Quarterly Equities and Multi Asset Outlook – Q2 2024

While the forthcoming Federal elections in the US are looming large for many, we do not believe the outcome of the Presidential Election will have a major impact on current policy with regards to the semiconductor industry, for a number of reasons:

Firstly, the US government restricted access to semiconductor technology to China under both the Trump and Biden administrations. So in terms of future actions, we would expect limitations on exports to China to continue regardless of administration.

Secondly, the CHIPS and Science Act – passed by Congress and signed into law by President Joe Biden in August 2022, which provides subsidies for semiconductor manufacturing in the US – received bi-partisan support. As such, we would expect either a Trump-led or Biden-led administration to support the manufacturing of semiconductors in the US, both in the interests of national security and to mitigate supply-chain risks.

For this reason, we believe our portfolio is neutrally positioned when it comes to the political landscape in the US, regardless of the outcomes of the US Federal elections. At the margins, some of our industrials and holdings related to managed healthcare could be exposed to tailwinds and headwinds respectively. For the former, our holdings (c.10% of the portfolio) are well-placed to benefit from increased capital spending on infrastructure and any moves to upgrade the electricity grid, for example. For our healthcare names, universal healthcare could change the landscape for managed care companies, particularly the introduction of a ‘single payer’ system. Historically, some Democrats such as Senator Bernie Sanders have pushed for universal healthcare, in the form of ‘Medicare For All’. However, this concept has not featured in Biden's (or Trump's) plans for 2024, rather Biden is looking to expand healthcare provisions in the IRA should he win.

Regulation more broadly does pose a tail risk for the wider technology sector, but we believe regulation can co-exist with the secular growth of technology and AI. We think the leading technology companies can make adjustments to appease regulators that are not overly burdensome. For example, we expect Microsoft to separate Teams from Office, to create two separate products and alleviate anti-trust concerns.

Infrastructure build-out for AI could come also under some pressure. Nvidia has discussed that AI datacentres are different to historical datacentres, and sees next generation datacentres as ‘AI Factories’. Building out these new datacentres will require power and cooling that could create bottlenecks to the build-out and unpopular environmental impact.

There has also been discussion around manufacturing capacity for semiconductors as demand growth continues. Semiconductors for AI are manufactured using leading-edge foundries, and we believe the industry will need to continue to increase capacity long term, but this risk is mitigated by planned geographic supply diversification.

³ Source: Bloomberg, MSCI ACWI IMI Semiconductors & Semiconductor Equipment, price returns, year to date through 29 March 2024

Although we can debate the returns that this spend will deliver and the pace of development from here, it seems clear that Generative AI is here to stay in a more meaningful way than prior Tech hype cycles such as the Metaverse. 

If you’d told me 12 months ago that 2024 would see the release of Gladiator 2, I’d have assumed that the award for “Least Wanted Sequel” of the year would be straightforward. But post Super Tuesday, it seems like that accolade is instead slated to go to the Presidential Election match up of Donald Trump versus Joe Biden in November. 

Despite their respective primary victories, US voters seem remarkably unenthused with their options this year. In a recent Reuters poll⁶, 70% of respondents – including about half of Democrats – agreed with a statement that Biden should not seek re-election. 56% of people responding to the poll said Trump should not run, including about a third of Republicans.

Despite these being two candidates running for a second term, the 2024 election has so far been a ‘vibes’ election, with actual policy platform details remarkably sparse, especially in the economic sphere. Contrast this to 2016 when Donald Trump was proposing the largest tax cut in a generation, or 2020 when Joe Biden was campaigning for an historically-large stimulus package. 

At this point, we are still waiting for the official manifesto launches of both major parties. Within that context, perhaps some of the most exciting opportunities starting to emerge are in areas that neither candidate seems to be talking about. The Healthcare Insurance sector has historically been weak into election cycles as changes of party have raised risks of systemic change. This time around has proven no different so far, but with two candidates who mostly seem to favour the status quo, this seems like a decent opportunity to invest at prices that historically tended to recover nicely once the election dust has settled.

