Inflation is moderating, and market expectations are building for the US Federal Reserve (Fed), European Central Bank and Bank of England to all cut interest rates in June. Should deposit rates continue to come down, cash will become less attractive, while, at the same time, a falling interest rate environment has typically been supportive of both bonds and equities.
Remi Olu-Pitan, head of multi-asset growth and income, Roberta Barr, head of value ESG and fund manager, Equity Value, and head of strategic research, Duncan Lamont, discuss how investors should respond to the changing investment environment.
How have bonds and equities performed in past rate-cutting cycles?
Duncan Lamont: On average, the stock market does very well once the Fed starts to cut interest rates. The average return above inflation 12 months after rate cuts begin is 11%. Government bonds outperformed by 5% and corporate bonds by 6%, versus a 2% real (inflation-adjusted) return from cash. So, investing in the stock market and bonds has produced pretty good real returns, handsomely beating cash in the process.
Remi Olu-Pitan: The concern of a lot of investors is that the market has already priced in the expected interest rate cuts, with the S&P 500 up 23% since October.* While the market has recovered from what was a very challenging 2022, the idea of equities still doing very well post-cuts is very important. When the cuts happen, that opportunity cost of finding places to move into really takes over.
How should we look at markets outside the US?
Roberta Barr: Beneath the massive outperformance of the S&P 500, you have a lot of companies in normal cyclical troughs on huge valuation discounts. There’s the saying that it’s always “darkest before the dawn” and, as a value investor, we are beginning to see some amazing opportunities. There are quite high quality, cash-generative, pretty robust businesses, which you’re getting at a real discount today.
Remi Olu-Pitan: Some clear macro and secular trends have driven the outperformance of the US relative to other markets, the large representation of technology stocks and the emergence of AI are key reasons for this and this theme will continue to support performance. However, this year, markets in Taiwan and Korea are doing just as well because of the high representation of technology and semiconductors, which links them to AI. That link is important and something investors can’t ignore. It is getting expensive, but the trend is significant.
Outside of the US, the floor for inflation is likely to be much higher than what we’re used to, which tends to be quite good for the industrials, the companies focused on activity and trade. This supports Europe and is one of the reasons why Europe is coming back, despite all the pessimism around European growth. This trend supports Japan, so I think we need to focus on the secular trends and identify the companies that are linked to them.
Markets at all-time highs – a red flag?
Duncan Lamont: It feels uncomfortable to invest with the S&P 500 hitting all-time highs. Intuition says returns are higher when the markets are cheaper, but it’s wrong, based on my analysis of the historical data. Over the long term, the market goes up, which means it is hitting all-time highs on a regular basis. So, while it feels hard, you would have done better if you’d invested when the market was high than if you hadn’t.
If you had sat in cash whenever the US stock market was at an all-time high, waiting for it to fall back before investing, it would have destroyed 90% of your wealth (over the entire nearly 100-year study period going back to 1926). Over 10 years, such a strategy would have destroyed about a quarter of your wealth, over 20 years about a third of your wealth, over 30 years it would have destroyed about 50%.
Roberta Barr: All-time highs, as a value investor, mean all-time opportunities given everything else which is going on in a market. Investing in markets in general is a great idea and investing in a balanced and diversified way is an even better idea.
In summary
Remi Olu-Pitan: Over the next few months the cash rate is coming down and, so, to achieve a higher rate of return, it is time to put cash to work. While equities might seem quite scary given the current levels, just looking outside of the US or under the surface is key, as well as investing in other asset classes, including corporate bonds, commodities, and real assets.
Roberta Barr: Sometimes it might feel like cash is the safe, sensible option, but it’s value destructive. If you’ve got a long-time horizon, history suggests you’ll do well by investing in the markets. Within that, diversify and add a bit of value.
Duncan Lamont: If you’re sitting in cash waiting for the perfect time to invest you could be waiting forever. It will always feel uncomfortable. Any knee-jerk reaction to go all in or all out of the market is risky, to think you can call those tops and bottoms.
A more systematic way of investing will lead to better long-term returns over time.
*Total return of S&P 500 between close on Friday 29 September 2023 and 20 March 2024, LSEG Datastream, Schroders.
