The outlook for global equity markets in 2024 and 2025 is bullish. Lower inflation, falling interest rates and economic recoveries are expected to buoy equity markets higher. Artificial Intelligence (AI) should add to the strong performance via its benefits to higher productivity and lower inflation. Markets first need to navigate the dual perils of potential recession, however brief and mild, and continued anxiety over persistent inflation. Monetary policy tightening has a lagged impact on economic activity. A good portion of the interest rate tightening cycle has not yet filtered through the economy. Many analysts believe a recession is inevitable, although they also feel that it will be shallow and short-lived. Many analysts also believe that inflation will remain sticky, that the final push to 2% central bank targets will remain elusive. There is a good chance that global equity markets will consolidate before commencing their bull market in 2024. Rising bond yields may well be the catalyst for the consolidation. The US 10-year Treasury bond yield has surged over the past month from 3.95% to 4.18%, threatening to break above its October 2022 levels.

As well as placing downward pressure on the pricing of global assets, rising Treasury bond yields also sap global liquidity. Global liquidity is crucial to keeping financial markets buoyant. It may be wise to raise some cash in global portfolios as a precaution against potential short- to medium turbulence in global markets that would arise from further increases in bond yields.

The UK equity market is a likely candidate for raising precautionary cash in global portfolios. The UK market is admittedly cheap and enjoys high dividend yields, but over the near-term is riskier than most. UK households have not deleveraged or mended their balance sheets in the same way the US and Eurozone have done since the 2008/09 Global Financial Crisis. Moreover, its residential property market has risen to bubble proportions and in danger of protracted decline due to the sharp rise in mortgage interest rates. In the second quarter (Q2) Buy-to-Let mortgages in early arrears increased at an astonishing 41% quarter-on-quarter. The bulk of homeowners are still at fixed mortgages of below 3% but they will increasingly need to refinance at higher mortgage rates, so the number of arrears will likely accelerate and dampen home prices.

The UK economy is heading towards recession. The composite purchasing managers’ index (PMI) has dropped below the key 50 threshold into contractionary territory, from 50.8 in July to 47.9 in August its lowest since January 2021. According to independent research firm Capital Economics, this is consistent with a GDP contraction of 0.5% quarter-on-quarter in Q3. Companies cited “a reluctance to spend among clients in the wake of higher interest rates and stretched disposable household incomes.” The manufacturing sector PMI fell from an already depressed 45.3 to 42.5 its lowest since May 2020 at the outbreak of Covid. The previously resilient service sector PMI fell from 51.5 to 48.7.

Unlike the US, where inflation has decelerated sharply, cost pressures remain worryingly elevated. UK core CPI, excluding food and energy prices, remained unchanged in July at 6.9% year-on-year and rose 0.5% month-on-month. High wages are one of the main culprits and they unexpectedly increased in July to a year-on-year rate of 7.8%. Due largely to rising wage pressure, services inflation accelerated from 7.2% to 7.4% on the year. UK inflation is outpacing all other G7 economies. Meanwhile, UK wholesale gas prices have surged, adding to the Bank of England’s headache. The UK natural gas price is up by over 70% since mid-July.

Despite prospects of imminent recession, the Bank of England is not yet done with hiking interest rates. It hiked by an additional 25 basis points in early August from 5.0% to 5.25% but a further 25 basis points is expected in September. An additional hike may be required after that due to domestically driven inflationary pressures, and unlike the US and Eurozone which will be well on their way to cutting interest rates in 2024, the UK may be left stranded with higher rates for much of next year. As a result, household spending, which accounts for two-thirds of UK GDP, will remain subdued. As it is, retail sales fell in July by 1.2% month-on-month and were still 1.8% below their February 2020 pre-pandemic level.

Independent research firm MRB Partners cautions “The UK may be the most extreme case of wage gains and sticky core inflation in the DM (Developed Market) world. The danger is that a self-reinforcing inflation feedback loop develops. … The UK has the greatest risk in the DM of becoming mired in stagflation, with weak growth and elevated inflation.” Wages and core inflation are rising concurrently with growing unemployment. UK core inflation is double that of the US, due to its more extreme labour shortage and yet in Q2 UK GDP was still 0.2% smaller than pre-Covid levels while in the US, GDP was 6.2% above the pre-pandemic level.

Edinburgh Investment Trust Plc (EDIN), one of the largest and most liquid investment companies in the UK “growth and income” peer group, has performed well since being added in November 2020 to Overberg Asset Management’s client portfolios. The share benefited from the strong 2020/21 equity market rally and has outshone its peers. In the latest financial results for the year to end March 2023, EDIN increased its net asset value (NAV) per share by a solid 7.9% exceeding the FTSE All-Share Index return of 2.9%. Since the end of March 2020, when the current managers Liontrust took over, NAV has increased 68.1% compared with 46.7% from the FTSE All-Share Index. While EDIN has contributed to clients’ portfolios over the past 2-3 years, there are currently better prospects available in global markets and the share provides a good source of precautionary cash to help de-risk portfolios.