Market commentary: 1st October to 31st December 2024

In the outstanding 2019 mini-series, Chernobyl, one of the final scenes is played out in the trial of the plant managers held responsible for the explosion. The scientist Valery Legasov outlines how an RMBK reactor (those in use at Chernobyl) achieves balance between two competing forces; the nuclear reactivity of the fuel once the process is initiated, and the graphite rods and water used to control the energy released from the fuel. If you do not moderate nuclear fission it never stops rising until the fuel is spent. If you reduce the reactivity too much then it becomes unstable. In an RMBK reactor the management of this process involved a nearly continuous adjustment of several parameters every minute to maintain this balance. 

The fluctuation in reactivity produces side effects, some of which are helpful in maintaining the balance: for example when fuel rods get hotter they become less reactive. However, other effects are catalysts, and amplify the speed of the change in reactivity. An example of this is that reactivity in an RMBK reactor turns water into steam and the more steam there is, the higher the reactivity – a vicious cycle. 

As Legasov explains it “So, fuel increases reactivity. Control rods and water reduce it. Steam increases it, and the rise in temperature reduces it. This is the invisible dance that powers entire cities without smoke or flame”. 

One of the key determinants for investors in 2025 involves a similar invisible dance. This time the competing forces are inflation and interest rates. In simple terms, economists believe that inflation is deemed acceptable/beneficial at moderate, controlled levels. If inflation is “too low” then the economy is failing to grow and there are other negative effects. If inflation is “too high“ then the value of people’s income and assets erode rapidly, which is also a negative. To control inflation when it is rising, interest rates are raised. This reduces economic activity and subdues inflation allowing interest rates to fall. This is the adjustment, the visible dance, that central banks in developed economies undertake to achieve the right balance. 

Over the last five years, the focus of central banks has been easy to identify. The COVID lockdown both caused and revealed inflationary pressures. Some inflation was caused by supply chain disruption and shifting demand from the lockdown. Some inflation was caused by factors unrelated to the lockdown – no growth in silicon chip supply since 2016, for example. The lockdown simply revealed these effects. 

The impact was clear: inflation fell to zero as the economy contracted during lockdown and then spiked when the lockdown was lifted. In the UK inflation was at over 8% for nearly two years between 2022 and 2024 [source: Office for National Statistics]. Central banks were remedially slow to recognise the inflation threat and it got away from them. In the UK, the first rise in interest rates was in the Autumn of 2021 when inflation was already at 5% and rising strongly [source: Bank of England, ONS]. A similar pattern was visible in the US and Europe; central bankers had dropped the ball. 

Interest rates rose eventually to 5% in the UK and inflation subsided to close to the “acceptable” target level of 2% [UK inflation 2.6% in November 2024, source ONS]. 

Now we have nuance. Central banks would like to reduce interest rates but do not wish to unleash inflation, having got it so wrong recently. We had a small reduction in the UK interest rates in August 2024, when a knife-edge vote in the Monetary Policy Committee (the body that controls UK interest rates) selected to reduce them from 5.25% to 5%, and then made a further 0.25% cut to leave us at 4.75% at the end of 2024. Despite inflation being close to target, there were lingering concerns over inflation levels in services which stayed the hand of further interest rate cuts.

In the globally dominant US (influentially), the same pattern was played out: inflation moderating leading to modest interest rate cuts from recent highs. 

It appears we have balance. However, there were non-economic factors that could have been influential in affecting this balance in 2024, most notably the US election. 

As a general rule, elections are much less influential on long term markets than the headlines would suggest. 2024 had the potential to be more influential for two reasons: the growing distance and enmity between the Democrat and Republican parties, and the potential for dispute and unrest over the election result in what appeared a close race. Ignoring any political preference, it is clear that a slender Kamala Harris victory would have been an unsettling result. It may not have been widely accepted due to Republican concerns (justified or otherwise) over voting “irregularities” and bad things happen very quickly when election results are disputed. A less unsettling result would have been a narrow Trump victory if only because it would have reduced this potential disruption. As it happens, we saw a, mostly unexpected, clear and decisive Trump victory, whereby he won the popular vote (more votes than his opponent – something no Republican had achieved since 2004), and control of both houses of congress. Trump’s victory fell short of a landslide but it gave a clear mandate to him personally and to his political platform which we can simplify as: pro-US, pro-business, anti-government, anti-internationalism. 

