Investment Perspectives

Reasons to be optimistic on the global economy

December 2024

It’s been a good 12 months for investors

Before looking towards the future, it’s worthwhile to quickly recap the recent past. With so many significant geopolitical issues and events in the front of minds this year, it would be easy to overlook the fact that investment returns have been strong relative to history. Returns have been driven by equities mostly, and especially by U.S. listed equities. Whilst weak in comparison, bonds have generally delivered above-inflation returns also, at least on a full 1-year basis, though some areas of the bond market are slightly negative in the year-to-date given recent declines.

Within equity markets, the concentration of returns from a handful of mega-cap stocks does raise some concerns. Indeed, it has been raising concerns among investors for the past few years. Yet, the likes of US-listed semiconductor manufacturer NVIDIA Corp. have been defying those concerns regularly by delivering incredible year-on-year sales and earnings growth. Just last week, NVIDIA announced results for the fiscal third quarter stating revenue growth of 94% to $35.1 billion.^[1]

More recently though, equity markets are showing signs of a healthy broadening to other stocks and sectors. For example, since the start of the second half of 2024, an equal-weighted portfolio of all the constituents of the US S&P 500 index has delivered returns similar to that of the famous (if not infamous) “Magnificent 7”^[2].

So, what comes next? As ever, there are risks lurking in dark corners if not in plain sight. However, the global economy continues to grow, some weaker areas are showing signs of stabilisation, and all sorts of technological progress continue at pace. There is also good reason to believe human spirits are rebounding with further to go in the year ahead.

Consumers and businesses appear to be overly pessimistic

Considering human spirits, the past few years have undoubtedly been challenging for consumers and businesses alike. As the global pandemic wound down in 2022, inflation took off like a rocket, sending the prices of everyday goods much higher and compelling central banks to raise interest rates aggressively. Higher rates had various consequences, but one predictable effect was to cool those aspects of the economy that depend on financing, such as home purchases. Persons with variable rate mortgages and other debts saw their disposable incomes shrink even further.

Despite improvements in the economy, many individuals’ perceptions of things like employment, inflation, and their own financial security remain negatively influenced by the difficult period they’ve endured. Of course, the circumstances from one individual to the next can vary considerably, and generalisations can at times be unhelpful if not harmful.  Nonetheless, surveys of the general population suggest there remains an overall pessimism about the state of the economy that is more negative than we might expect given the prevailing economic facts.

More specifically, measures of consumer confidence are still toward the lower end of historical levels, despite having improved since the extreme lows of the Covid-pandemic. This is true of US consumers^[3] – an important driver of the global economy, and it’s true of UK consumers, who play an important role in the UK’s economy.

Similarly, surveys of businesses, particularly in the US, have been signalling uncertainty and negativity for the past several months. This is despite continued economic growth. In October, the US reported that third quarter Real Gross Domestic Product (GDP) grew at a 2.8% annualised rate – well above the 2.2% average over the last 20 years.^[4]

This gap between perception and facts presents room for optimism about the economy going forward. Should consumer and business sentiment merely begin to close this gap (e.g., revert to the mean), economic activity may accelerate or at least have much further to run.
 

All else equal, their sentiment should rebound

Sentiment is an inherently comparative thing. It is an evaluation of the “before” and “after” states relative to each other. Moreover, the degree of change in states and its perceived implications for the future influence the intensity of sentiment.

With that in mind, and thinking about the degree of changes within the economy over the past 5 years – e.g., incredible swings to employment during the pandemic^[5], once-in-a-generation-high rates of inflation, and a rapid rise in interest rates from a starting place of close to zero – it’s unsurprising that sentiments over economic matters have been extreme.

For the past several months, however, economic conditions have been relatively stable, and so there is less change to drive a continuation of negative sentiment. Even if economies were to make zero progress from where we are today, sentiment should improve off the current negative levels.
 

Changing circumstances may drive further improvements to growth

Fortunately, we need not rely on the simple passing of time. There are important contextual factors and changes that should serve as catalysts to drive further improvements to the sentiment of consumers and businesses.

Firstly, 2024 has been the biggest year of elections in history^[6], at least in terms of the number of voters globally. Votes have taken place in over 60 countries in addition to the European Union as a whole. This matters economically not least because elections create an environment of perceived uncertainty about the future. One economic consequence is that people delay making long-term plans and decisions, including significant purchases and investments.

What’s worse, election campaigns are often nasty affairs. The challengers constantly remind anyone who’ll listen how miserable they should feel due to the failings of the incumbent government. Meanwhile, the incumbents warn of an apocalypse should the challengers gain control. And so again, in the biggest election year in history, it’s unsurprising that sentiment should be negative.

Fortunately, the elections of 2024 are coming to an end. Mind you, the uncertainty doesn’t end on election day; there is a settling-in period for most any new government, with budgets and policies to be announced and then digested. Still, as the adage goes, “this too shall pass”, and with it some of the lingering negative sentiment.

A second catalyst for improvement is the fact that real wages (i.e., wages after discounting for the negative impact of inflation) have been growing again.^[7] This has been the case for the past several quarters in the US, the UK, and other developed economies, resulting in improved consumer spending power. It’s also true that people don’t fully realise it’s happening. They still see prices in the shops and elsewhere remaining much higher than what they remember from four or five years ago. But modest rises in nominal prices matter less in the long run if one’s earnings can more than cover them, and so this memory of reduced spending power shall come to pass also.