The good news for investors in general is that election results have rarely impacted the ability of the US stock market to provide attractive returns in aggregate. 

Although there will undoubtedly be opportunities thrown up by the upcoming political cycle, our philosophy will be to focus on high-quality, high-returning businesses with long-run opportunities to grow their earnings regardless of the political weather, rather than try to get too cute about timing voting volatility. To quote Benjamin Franklin – "The bitterness of poor quality remains long after the sweetness of low price is forgotten".

Since the end of the Second World War, the US has proved to be a fantastic market for long-term investors to put their money to work in. That wealth creation function is underpinned by an entrepreneurial culture that persists and thrives regardless of who sits in the White House. I firmly expect that dynamic to continue into the future. 

⁴ Source: Bloomberg, 29 March 2024
⁵ Source: Pitchbook (online), 14 June 2023, The most active investors in generative AI - PitchBook; Macrotrends (online), 4 April 2024 NVIDIA Market Cap 2010-2024 | NVDA | MacroTrends
⁶ Source: Reuters, 25 January 2024, Trump vs Biden: The rematch many Americans don’t want

A few notables from Japan over the first quarter would include the following: 

Firstly, observers have been keen to see whether or not retail investors have been using the increased tax-free savings limits for stock market investing since the NISA scheme was revised on 1 January 2024¹⁴. We only have data for January and February but, so far, inflows into NISA accounts have roughly tripled year-on-year to approximately 1.7 trillion yen with almost half of that inflow going to domestic stocks. The NISA regime change was never going to unleash a ‘financial tsunami’ of inflows, but it has clearly increased household interest and participation in the domestic stock market, a helpful and healthy development for the market. 

Secondly, the yen exchange rate has been a hot topic so far in 2024. The currency continues to confound the pundits. Most observers believe that the yen is currently too cheap and will strengthen from here thanks to rising rates in Japan versus peak rates in western economies. However, following the Bank of Japan finally announcing a well anticipated, if modest, increase in interest rates in March, the currency went on to weaken further. 

We believe that corporate reform is driving productivity growth in Japan. This, along with a narrowing of interest rate differentials, leaves us sympathetic to the consensus view that yen is too cheap. That said, we also acknowledge we have no edge in currency forecasting, and so continue to build a portfolio that is designed to be broadly unimpacted by currency outcomes. 

Wages have also been a KPI that Japan observers are paying attention to. Signalling not just improved consumption prospects, higher wages have also been seen as a signal of rising ‘animal spirits’ and a dismantling of the old state-led economic model. On this front, it’s notable that in March, the Japanese Trade Union Confederation announced that large-sized companies have agreed to an average wage hike of 5.25%, the largest increase in 33 years. Furthermore, Prime Minister Kishida stated publicly in late March that he is dedicated to maintaining wage increases beyond 2025. This was taken positively by the market. 

Although the Kishida administration has worked hard to support higher wages, the administration’s approval-rating remains alarmingly low at around 20%–25%. Public trust has been eroded by the political-funding scandal that emerged in 2023. The Kishida administration now faces a critical few months ahead. If Kishida’s party loses the Lower House by-elections in late April, calls for his resignation will emerge. Like other major economies, the election dynamics in Japan this year offers ample scope for surprises. 

Looking ahead, we need to acknowledge the valuation expansion in Japan in the past year or so. At the start of 2023, the Japanese market was simply too cheap versus the existing earnings power, irrespective of the corporate reform dynamic which we believe will help drive strong long-term compounding gains from Japan equities. Today, more than a year on, the excessive undervaluation has been removed for many large cap stocks. That said, the long-term opportunity from corporate restructuring and balance-sheet reform remains firmly intact and the pace of reform continues to accelerate. 

¹³ Source: LSEG DataStream, April 2024. TOPIX, price indices in local currency terms through 29 March 2024 
¹⁴ Nippon Individual Savings Accounts (NISA). The new NISA was introduced in January 2024, with changes to the system including making the system permanent, making the tax-free holding period indefinite, and increasing the annual investment limit and the tax-free holding limit.