Even accepting the (sometimes cavernous) distance between his words and actions, his manifesto is radical and he has agency and power. There are considerable risks in a willingness to part with convention and to be forcefully anti-government and pro-business, and there are global ramifications of major policy changes to tariffs, foreign policy and taxes. Trump is not a long-term thinker and this is his second and final term. He will run fast and break things. However, his Presidency will unleash some of the “animal spirits” that drive economic growth. Businesses, investors and markets are likely to thrive, at least for now. We have been pivoting our focus towards the US for some time now and, especially after the terrible anti-growth, anti-wealth UK budget, this will both persist and extend. 

As an aside: in 2024 almost every incumbent government that faced an election lost. The dissatisfaction with the electoral status quo was comprehensive. Globally there has been a shift away from centre left governments and policies, with the UK being a stark exception where hatred for the repeated competency issues of the Conservative party led to their evisceration.  

The US yield curve – the interest rates of US treasuries over time – reveals a decisive change in investor sentiment over the course of 2024. For many years the yield curve has been negative – that is, investors receive a higher interest rate for lending money to the US government for short periods than they do for longer periods. This is a strange situation as normally lending money for longer periods requires a higher yield to compensate you for the additional risk. It has been this way because negative yield curves suggest that economic growth is slowing or in reverse – the implication is that interest rates will fall in the future because of weak economic growth. Over the course of 2024, the yield from short duration treasuries has reduced, from 5.4% to 4.3%, and the yield from long duration treasuries has risen from 4.4% to 4.5% [source: Bloomberg, SORBUS]. Yield curves have gone from negative to positive (interest rates higher in the long term than the short term), suggesting stronger long term economic growth. We believe this is an appropriate response to the circumstances, politics and data, and we have been incorporating this into our investment portfolios accordingly. 

At some point, the unending growth in global private and government debt is likely to have consequences. It does not appear that this will be soon. The geo-political issues in Ukraine, Syria, and Israel, while proving intractable, are not showing a propensity for escalation. Interest rates have been normalised after the near zero levels we experienced since the global financial crisis. This leads to better functioning capital markets and less warping and distortion from “free” capital. It also allows for central banks to intervene positively if economic growth disappoints or unemployment grows etc. 

Overall, this means that investors received solidly positive returns from risk assets in 2024 and there is a reasonable probability this trend will persist in 2025. 

The dispersion of the returns may change. Investment returns in 2023 were highly concentrated on the performance of a small number of companies – what was referred to as the ‘Magnificent Seven’: (Amazon, Apple, Tesla, Alphabet (Google), Meta (Facebook), Nvidia and Microsoft). 

This high concentration effect persisted in 2024: those same seven stocks accounted for over half the growth in the S&P500. [55.1% of S&P500 market capitalisation gain in 2024, source: S&P500, Nasdaq, Yahoo Finance]. However, the effect was moderating towards the end of the year and we expect 2025 to be far more balanced in terms of market leadership.  

We enter 2025 with optimism with the following elements in our base position: 

• Inflation is now mostly controlled, if sticky.
• Interest rates look to have peaked and should slowly decline.
• The US economy faces some headwinds but will likely lead the G7 in terms of GDP growth.
• The UK and EU may avoid recession but will struggle to grow for structural and self-imposed reasons (climate change/net zero policies driving energy costs higher, high tax/low growth policy decisions). 
• Gold and silver should continue to deliver strong returns after achieving all-time highs in 2024: they have been a good hedge against political risk and inflation. 
• Our focus on short duration sovereign debt assets has protected our clients from falling prices and we have been puritan in our approach: minimising counterparty and duration risk. The potential rewards for accepting these risks have been (and remain) insufficient to justify them.  

After a good year for investors in 2024, we believe we can make further progress in 2025.