When I first started writing this piece, global equity funds had been having a bit of a moment, attracting their biggest inflow in 12 weeks up to 16 June.
Digging behind the figures, the reason for this sudden excitement came back to the monetary policy lever that has been keeping us all on our toes for months now, interest rates, in this case, US interest rates.
The US Federal Reserve left rates unchanged at its June meeting, with all members of the Federal Open Markets Committee supporting the decision to keep rates at 5.25%.
The surge in flows into global equity funds was driven by a belief the US interest rate hiking cycle is now over, and that with inflation declining, rates could even start to fall before year end.
Some market watchers see the Fed decision as a pause, not a stop. In fact, global equity funds went on to suffer substantial outflows during the seven days to 21 June, amid concerns over borrowing costs staying higher for longer as the European Central Bank raised interest rates and the Federal Reserve signalled more hikes.
But if US interest rates do start to fall, “this would deliver the goldilocks outcome of a soft landing and return to low interest rates that the market demands”, says Nick Clay, manager of the TM Redwheel Global Equity Income fund.
Global returns hang on the expected pathway of US interest rates, (followed by China’s recovery as vital for particularly emerging markets and Europe).
“The hope is that growth can remain robust whilst inflation fades and thus interest rates can return to lower levels,” says Nick. “This allows for investors to return to a Pavlovian response that 15 years of quantitative easing and low interest rates has conditioned them to behave: buy high growth long duration companies – large tech – at any valuation.”
Hopes in this direction led to the rally in markets being driven by a small concentration of technology stocks. Flows into ETFs underpin the large stocks, and now the market is hoping for the rally to broaden out.
US firm Nvidia, a world leader in artificial intelligence computing, has been leading the tech stocks charge. It announced earnings upgrades of almost 75% due to demand for its AI-powering GPU processors, including the estimated 10,000 graphics processing units (GPUs) Open AI-Microsoft’s ChatGPT used for its training model.
Nvidia is the largest holding in the Rathbone Global Opportunities fund, managed by James Thomson, who says while the benchmark price for these GPUs is $25,000, “due to shortages they’re now selling on eBay for $50,000 each” and capacity constraints are “a risk to monitor over the coming months”.
Some analysts believe this is the start of a new computing era, similar to the mainframe, PC and smartphone eras of the past.
James says: “In those ecosystems, typically a single vertically integrated company has captured more than 80% of the entire market value. Nvidia has designed itself as a vertically integrated AI solution with its chips, hardware and software, giving itself the best shot to dominate this era. The early signs look good.”
Nvidia is a near-monopoly in the processors and computing used for AI training, as the cloud service providers, and eventually enterprises, trip over themselves to compete in chatbots, and other AI applications.
Despite the deserved hype, the outperformance of Nvidia’s shares took the Rathbone Global Opportunities fund holding close to its maximum limit and so Thomson trimmed some of his exposure in May as a risk management exercise.
“We want to have broad and balanced exposure to any investment theme, so we maintain holdings in Microsoft, Google, Amazon, Accenture (consulting) and Equinix (datacentres) as further plays on generative AI adoption,” he says.
Nvidia’s share price is not the only thing that has been soaring. That’s right, I’m talking about the runaway inflation that has triggered the interest rate rises we’ve been seeing in not only the US but in the eurozone and of course the UK.
“The return of inflation has wreaked havoc among global financial markets: rising bond yields have tarnished fixed income’s reputation as a safe-haven asset class, while equity markets have been battered by an abrupt reality check,” says M&G Global Dividend fund manager Stuart Rhodes.
Investors have sought refuge in dividend stocks and their typically reliable stream of steady income. Stuart argues the comfort of safety is not enough in the current environment, however.
“Investors need growth in their income streams to protect against the ravages of inflation,” he says, “we cannot emphasise the importance of dividend growth strongly enough”.
Dividend growth is exactly what Rhodes is all about, and he does it very well. The ability to provide inflation protection with a rising income stream has not been a flash in the pan for the M&G Global Dividend fund.
Since launch in 2008, the fund has increased its distribution with an average annual growth rate of 7.3%, comfortably ahead of UK CPI and RPI which have averaged at 2.9% and 4% respectively over that time.
What’s more, Stuart believes dividends and share prices go hand in hand.
“History shows that many companies with long track records of dividend growth have enjoyed strong performance in their share prices over the long run”, he says, “with the result that investors have benefited from solid total returns in capital and income growth, over time.”
One of the big stories this year is that central banks continue to surprise the markets, including the shock 0.5% hike by our very own Bank of England on 22 June, sending the UK bank rate to 5%. Global managers are doing what they can to weather the storm.
“We believe the market will remain volatile rather than simply go up in a straight line,” says Nick Clay, manager of the Redwheel Global Equity Income fund. “We are most likely returning to a normal environment, of cycles and volatility, rather than simply returning to the era of QE and no cycles.”
Darius McDermott is managing director of Chelsea Financial Services & FundCalibre. This views expressed above should not be taken as investment advice.