An initial test of the popularity of ‘Value Up’ was the 10 April 2024 legislative elections in Korea for the National Assembly. The President’s right-of-centre People Power Party has pitched the programme as an effort to share corporate wealth with individual shareholders, while opposing parties have criticised some of the policies as favouring the wealthiest in society, including the families that control the Chaebol¹⁶. This election result saw the leading opposition party maintain their majority in the legislature, but not secure a super majority which would have allowed the party to override a Presidential veto. Korea’s KOSPI Index was down c.1.6% on opening, but subsequently rallied to close the day up. Although the electoral setback could reduce momentum for ”Value Up” at the margin, it will not lead to widespread repudiation of the programme at this stage. With President Yoon still in power until 2027, the policy will remain in place for the foreseeable future. 

India’s impending election is very important for the Asian market. The incumbent ruling Bharatiya Janata Party (BJP) is widely expected to win, and their victory is largely discounted. We have no reason to quarrel with the consensus in this regard, but we would note that, in the unlikely event the BJP does not win, the market could perform very poorly. 

Arguably, the greatest source of political uncertainty for the region in 2023 comes from, you guessed it, the US. The US Presidential election is discussed in detail elsewhere in this note. Certainly, some of Donald Trump’s comments on trade and China will mean Asian markets will be vulnerable to headlines tied to a Trump victory and related trade policies. Importantly, this is 2024 not 2016. Since the last Trump victory and associated tariff policies, regional trade practices and operations have evolved and companies have been pursuing China Plus One (C+1) strategies¹⁷ in their production plans. This does not mean that the Asia region will be immune from renewed trade friction, but it does mean it should be more resilient. Indeed, the exporters we own in the portfolio have been carefully picked so that they are less vulnerable to new or higher tariffs on their operations. 

¹⁵ Source: LSEG DataStream, April 2024. MSCI (Price) indices in US dollar currency terms through 29 March 2024. Same source for KOSPI.
¹⁶ System of large family-owned business conglomerates in South Korea
¹⁷ Supply chain strategies that encourage companies to diversify their supply chain and manufacturing activities away from China to mitigate risk

Unstable political environments routinely lead to volatility in EM assets. We increasingly find our own clients have geopolitics, rather than returns on capital, top of mind. To allay fears, we firstly point towards our long history of investing in countries which have elevated geopolitical risk premia and, secondly, we highlight that astute EM investors often use these episodes as advantageous entry points. We would also highlight that volatility does not always reflect downside risk. The truth is, elections and geopolitical risks are very hard to price.

Much has been made of the ‘world of elections’ in 2024 but we would also point out elections that have just happened. Noteworthy recent examples include Taiwan, Indonesia, Turkey and Argentina. A diverse spread of countries that have had equally diverse election outcomes and ensuing impacts on asset prices. 

In January, we saw the pro-democracy party returned in Taiwan, a result that fanned regional tensions but was perhaps expected by global markets. We have been underweight Taiwan in our portfolios due to valuation concerns posed by frothiness in the global AI trade, rather than the optical geopolitical risk premia. In Indonesia, President elect Prabowo Subianto represents a continuum of the status quo, albeit with a potentially-different policy bias; he had previously been banned from the US due to purported human rights violations and, policy-wise, may be seen as more pro-China than his predecessor, Joko Widodo. For both of these Asian economies, the interpretation of their respective political outcomes and the impact on their economies sits squarely between two giants: the US and China.

Markets in Turkey have warmed to President Erdogan’s apparent return to monetary policy orthodoxy with the Finance Minister and Central Bank raising rates aggressively to staunch the chronic inflation picture. Erdogan’s power appears to be ebbing, as he signals this is his last term and the AKP party have lost further ground in local elections, with both Ankara and Istanbul now run by the opposition CHP party. Erdogan has subsequently made his maiden voyage to the White House, purportedly to consult on tensions between Israel and Hamas. Again, the lens of perception for Turkey is led by relative closeness to the US. Argentina is more anomalous to the rest; years of economic malaise and lowly regard from international investors has received a veritable fiscal shot in the arm from populist right winger, Javier Milei. The country has huge economic problems to fix, but the radical policies espoused by the new government has certainly brought Argentinian companies back on the radar.

