As the world waits with bated breath, and some nervousness, for the official arrival of President Trump 2.0, Rachel Reeves has been dragged into the media spotlight to fill some temporarily empty white space. There is a problem in the UK. Long dated UK government bond yields have spiked higher, back to those in the troubled era of Truss, and in the case of 30-year bonds up to levels not seen since a very wobbly 1998, when Russia defaulted on its bonds.
For us the immediate observation is a split in the fortunes of the UK stock market. Since the high in the FTSE 100 of 18th October, it is down merely 0.5%, and might even be building an uptrend since the mid-November low. In contrast, the mid cap and small cap indices are down 6%, a notable differential. Since the August peak the FTSE 250 has lost 8%, a downtrend has taken hold. The immediate technical indicators are negative.
My guess, I put it no more strongly, is that this downtrend can only be broken in the short term if dramatic action is taken by the government and the Bank Of England, specifically to stop the rot in gilt yields as well as provide stimulus for an economy which is now in recession e.g. the authorities can re-commence buying gilts, interest rates can be cut by 0.5%, proposed tax increases and spending increases can be postponed, as a minimum.
Yet this is not solely a UK problem. Government bond yields have also jumped in the US and France, where there are also concerns on runaway government debt levels and marked political uncertainty.
Longer dated bonds can be impacted by a range of risks. Expectations for inflation years ahead is typically the most significant issue. At the other end of the scale is the risk of default, such as Russia in 1917 and 1998, and Argentina, Ecuador and Lebanon in 2020.
In between those two is supply and demand. Who is going to buy them? Most countries are increasingly living beyond their means. They can raise a certain amount by taxes, but only what the economy (companies and individuals) can bear. The rest of the governments pocket money has to be raised by selling government bonds, gilts in the UK. Most of these bonds are bought by institutions.
It gets a bit awkward when those institutions either don’t have the capacity or the desire to buy those bonds. If they don’t have the desire you will see reference in the headlines to “bond vigilantes” and buyers strikes. When it gets to this point it also catches out those who have been playing smoke and mirrors in the gilts market, particularly using gearing and fancy, and ultimately flawed, maths. This is what happened with the Truss crash.
Beyond this entertainment from the bond markets over an otherwise fairly non-descript Christmas period for financial markets, there was a consensus on two matters from the investment banks. The US stock market will go up again in 2025, and the US dollar will stay strong. Yet both are priced for perfection. (As an aside, in the 20th December note, my technical analysis suggested 10% more downside in the S&P, and then a resumption of the uptrend in the short-term. I am not yet seeing anything to change that observation. But don’t confuse that with the gung-ho in other quarters!)
The valuation bubble in the US isn’t all about tech, as many believe. This from Goldman Sachs:
“The US equity market is still trading at close to record valuations even if we exclude the mega cap technology companies”
Such bubbly valuations are particularly dangerous when combined with an investor mania. When investors have the fever and don’t have enough money to buy more, they borrow money, or buy leveraged products.
For example, one ETF invests solely in Nvidia, with a 2x exposure e.g. if Nvidia goes up 10%, your value goes up 20% - the reverse also applies, but in your fever you KNOW that will never happen. That certainty meant that the investments into this ETF went from a few hundred million dollars to $6 billion over the last year. This aura of certainty always prevails at major turning points. Navigating the range of known risks in 2025 will not be easy. But one way to do so is not to take on more risk!
Consensus views have a tendency to unravel when reality bites. One of Bob Farrell’s famous market rules was that when all experts and forecasters agree, something else is likely to happen.
There are three blogs to start the New Year. Firstly updated research on smaller companies, in this case a Dynamic Global Smaller Portfolio. It has some fascinating angles, such as being a huge success pre-Covid, and then mundane after that as the US dominated. We will be doing more work on this.
Then there are two 2024 reviews, one for the Stars Of 2024 and the other the Duds Of 2024. Each shows the whole year, and then breaks down each 6 months, where the trend of the last 6 months is particularly interesting.
Thank you to Stan Hull for some great work this week to get these completed before returning to Uni.
Next week I will look at some investment ideas for 2025, and in advance of that do try and find some time for reflection, for example:
- Does your investment plan need some tightening? Is it even written down?
- What is the rationale for your asset allocation?
- Ditto for your investment selection?
- What is your defence? Is it clear and have you applied it?
- Do you need to adjust your stop-loss strategy for today’s environment?
- Are you using our unique Stop Loss Tool? If not, why not?
- Are you still comfortable self-managing all of your portfolio?
Do share your thoughts with us on your thinking as you look forward into 2025. You can email here, or reply to this email. The more we can share ideas and insights, the greater the help to the whole FundExpert community.