Webinar Q4 Market outlook webinar - Falling leaves, rising prices?

(00:01): Good afternoon, everyone. Thanks for joining me today.
I'm Anthony McDonald, Head of Portfolio Management at Aegon UK. We've had an eventful year for markets, with Donald Trump becoming US President, announcing his tariff, immigration and tax cut policies. The central banks more recently, including the Federal Reserve, have been cutting interest rates and the UK has been living its own political and economic dramas as fiscal concerns have cast a long shadow over the Starmer/Reeves administration. What's next? We're into autumn, hence clearly the note in the title here to falling leaves, and over the next 30 to 40 minutes I'm going to get to grips with some of the key developments, their impact and what we think they mean for investors and markets. That's all captured in the learning opportunities, the learning objectives on your screen there now. As always, there'll be plenty of time for questions, please do use the Q&A button on your team screen to ask any questions you have, and I'll make sure there's plenty of time to answer them at the end of the presentation. There's been a lot going on this year and happy to go in any direction you'd find useful.
Importantly, we'll also share the CPD certificates in the comments section towards the end of the webinar, please do look out for that.
I always to start with a reminder of our approach to investing.
It helps frame the way we look at market events and the way I effectively present opportunities and risks to you.
Our approach is rooted in the long term, is a long term valuation based philosophy. Believing, in a nutshell, that the starting price that we pay for investments is a key determinant on the eventual medium to long term outcome from those investments, we absolutely believe and it's clearly linked to that the markets can trade expensively or cheaply versus their underlying value - and sometimes very expensively or very cheaply compared to their underlying value.
The reasons are often behavioural there.
We think about cycles of greed and fear, not wanting to miss out in bull markets and bubbles and then effectively capitulating and selling at the bottom of cycles.
And then there are also technical factors as it's easy sometimes not to pay enough attention to that.
There are lots of different participants investing in markets for lots of different reasons, short term trading hedge funds, lots of people hedging underlying economic exposures.

(03:04): We think a lot of that short term flow can help drive markets away from their medium term value and that's where we think that our disciplined focus on what we think our edge is, which is our longer-term approach underpinned by value, can absolutely add for your investors.
And the flip side of that is absolutely seeking not to destroy value through tactical trading, which we think is very easy to do and very much to be avoided.
Now, interestingly, if I turn to the next slide.
A couple of weeks ago, Deutsche Bank published their long-term asset return study, rather grandly called The Ultimate Guide to Long-term Investing.
It draws on data from 56 countries, stretching back in many cases for over 100 years, and it's just over 50 pages long.
And perhaps, as you'd expect, absolutely fascinating to a geek like me, an evaluation geek at that.
One of the most relevant findings was evidence that starting evaluations matter enormously for long-term performance.
And you can see that in this chart here, they've constructed a portfolio investing in economies with either above or below average valuations based upon those different metrics and a dividend DLP ratio and rebalancing annually.
You can see across each of those valuation metrics the better start evaluation delivered a notably better longer term outcome of the three of them given the yield P ratio and CAPE ratio, that's the Cyclicly Adjusted PE that we show you, sometimes it smooths out the earnings the normally a little bit to allow for cycles, business cycles.
We think that the CAPE ratio it has the best predictive indication, the longer term performance, but it's really clear here even on a really deep study in terms of number of countries and time taken that philosophy we have of starting valuations matter for future returns is absolutely comes through a space really.
It's absolutely in line with the way we think about investing.
Now I haven't got a slide on it, but the bond analysis in that paper was also really interesting in the first stage, I suppose it reinforced our logical view and where our research has taken us that yields are a really important indicator of long-term performance potential, especially when you think of them in the context of the economic environment.
But in a bit more detail, the evidence in the paper showed that.
Returns from bond markets have only been meaningfully positive when starting interest rates and 10 year yields have been around 4% or higher.
And that chimes interestingly with our current views.
When we think about bond markets, we're still particularly positive on gilts where interest rates are at 4% and 10 year yields are closer to 4.5%, but there are other countries where the bond yields and interest rates have come down a long way from their peaks in the aftermath of the 2022 inflation shock and where we do think there's a little less opportunity.