Yet to come are elections in notable EM heavyweights South Africa, Mexico and India. We have moderate overweight positions to both South Africa and Mexico and will remain watchful in the buildup to both events. The election in South Africa could be a moment of peril or real opportunity, depending on whether or not the ANC lose the majority they have enjoyed since the end of Apartheid and, if so, which party may provide coalition support. A coalition with the Democratic Alliance, who have provided a degree of stability since they took power in Cape Town in 2006, could increase the chances of market-friendly reforms. Both Mexico and India are not expected to provide fireworks. In India, Prime Minister Modi looks certain to win re-election for a third term, sufficiently so that the Minister of Finance Nirmala Sitharaman feels confident enough to have already announced a fiscal consolidation, targeting a less than 4% deficit by the end of fiscal year 2026. India has doubled its deficit through the COVID years and is now looking to remove such stimulus as the country’s overall debt-to-GDP looks high at close to 82%. Time will tell what effect such moves have on India’s growth and elevated market valuations. Finally, in Mexico, incumbent party Morena is expected to regain power via AMLO’s protégée Claudia Sheinbaum. Little is known about her likely policy direction with the New York Times calling her ‘an enigma’; the race, thus far, has been very low-key. 

The US election in November is of course hugely consequential for the globe. Meanwhile, key geopolitical issues (Russia-Ukraine, Middle East and China-Taiwan) remain unresolved and the US elections are not helping to ease the uncertainty on this front. As mentioned though, the truth is that elections and geopolitical risks are very hard to price. It is why, rather than focus on the events in-and-of themselves, we spend our time diligently analysing companies from a bottom-up perspective and seek to take advantage of any market dislocation in valuations. 

¹⁸ Source: LSEG DataStream, April 2024. Price indices in US dollar currency terms through 29 March 2024.

Several factors contributed to this – not least, the higher interest rates at a time of refinancing needs²⁰, a recovery in stock prices and renewed enthusiasm for ‘hot’ themes such as Artificial Intelligence (AI) and bitcoin. We have previously discussed AI in our Q3 2023 Equities and Multi Asset Outlook – Beyond Nvidia²¹. Since then, we have seen three direct AI plays issue converts, with the poster child being Super Micro Computer’s $1.7 billion bond in February. Additional excitement came from crypto names. MicroStrategy continues to trade at a very significant premium to the value of its bitcoin holdings. It capitalised on its meteoric rise in March by issuing two convertibles in rapid succession within two weeks of each other. The stock price has been rising so fast (c.67% in March), that the first bond entered the FTSE Global Focus Convertible Bond Index²² and is likely to come out after just one month as it is deeply in the money already. 

In a year in which politics will increasingly be in focus, it’s worth noting that any volatility caused by geopolitical events can, in our view, affect positively the pricing of convertible options – supporting their valuation and mitigating (but not completely offsetting) the negative effects of any volatility on equity and credit values. This can help convertibles produce better risk-adjusted returns than other asset classes in times of political upheaval.

Geopolitical events are notoriously unpredictable and, as such, it is a challenge to position a portfolio for the whole gamut of political risks. Therefore, our focus remains on having a well-diversified portfolio with strong equity and credit fundamentals, attractive valuations and favourable risk-reward characteristics that can withstand such uncertainties. It is also important not to be unduly exposed to themes or areas of the market that may have greater sensitivity to political or policy uncertainty. 

For example, three areas that would be influenced by the US Presidential election, as mentioned by my colleagues elsewhere in this outlook, are protectionism and the technology export restrictions to China, potential healthcare reform, and energy transition. 

