate was considered ineffective and unnecessary. This has meant that today, the Fed is much better positioned to handle inflationary pressures and prevent the entrenchment of high prices in expectations. Even so, the chart still serves as a warning of the potential consequences of declaring victory over inflation too early, and the growing narrative of rates staying higher for longer is a promising sign that the Fed has learnt this lesson. The Fed will certainly be hoping that 2024 will be the year that this visually appealing correlation breaks down.

What does the chart show?

This chart shows the amount raised in the top ten Initial Public Offerings (IPOs) in the US over the past five years and the share price performance since the date of their listing. An IPO is a process by which privately owned companies raise capital, offering shares of their company to the public through listing their shares on an exchange. This can be a very challenging and time-consuming process for companies to undertake and leaves their business subject to the intense scrutiny of investors. IPOs are very volatile, risky investments and performance mostly disappoints, with two thirds of IPOs between 2010 and 2020 underperforming the initial market price in the first three years after flotation (according to a 2021 Nasdaq report). While the vast majority of the top ten IPOs shown in the chart have followed this trend over the past five years, the semi-conductor design company, Arm Holdings, listed on Thursday (14 September) and has traded higher than their initial price. The British-based technology company, which has been the latest to benefit from the recent artificial intelligence (AI) optimism, bounced 25% in the first day of trading, and although this has moderately dropped since, it still remains higher than its issue price.

 Why is this important?

 The Arm Holdings IPO is the most valuable listing since electric-car maker Rivian Automotive floated in 2019 and comes at a time when new listings have slumped due to the worsening economic outlook, high market volatility and tightening monetary policies. Investors’ valuations are heavily reliant on forward sales and earnings forecasts, and this is negatively impacted by interest rates. Therefore, valuations are generally depressed in a high-interest environment, which is a key reason why in the last few years company management teams have been waiting for economic conditions to improve before taking the leap of going public. In contrast to Rivian Automotive’s IPO which has fallen over 70% since its listing, the success of Arm Holding’s IPO (or rather absence of any major downfall) may be the catalyst privately owned companies need to deem the public market stable enough to enter. The process appears to be underway, following the recent public listing of online grocery platform Instacart. Last week, the company increased its issue price range and this week, saw a 40% surge in trading during its successful market debut. With additional new listings also lined up, such as marketing and data platform Klaviyo, car sharing business Turo, and shoemaker Birkenstock, investor appetite for IPOs will become a lot clearer and the outcomes should be carefully monitored to determine whether this market is back open for business.