Market Update 5th February 2024

Don’t count your chickens when there are black swans about

Another record-breaking week. The S&P soared to a new high (hyperbole is a requirement when talking about records, especially in the US). Part of this was driven by blowout earnings from Meta, which has not only surged past the $1 trillion market cap barrier, but also became the first company to bolster its market cap by $200bn in a single session.

One record slipped under the radar though. Last week saw a new low in the price of UK carbon credits. Effectively, these are tradeable pollution permits, and work in a similar way to other schemes around the world. Large industrial groups receive allowances, which they can either use themselves or sell to other more polluting peers. These schemes can be very lucrative for the beneficiaries – Tesla has earned $4.8bn from selling its credits to other car makers in the last three financial years. That’s over a quarter of its total net income in that time.

The number of permits issued each year is supposed to decline to ensure companies invest in finding greener solutions, but the government has bent the rules to allow more allowances than previously anticipated. Over 2024 -2027 there will be 53.5m tonnes of extra allowances — about half a year’s worth of UK emissions covered by the scheme according to the FT. The government says this will “smooth the transition to a net zero consistent cap”. Nonsense. It just says we are not serious about climate change. To be clear, and in the interest of balance – this is not a party-political broadcast. Labour has rowed back violently on its ‘Green Prosperity Plan’ too.

Inaction and inertia are, ironically, nothing new. It’s a very long time since CS Lewis apparently said “isn’t it funny how day by day nothing changes, but when we look back everything is different”. The danger for us now is that this wonderful quote will take on a much darker meaning in years to come.

This is particularly frustrating as I genuinely believe business is capable of creating the solutions we all need. Resilience and a capacity to innovate are central to why stock markets work. Problems arise, and companies provide solutions. The best ones are rewarded. That is capitalism in a nutshell. All government needs to do is set the right rules.

Why is it not doing this? Another quote from yesteryear provides a possible explanation. It’s the economy, stupid. In election years, people want to see results. Long-term policies don’t land with either policy makers or the electorate since they have very little tangible benefit in the immediate term. And when it’s spluttering, boosting the economy is all the more important.

The good news for investors is that there are signs the pieces of the jigsaw are starting to fall into place. The dreaded hard landing looks further away. The Bank of England last week moved to upgrade their forecasts for GDP growth, while the US figures continue to impress. Visa, Mastercard and major banks such as JPMorgan have all described the consumer as resilient. And they know a thing or two about these things. Corporate results have, barring the inevitable occasional slip, been reasonably encouraging.

Inflation is stalling too. In that same BoE report, the boffins of Threadneedle Street confirmed inflation has fallen from a peak of 11% in 2022 to 4% in December 2023, and could well drop below 2% ‘within a few months’. Receding inflation opens the door to rate cuts. The Fed’s own ‘dot plot’ implies there will be 75bps of cuts this year. Markets are slightly more optimistic and are baking in a little more loosening. We’re likely to have a similar trajectory this side of the Atlantic, with forecasters thinking both the ECB and BOE will trim by 25bps about four times.

Resilient earnings, lower inflation, rate cuts and higher growth sounds like a good combination to me.

There are, as always, tripwires. The trouble in the Red Sea has the potential to reignite inflation and re-couple supply chains. And there will always be the unknown unknown of black swan events, so we can never… err… count our chickens.

But in our view, these are not reasons to be out of the market, especially if money is entrusted to high-calibre fund managers or invested directly in high-quality, financially resilient companies. The rally in Q4 showed what can happen when sentiment becomes more positive. Being on the sidelines when the next bull market takes off will be an error.

George Salmon – Senior Investment Analyst

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