(06:26): And we'll talk about clearly the budget in due course and there are reasons why the UK market is a higher yielding market at this point in time, but we do think it's indicative of of opportunity in the UK and more broadly the potential for a bit of dispersion in returns between different government bond markets going forwards.
Moving on then to talk about where we are now in a bit more detail, having talked a bit about the philosophy and that longer term support for for the way we think about investing, this chart captures what might at first seem to be a bit of a dichotomy between prices, that's inflation on the left and and policy got the interest rates there on the right.
Put very simply the inflation rate in the UK and the US has been rising and you can see over 3% at or over 3% considerably above those central bank 2% targets and yet the central banks are cutting interest rates.
The UK has been gradually cutting interest rates over the course of the year.
The US paused for a lot of the year and started again in earnest during the third quarter.
That's unusual and it's notable given the 2022 inflation experience absolutely lives in all of our memories and the impact on the on the cost of living and the central bankers have been very careful.
They're very focused on inflation expectations because one of the key drivers of future inflation is inflation expectations.
And over the course of that 2022 shock, the inflation expectations didn't, they weren't de-anchored, I suppose, is the technical central bank term.
They rose a little bit, especially over the short term.
Longer term inflation expectations stayed broadly anchored, indicating trust here in institutions and the policy response.
The longer that inflation stays or if it returns to meaningfully above target, the bigger risk there is that longer term expectations start to fray.
In that context, we can understand why the Bank of England has been a little bit more hesitant in some in cutting interest.
Rates this year, the last cut they did was accompanied by a pretty hawkish commentary suggesting that they were absolutely thinking very carefully about the inflation data and words on a preset path to more rate cuts.
In that context, it's pretty interesting that the US is willing to put in a more cuts this year and the UK may be starting to look at December.
Why would that be?
They're starting to feel a bit more comfortable looking forward.
The key thing I'm putting in the in the strap line there is that labour markets are looking weaker.
The US hiring has slowed significantly over the course of the year.
Some indications that I also may be starting to pick up, but that's pretty noisy data, but we can certainly say that hiring has slowed significantly.
And we saw it yesterday that the UK data has been and it remains very weak.

(09:26): Obviously the unemployment rate hit 5%.
Further, we've had a very an unusually prolonged period now of number of employed workers payrolls falling.
Wage growth had been sticky, but it's now starting to come down, it's all pretty soft labour market data and central banks are responding to that partly because of the growth implications and if the labour market and unemployment rate really does start to to worsen, it can create a a very vicious cycle between layoffs, lack of spending, reduced demands creating more layoffs, effectively a a more recessionary cycle very quickly.
Central banks are keen to avoid that on the one hand and on the other hand, the evidence of that looser labour market would typically lead to lower wage inflation coming through, which is what we're starting to see.
And they might be less worried about those inflation rates on the left on a on a forward-looking basis.
Which is reasonably logical, probably, and we'll talk about it in due course, particularly for the UK.
But there are absolutely risks here and I'll touch on them a bit more in in in due course.
The key point is that these economies and particularly the US here are still growing at a reasonable rate.
And making policy more stimulative, lower rates here, but also the tax cuts you've seen in the US increases the risk of overheating and pushing that inflation rate up further.
It really is a delicate balancing act between.
Growth and jobs market on the one hand and the inflationary impetus that you might get from policy.
On the other hand, the UK rhetoric obviously seems more attuned to that balancing act, but in the US the combination of Trump's policies and central banks increase those risks in our view.
Now those risks absolutely are not for the here and now and this snapshot of Q3 market performance.
I know we're a bit through Q4 now, but it's it's still very relevant because it's broadly in keeping with with with with the strong equity market recovery we've seen since the those Operation Day tariffs were were famously announced in in early April, a really strong recovery from global equity markets up towards all time highs across many of these markets, which is logical.
Trade deals have been coming through.
We spoke about the US tax cuts.
Uncertainty generally has faded and that's helped boost economic sentiment from that sudden drop off it had early this year and boosted these riskier assets equity markets and you can see there's a.
Decent basis there.
Emerging markets have done particularly well, think the weaker dollars help there.