A third catalyst is the fact that interest rates have started to fall again. The European Central Bank (ECB) got things started with a rate cut in June, the Bank of England (BoE) made its first cut in August, and the US Federal Reserve (Fed) made a bigger cut in September. The ECB and BoE have both made additional cuts since then, and all three central banks are likely to make further cuts over the next 12 months.

It’s true that financial markets continue to oscillate over the outlook for inflation and the pace of further interest rate cuts. Still, rates have undeniably come down, and that’s an important signal to consumers and businesses alike. It should lead, however marginally, to increased economic activity. The marginal prospective home buyer will return to the market, the marginal commercial property deal will receive financing and be completed, and the marginal manufacturer will invest in productivity-boosting plant and equipment.

As the elections pass, as spending power recovers, and as interest rates decline, the sentiment of consumers and businesses should begin to improve, leading to an increased demand in goods and services – i.e., real economic growth.
 

Economic growth can drive growth in corporate earnings

It’s worth considering why any of that should matter to investors. In the endless onslaught of economic data and news flow, it can be easy to lose sight of the “why”.

At its most basic, every investor is looking for a steady if not growing return on their investment. When investing in the stock of a company, you’re buying a share of that company’s earnings (and taking equity risk). When lending a company money by buying its bonds, you’re expecting to receive interest but also a margin that compensates for taking the risk the company never repays (thus credit risk).

When assessing these and other risks, there is no one best divining rod for an investor to follow. Instead, we’re left to triangulate amongst a litany of factors and changing contexts. But, all else equal, as economic activity grows so do corporate earnings, and with it your returns on investments in equities and credits.

It may come as a disappointment to end by noting that the link between earnings growth and stock market returns appears to be weak, statistically. However, it does appear to be useful when earnings are at their worst. One study of US equity returns versus earnings growth shows that stock returns were on average negative only during the 10% worst earnings growth outcomes.

And so a long-term investor might conclude it important to avoid stocks only if they’re sure a severe earnings recession is about to unfold. Otherwise, hang tight. For the reasons discussed earlier and more, we’re not expecting a severe earnings recession and remain fully invested in equities for all relevant client mandates.

Thank you for reading and don’t hesitate to reach out with any questions, thoughts or feedback.

An afterword on the end of the CIO Blog
As a separate practical matter, regular readers may notice that we’ve filed this writing under “Investment perspectives”. Over the past year, we’ve continued to release several investment publications and thought pieces, as we do in any given year, yet very few have appeared under the guise of the “CIO Blog”. It’s our feeling that the term “blog” should be retired.^[8] Short of a catchier name, we’ll instead use “Investment perspectives” and aim to provide exactly what it says on the tin.

^[1] See nvidianews.nvidia.com/news/nvidia-announces-financial-results-for-third-quarter-fiscal-2025.

^[2] See edition.cnn.com/cnn-underscored/money/magnificent-7-stocks.

^[3] University of Michigan, University of Michigan: Consumer Sentiment [UMCSENT], retrieved from FRED, Federal Reserve Bank of St. Louis, November 23, 2024. See fred.stlouisfed.org/series/UMCSENT.

^[4] U.S. Bureau of Economic Analysis, Real Gross Domestic Product [GDPC1], retrieved from FRED, Federal Reserve Bank of St. Louis, November 23, 2024. See fred.stlouisfed.org/graph/.

^[5] U.S. Bureau of Labor Statistics, All Employees, Total Nonfarm [PAYEMS], retrieved from FRED, Federal Reserve Bank of St. Louis, November 23, 2024. See fred.stlouisfed.org/graph/.

^[6] See time.com/6550920/world-elections-2024/

^[7] U.S. Bureau of Labor Statistics, Average Hourly Earnings of All Employees, Total Private [CES0500000003], and Consumer Price Index for All Urban Consumers: All Items in U.S. City Average [CPIAUCSL], retrieved from FRED, Federal Reserve Bank of St. Louis, November 23, 2024. See fred.stlouisfed.org/graph/.

^[8] “Blog” is short for “weblog”. See https://www.etymonline.com/word/blog

Important Information

This document is a marketing communication provided for information purposes and is not investment advice or a recommendation. It is not intended for distribution in or into the United States of America nor directly or indirectly to any U.S. person.

Limitation

Information in this document is believed to be reliable but SG Kleinwort Hambros Bank Limited does not guarantee its completeness or accuracy and it should not be relied on or acted upon without further verification.

Marketing Opt Out

If you do not wish to receive this document in the future, please let your Private Banker know or call us on +44 (0)20 7597 3000. Telephone calls may be monitored or recorded.

Legal and Regulatory Information

This document is issued by SG Kleinwort Hambros Bank Limited which is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority in the UK. The company is incorporated in England & Wales under number 964058 with registered office at One Bank Street, Canary Wharf, London E14 4SG. Services provided by non-UK branches of SG Kleinwort Hambros Bank Limited will be subject to the applicable local regulatory regime, which will differ in some or all respects from that of the UK. Please see the Information Documents on our website for further information: www.kleinworthambros.com/en/important-information.

Group Information

Further information on SG Kleinwort Hambros Bank Limited and its branches including additional legal and regulatory details can be found at: www.kleinworthambros.com.

SG Kleinwort Hambros Bank Limited is part of the wealth management arm of the Societe Generale Group, Societe Generale Private Banking. Societe Generale is a French bank authorised in France by the Autorité de Contrôle Prudentiel et de Résolution, located at 61, rue Taitbout, 75436 Paris Cedex 09, and under the prudential supervision of the European Central Bank ('ECB'). It is also authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority.

CA274/Nov/2024