Please see below, an article from Tatton Investment Management analysing the key factors currently affecting global investment markets. Received this morning – 13/01/2025
UK bond yield surge – more than meets the eye
Bond markets took centre stage again last week. Globally, yields went up thanks to US economic strength – but UK media focussed on UK bond turmoil, as yields spiked more sharply than elsewhere. The sell-off in UK government bonds (Gilts) was not a ‘Liz Truss moment’ but it was similarly driven by structural selling pressures from UK pension funds. Despite all the talk about Britain’s weak economy, the rise in long-term real (inflation-adjusted) yields should reflect higher growth expectations – even though no one actually thinks growth has improved. The pension fund adjustment helps explain this discrepancy, but it doesn’t help explain why yields also spiked in other bond markets.
We think the global sell-off is a broader story about political uncertainty. Gilt traders don’t trust what the UK treasury says, and we have argued for a while that risk measures for US bonds have been increasing. The latter reflects perceptions of potential instability in the world’s largest economy – both in terms of public debt and the health of US institutions more broadly. Donald Trump’s military threats against NATO allies are clear examples, as are the attempts of his adviser Elon Musk to install preferred far-right candidates in the UK and Germany.
This uncertainty can impact markets. Government bonds being seen as more risky, for example, suggests investors are generally less keen to take on long-term risks. That is a problem for risk assets like equities, and it’s notable that recent bond turmoil coincided with increased volatility in US tech stocks. There is no sign of a broad equity sell-off yet, but this is a warning sign.
Higher real yields means less market liquidity, which increases the ‘gap risk’. UK bond problems are only partly UK-specific. Global yield increases reflect waning risk appetite, in the face of political uncertainty. Politicians should heed bond market signs – regardless of their electoral mandates. If they don’t, the chance of an equity market shakeout increases.
December asset returns review
There was no ‘Santa Rally’ in December, but thankfully none was needed. Global stocks lost 0.9% in sterling terms on the month, but finished 2024 up 19.6% overall, and every major stock market was in the black. Last month’s troubles were mostly down to the US Federal Reserve signalling fewer interest rate cuts. Bond yields rose, making equities relatively less attractive. Big US tech stocks fell in the aftermath – which is strange, as they are cash rich and therefore immune to higher interest rate costs. That suggests a valuation pullback reaction to the Fed, rather than changing economic expectations, and for the month overall tech stocks gained 2% in sterling terms versus a 0.9% loss for broader US equities.
European also dropped 0.9%, but had a tougher 2024 overall, gaining just 1.9% through the year. UK stocks performed the worst in December, losing 1.3% after the Bank of England kept rates steady. Japan was one of the few positive performers last month, gaining 1.1% thanks to the Bank of Japan’s stimulus plans and upwardly revised growth figures. China was the best performer – up 3.6% through December. This was again due to government stimulus expectations, but there were also signs of economic improvement. Incredibly, China was the second best performer in 2024 overall, gaining 18.8% in sterling terms.
December was a drab end to a great year for globally diversified investors. However, after two years of strong returns, some might wonder whether this can be repeated in 2025, and whether December’s wobble might be the start of something worse. We don’t think last month’s troubles say much about the market mood (it looked more like year-end rebalancing) but there is a lot of economic activity expectations ‘priced in’ to markets. Assets aren’t under threat, but returns might not live up to recent standards.
Global earnings growth
Stock markets are at the moment more sensitive than usual to earnings growth expectations. Analysts think US earnings will yet again power ahead of other regions in 2025, and investors seem to agree. This is largely about Donald Trump: markets think tax cuts and deregulation will help American companies, while tariffs will hurt global companies. Business sentiment indicators back this up, as does recent retail sales data – suggesting US consumers buy the American exceptionalism story. Some worry that tariffs might undermine confidence, but they could also mean that a larger share of US consumption filters through to US corporate profit.
US outperformance is also about underperformance elsewhere. European companies are suffering from weak demand and high energy costs. UK profit expectations are gently improving, but from a low base. Japan’s corporate earnings have been relatively strong, but are stable rather than growing. We have argued before, however, that markets are overly pessimistic about growth outside the US. This negativity is probably clearest in Europe, where investors are arguably ignoring the upsides that might come from more accommodative monetary (and perhaps even fiscal) policy.
We’re less convinced about US dominance. There is a worrying divergence between the ‘soft’ sentiment data and the ‘hard’ economic data. It is hard to see how smaller companies can improve while interest rates are still high – and Trump’s policies have already pushed the Federal Reserve into a tighter stance. This might not be a problem if the biggest US tech stocks can maintain their stellar profits, but that would be doubtful if their customers are less healthy than hoped.
US earnings growth will likely outperform for the first half of 2025, but the current projections seem too optimistic. Markets could be setting themselves up for disappointment. We will keep a close eye on earnings expectations in the months ahead.
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Alex Kitteringham
13th January 2025