In our portfolios, our largest technology exposure is in software, an area that has attracted less political attention, rather than semiconductors and hardware. That said many semiconductor and hardware stocks are likely to weather the storms thanks to their strong intellectual property and innovation capabilities, and we have actually taken advantage of price volatility around political and regulatory risk to add exposure to a Korean memory chip manufacturer at depressed equity valuation and favourable convertible terms.

Similarly, we believe diversification and intellectual property are the best defence to counter any volatility in the healthcare sector driven by drug pricing concern. We focus on companies with the ability to extend patent life, improve cancer detection, those offering novel, differentiated treatments, and those expanding the availability of difficult-to-manufacture new formulations. 

In energy transition, we also prefer firms with idiosyncratic, company-specific drivers, rather than those relying on external developments or government incentives. Hence, whatever political zigzags the US election may bring, we attempt to steer clear of the names that may be unduly swayed (positively or negatively) by the political winds. 

Last but not least, when it comes to protectionism and trade restrictions, while we are cognisant of government actions that may be detrimental (or favourable) to individual sectors or companies, we focus much more on fundamentals and valuation. Our large overweight position in China/Hong Kong names focuses primarily in out-of-the-money cheap, high-yielding convertibles with very limited equity sensitivity, and issued by domestic consumption businesses – dominant in, for example, food and parcel delivery – along with hotels and real estate businesses. 

Globally, politics turns and turns but it does not make the (investment) world go round. At its core, the key to generating consistent investment performance in our view, is a steadfast focus on fundamentals, valuations, risk management and diversification – whatever the prevailing political backdrop. 

¹⁹ Source: Bank of America Global Research, Data as of 25 March 2024 
²⁰ We talked about maturity walls in the Q4 2023 Quarterly Equities and Multi Asset Outlook – Landing in the dark, in our section entitled: Soft, hard or no landing, debt falls due
²¹ We discussed AI in the Q3 2023 Equities and Multi Asset Outlook – Beyond Nvidia, in our section entitled: Expect a wave of AI-related issuance, but beware the lagging productivity boost
²² Source: LSEG DataStream, April 2024. Monthly return data through 29 March 2024. The Global Focus Sub-Index is an index derived from the Global Index using Regional Market Capitalisation, Percentage Price, and Premium criteria.

Political known unknowns are of course not all created equal, and for 2024 the obvious elephant in the room is the US election in November which we fully expect to dominate headlines from the summer onwards at the latest.

As investors, one of the most interesting features is that – despite the two candidates having very little in common in terms of political platforms – Biden and Trump both seem inclined to keep the US on a path of fiscal largesse and elevated debt issuance.

This is all the more relevant as – while there are no apparent challengers to the US dollar status as the international reserve currency, which is granting the US its exorbitant privilege to enjoy lower debt service costs than it would have to incur otherwise – markets are increasingly asking questions about the sustainability of its fiscal trajectory.

Until now, data shows no clear relationship between public debt levels and yields on US treasuries over the long run:

Nonetheless, we have entered a markedly-different environment after the historic fiscal and monetary policy response to COVID, with interest rates having conclusively exited the c.40 year downward trend that started with the Volcker-led Federal Reserve interest rate hike peak of 20% in 1981.

While this change, in our opinion, demands increased vigilance and creates potential vulnerabilities for the US debt profile – a theme which markets already explored in 2023 as US 10-year yields briefly touched 5% – any meaningful impact to the attractiveness of US treasuries is likely to potentially only play out over the long run, or it would at least require a large and US-focused shock to push investors away from the ultimate safe haven.

On balance we remain constructive on US treasuries. We also think that 2024 might bring about potentially more conducive conditions for short-term spikes in US yields – and likely therefore in other government bonds as well – which could present us with investment opportunities to purchase these assets and increase our holdings at potentially attractive levels. Indeed, we maintain conviction that US treasuries should still provide portfolio insurance in most scenarios, despite the potential for politics-led volatility in the US.

As usual, we expect that keeping things in perspective and exercising judgement will once again be key to successfully manage our portfolios through periods of high volatility.

²³ Source: LSEG DataStream. All returns in US dollar terms through 29 March 2024.