(12:26): Also the fading of some trade tensions is very directly supportive for emerging markets.
But then political events have also been an ongoing theme this year and and not just Trump.
You see Japan's had a good run and that's continued.
There's a there's a new Prime Minister, Takichi was elected and expected to try to run more stimulative policy.
On the other side in in UK and Europe, Starmer's had his issues and clearly in France, Macron is encountering a number of challenges, getting a budget through and having a stable government in the context of a fractured National Assembly.
There's a lot of political developments on all sides and I suppose the shorter term from which we can see those that are deemed more positive, favourable - Japan, those markets have done better than the than some of those European markets.
Government bonds, clearly you can see over on the side of the chart have lagged equities.
We think that's due a bit to the inflation, the investor caution on inflation, the inflation trajectory and the the space there is for central banks to sustainably cut interest rates.
We do think investors have got a little bit more comfortable there, particularly in the UK following some of that weaker data we've seen over the last last month or two and and far in the fourth quarter we've seen a decent rally in government bonds and gilts have done pretty well there.
But over the course of the year the equity recovery has been a clearer story.
Looking forwards and one of the key upcoming events is the UK budget on the 26th November.
I wouldn't say we're all waiting with bated breath to see what Rachel Reeves does, partly because it's unlikely to be particularly pleasant and partly because we've had quite a lot of indications already.
But nevertheless, against that rhetoric of fiscal black holes and the periodic concern we've seen this year from global investors about the stability of UK finances, it's an important event and I suppose I will turn to the political elements of it in due course because we've seen with the Wes Streeting coup or not coup news overnight that there are that there are absolutely a lot of potential political ramifications to play through over the coming weeks and months, but I think the economic context I'll talk to first because the economics are typically a more significant constraint as as Starmer has found out constraints on policy making than politics.

(15:34): Most of us I'm sure will know about the backdrop of the OBR downgrading its productivity estimates for medium term productivity estimates in the UK mostly based upon the fact that they did a huge piece of analysis that that that they published in the summer indicating that their previous approach to estimating productivity had proved to be too optimistic for a considerable period of time.
It's interesting that taking the decision to downgrade productivity to this point of time when the the the AI boom has the potential to be supported but it's it's it's databased and and it makes sense.
And if we combine that with the failed spending cuts from the Labour government this year, obviously the winter fuel allowance for pensioners and the welfare reforms that had to be substantially watered down, we do think that the main impact of the government's desire to meet their fiscal rules is that taxes will go up.
That's not particularly out of consensus, but it does seem very clear.
And judging from last week's breakfast speech from the Chancellor, she does seem to be pairing the country for significant policy change that might be in breach of the manifesto policy, manifesto promises, and that's where some form of income tax hike seems clearly to be at least on the table.
It'll be accompanied by other measures.
The pension system and salary sacrifice are again under scrutiny.
But it's possible that there will be on the other side of things some, not balancing factors, but some movements in the other other direction on small taxes designed to help with inflation and cost of living we're hearing about.
The potential to reduce VAT on some utility bills, measures that are quite heartening because it's clear that the Chancellor seems to be much more focused on avoiding inflationary implications from tax changes, having learnt the lesson I suppose from the move on employer National Insurance contributions earlier this year.
But what it does mean is all the indications are there'll be a challenging budget for both economic growth and individual finances.
Which will in itself be challenging, but from an investment point of view, we think it should be quite positive for gilts, the elements of maintaining fiscal discipline in a disinflationary manner should, we think, give the bank and the confidence it's previously lacked to cut interest rates down towards levels that the economy seems to need to to stay on an even keel and they might be willing to do quite quickly.
We think that that's absolutely gilt positive and whilst gilt yields are higher, notably higher than other main developed countries, the US, the eurozone, we think there's potential for that gap to close.
I'll talk about that a little bit more on the next slide.
But clearly the one factor that will remain to some degree in play is the political risk.
I don't mean at this stage of it's still there, but I think it's lessened the political risk of a budget that doesn't do these things.

(18:42): The political risk of, despite the significant majority, the Starmer administration at some stage falling, maybe a coup by a waste treating or similar succeeding given.
The unpopularity that the polling suggesting of the star administration, I don't know.
We absolutely shouldn't rule that out.
And with that comes the risk of a lurch to left which would not be received by markets.
And we are monitoring developments very closely at the moment.
We think that what looks to us to be the political premium in markets such as gilt is excessive relative to the risk for two reasons.
Firstly, we think it's likely that any such risk doesn't solidify until the elections in May, very few potential contenders, potential leadership contenders, I think we think would rather wait until those challenging elections are out of the way rather than starting with a a potentially difficult economic, political set of set of polls.
But but second also even if there is a move the fact it then moves creates alerts show left is in no way certain.
We do think there are fiscal risks, but we think the economic constraints are currently on top and we think that that will be the case for for for some months at least.
This page then talks a little bit more about those interest rate expectations I spoke about and I think we do, I do think it's it's relevant to think about the UK and the US because in absolute terms we think that UK gilt yield is is is pretty attractive just under 4.5% on the 10 year up towards.
5.2% on the long day to go that they are in our view attractive yields in a fragile economic environment at a time when, as I'll talk to you in a second, many other markets look expensive and hence the prospective return from them is most is is likely to be lower than what what we might have enjoyed in the in the recent past.
But in relative terms as we also think there's a good opportunity here and this gives some flavour to it and it's what I touched on earlier on that inflation/interest rate slide, which in the UK backdrop is one of fiscal consolidation.
There are some spending cuts already baked into the department's budgets.
We don't expect more to come through, but there's some there is a degree of fiscal consolidation coming in the next couple of years.
At the same time, we're going to see some tax hikes that also help with elements of fiscal consolidation.

(21:43): We think they will to some degree address some of the sustainability concerns investors have, especially because when we look at the debt and deficit levels of the UK, they're absolutely not at levels the other countries are suffering and that's where the US comes into play.
They're going the other way.
Taxes are being cut next year.
The deficit is likely to be over 7% we think might be up towards towards 8%, that's an extremely high deficit at any time, particularly at a time of healthy economic growth.
And we think if you combine that with some of the supply side curbs that Trump's tariff and immigration policies are bringing into play, we think that does bring quite meaningful risks of continued probably gradual rises in inflation in the US, but from a starting point which is already quite high.
The flip side is the UK where fiscal consolidation, some of the much of that inflation rate we think we're seeing this year is a one off pasture of the National Insurance contributions.
We think the UK inflation rate may already have peaked and be coming towards a downward trajectory.
If we put that together, we think there's quite a lot of space for the UK Bank of England to cut interest rates and not much for the Federal Reserve to cut interest rates in a way that proves sustainable.
And that's where this chart comes in.
What you see is the forward expectations for the market.
That shows where interest rates are expected to be next June 2026 and the the purple line is the UK.
How that's changed over the course of the summer.
If you move to the most recent reading there, the UK interest rates are expected to be around 3.5% next June.
That was up towards three, three and three quarter percent a few weeks ago.
In contrast to Greenland, UK, the US is is lower than the UK, those interest rates in the US are expected to be to be lower next June than UK interest rates.
And you can see for some time there was quite a considerable gap between those two lines.
Our contention here is that the ability of Bank of England to cut interest rates if the budget goes as we expect is considerably underestimated and probably the willingness as given some of the labour market data we're seeing come through.
Whereas we think there are, as Jerome Powell set out at the last meeting, we think there are more questions as to the direction of US policy from here and the degree to which that they're willing to keep on cutting interest rates against the the the the Trump policy backdrop.
We think this shows both the opportunity in UK gilts and and warrants a degree of caution in in US government bonds.

(24:45): We do always think about what we think about all risks, but also those that we think may be particularly relevant at any point in time.
We use them to help build relevant scenarios to shock our portfolios against.
I highlight here is that the comment there on high valuations, thinking back to our valuation based investment approach, the strong recovery in markets since April has has sent US equities and global investment grade credit in in particular to very expensive levels versus history.
The credit spreads look very extra yield you get for lending to companies of governments.
They look very, very tight versus history, not much margin for error or credit loss there.
And US equities have pushed back up towards what I would call valuations consistent with previous bubbles, and with the AI narrative behind, it's possible that at some stage we maybe even probably will look back and see that US equities did absolutely get to bubble territory.
What that means for us is we avoid some of those markets that that look to us egregiously expensive and try to focus the portfolio on those the where valuations are are less extreme.
And if possible to combine that with positions in more defensive assets that are priced, especially if they can help us address some of those sticky inflation risks that that I set out at the bottom as one of the other risks and that's particularly in the US.
That's where we are very happy holding UK gilts as what looks to us as a relatively cheap defensive asset.
US Treasuries don't look as cheap and if inflation is sticky may not be as defensive.
That's where we're thinking very carefully about the potential merits of different regions, countries, and assets in the context of both valuations and the risk environment that we're seeing.
That all comes together here in our in our current views.
This is our effectively our conviction on the main assets here.
Our conviction can range from large underweight to large overweight.
You can see is all between the underweight and overweight spectrum and and I suppose in big picture terms we're we're still focusing on balanced portfolio equities, neutral bonds a little bit overweight, that balance reflects the fact that they're going to, the current policy backdrop and economic growth backdrop is, is reasonably positive for equities and we do think we can find some cheaper equity markets you see here, particularly on the overweight side, the US and Japan that can continue to to benefit in that environment.
On the underweight cycle, I've mentioned that the US before that those bubble valuations, it does look very expensive to us and typically that would lead to lower expected future returns.

(27:59): It doesn't have to collapse, but just generally we'd expect valuations to come down over time and to get to get lower future returns from that US market, which we must remember was has enjoyed a long period of outperformance now compared to some of those cheaper markets the UK and Japan.
In bonds you see a small overweight there.
The key preference there is as I've touched on, given the economic and policy backdrop is for those gilts and the main change since the last webinar in July has been downgrading that investment grade credit from neutral to underweight and that absolutely reflects what I've just spoken about before about the really tight credit spreads, we increasingly don't feel that investors are being very paid for taking corporate credit risk and we we prefer to hold other assets and maintain the neutrality weight to hold those gilts where we think that the yields are, especially if you compare longer data gilt years to credit are comparable and come with different in our view preferable risks.
A summary, there's been a lot of political change this year.
We think that a long term valuation approach is absolutely.
We think that if anything times have changed such as political change can be a catalyst for cheaper markets to perform.
We're very focused on the UK budget in a couple of weeks’ time.
Our expectation is it'll highlight the UK's economic challenges at a time when the US policy mix comes in more inflation risk.
We think that will reinforce the opportunity in gilts where yields are high.
US Treasuries really look less attractive from a portfolio point of view, that all comes together to balanced asset allocation, but with a clear preference for the cheaper markets over those that have got to very expensive levels and where possible, we're looking to incorporate defensive strategies where they look priced to us to help mitigate downside risks at a time of continued uncertainty.
I will pause there.
Thank you everyone for your time and please do use the Q&A to submit your questions.
I'll just flick across to see them.
Oh, alright, sorry.
Some questions on screen there.
OK.
Here we go.
We've got one here.
This is a good one.
We've got one here on tariffs.
Interesting after the year we've had that you haven't mentioned tariffs and what are your views there.
And please do everyone keep keep keep sending through the questions.
That's a really good question.
We.
We absolutely think tariffs still matter.
It's clear that the market has moved on from the from the time being and we are still in the zone of trade deals coming through.

(31:01): We've seen the China, the fentanyl tariff being half the India and Swiss tariff rates may be coming down in due course and we're still on the focus of in the zone of marginal good news coming through and the likelihood is that the effective tariff rate may continue to grind down a little bit from here.
That I think has has helped the equity markets push on a little bit, but what I would say is if we step back and look at the US tariff rate compared to history, it's still orders a magnitude higher than we've been, than the world's become used to over most of the last 50 to 100 years.
We think that there is a difference between understanding the shock and noting that the additional risks around it have faded compared to understanding the economic implications of it.
And whether a strategy or a policy that broadly we haven't experienced over the last 100 years.
It's very difficult for anyone to know the economic implications.
We still think there are quite considerable risks of its impact on growth and inflation into next year.
And I'm not suggesting it's going to cause a recession, but we do think it has the potential to weigh on growth in the US and push on the inflation rate a little bit.
And that's an unhelpful mix given the environment I've already described.
The fact I haven't really mentioned it talks to the fact there's not much new news more than anything else and that they're in our view that the risks are, still are, still out there.
And probably likely to be a more of a story for for next year.
Please keep your questions coming.
We've got one more here on Japan.
Can we talk a little bit more about the the new Prime Minister and could that could that create problems with the yen and bond yields?
We think the risk of that, Takishi succeeded Ishiba as Prime Minister of Japan and is seen to bean aspect of the late Shinzo Abe's ‘Abenomics’, which was linked to a weekly yen trying to get inflation back on track and fiscal spending.
From her previous speeches, including when she was running previously for me, that idea of a looser fiscal environment was absolutely does seem absolutely to be her preference.
So far that's been taken positively, which is logical by Japanese activities that the yen is weakened, has weakened a little bit.
We think the magnitude of those responses are probably about because the political environment, which doesn't have a majority now the House and has had to run a new coalition partner, which is a little bit more wary of significant government spending and is likely to create some constraints.
We could have almost, I suppose, gold locks world where there's a little bit more focused spending to support the economy without anything that is is deemed to to be to be reckless.

(34:06): I think that's broadly what's being priced by the market at this stage and it seems a logical analysis of the current political situation.
We still think the structural reforms within Japan have not been in any way anywhere near fully rewarded by markets and that can and that can support support the equities compared to other markets.
But they have moved quite a long way since she was elected in this global rally we've seen in much of the second-half this year.
We are being focusing quite carefully on valuations at this stage to make sure they don't go beyond where we'd be comfortable.
We’ve got one question, an excellent question to finish.
Some people are looking to sell down to cash and then try to go back in when the crash happens.
Is that risky?
Yes, that's absolutely risky.
Owing the fact I've spoken about some of the risks about the inflationary environment and that doesn't typically help real returns on cash, but the idea of timing a market crash is very very difficult.
I've spoken here about the fact that US equities in valuations look to be at bubble levels.
I'm worried about some of what we're seeing in some of the parts of the market and a longer term view, but I absolutely don't think valuations are a very good timing tool.
That's why we have a medium to long term focus and I could absolutely point to some of the elements of the current environment, the policies, the healthy and resilient US economic growth as factors which have been and could continue to be in the short term equity, equity supportive and we do think there is potential to add value by tilting our clients exposures towards those asset classes, which evaluations seem to embed less risk and more return over the medium term.
But there we're thinking about the nature of the asset class as we're not trying to time a market crash.
I think we can do it and think that with any repeatability and I'd go even further and I'd say the valuation focus that leads us to prefer other markets from the US doesn't mean there necessarily has to be a crash.
The US market, it doesn't happen very often, but it's quite possible that the US market valuations gradually deflate as the as the returns are just anemic for a period of time and other markets perform much better.
There are different ways that valuations can normalise, if indeed they do, and we think that the way to think about it is to focus on those markets that have better valuations.

(37:16): That gives us and our investors a higher probability of higher longer term returns, but to do that in a way that is absolutely in keeping with both the risk profile of each portfolio and the wide range of different both short and longer term outcomes and ways in which those valuation disparities can be can unfold.
The old cliche of time in the market rather than timing the market is clearly at play here in this question and we typically think that it's, yeah, we'd never advocate anyone selling down to cash and timing a market crash.
Even the behaviour risks around that are extreme.
Thank you everyone for joining.
Thank you for your questions.
I hope you all have a really good run through to Christmas and I look forward to seeing many of you in the next webinar in January.
Thanks again.