Video transcript
Speakers
Transcript
Introduction
Tom: Hello and welcome to the Rathbones MPS and Multi-Asset webinar. My name is Tom Whitfield, Multi-asset Investment Specialist at Rathbones, and I'm joined by Fund Manager Will McIntosh-Whyte.
Today we'll discuss portfolio positioning and strategy, focusing on Kevin Warsh and recent changes at the US Federal Reserve. We'll then turn to developments in the UK following the change in government, before finishing with a discussion on the global capex supercycle and the ongoing impact of artificial intelligence on markets.
Before we begin, a quick reminder that this webinar is hosted on BrightTALK. If you have any questions, please use the button at the bottom of your screen. If we don't have time to answer them during the session, we'll follow up afterwards. A recording of this webcast will also be available after the event should you wish to share it with clients or colleagues.
Federal Reserve policy and the outlook for interest rates
Will, let's start with Kevin Warsh and the outlook for US interest rates. He's clearly putting his own stamp on the Federal Reserve. At a high level, what has changed and what could it mean for markets?
Will: I think it represents a genuine change in approach compared with Jerome Powell. Powell did an excellent job through a number of difficult market environments and economic cycles, but Warsh appears keen to move away from the forward-guidance model that has dominated recent years.
Historically, the Fed's dot plot gave markets an indication of where policymakers expected rates to be in the future. Warsh seems much more focused on being data-dependent and providing less explicit guidance. Given the number of variables influencing markets today, that's probably the right approach.
There were concerns that the new administration would appoint someone prepared to cut rates regardless of inflation concerns. However, Warsh has significant credibility and has initially adopted quite a hawkish tone by emphasising the need to keep inflation under control.
More recently, though, he has suggested that inflation may be less problematic than initially feared. Falling oil prices have helped that narrative, and our view is that rates are likely to remain unchanged for the rest of the year, with the possibility of cuts if inflation continues to moderate.
Changing the way inflation is measured
Tom: One of the more interesting developments is that he's also changing the way inflation is viewed.
Will: That's right. Traditionally the Fed has focused on measures such as PCE inflation. Warsh appears more interested in trimmed mean inflation, which removes the most extreme price moves, both positive and negative, to focus on underlying trends.
The significance is that trimmed mean inflation currently sits materially below headline CPI. That provides support for the argument that inflation is moving closer to the Fed's 2% target and reduces the urgency for further rate rises.
There are also discussions around improving the way housing costs are measured. The current owner's equivalent rent methodology can create distortions and arguably overstates housing inflation. A more modern approach could provide a more accurate picture of underlying inflation pressures.
Impact on markets and the US economy
Tom: Markets continue to hit record highs. How important is the path of interest rates to sustaining that momentum?
Will: Historically, once US Treasury yields move significantly above 5%, equity markets tend to struggle because borrowing costs become restrictive. We're not there today, but higher rates would likely narrow market leadership and favour a small group of companies capable of delivering growth regardless of the economic backdrop.
Lower rates, by contrast, support broader economic activity, housing and consumer spending, allowing gains to spread more widely across the market.
The encouraging point is that the US economy remains relatively healthy. Employment growth has softened but remains solid overall. Consumer balance sheets remain in good shape and recent earnings from major US banks suggest household finances continue to be resilient.
US banks and the dollar
Tom: US banks have reported strong results recently, and we hold exposure in portfolios.
Will: Morgan Stanley remains a long-standing holding and continues to benefit from growth within its wealth management business. Goldman Sachs has also delivered strong results, supported by active capital markets, IPOs and deal activity.
As for the US dollar, Warsh's credibility has arguably helped stabilise sentiment. Investors were concerned about policy becoming overly political, but his approach has reassured markets that inflation remains a priority.
New UK government and fiscal challenges
Tom: Turning to the UK, we have a new Prime Minister and significant cabinet changes. From an investor's perspective, what does this mean?
Will: The new government faces a difficult balancing act. Bond markets reacted quickly to suggestions of greater fiscal flexibility, highlighting how sensitive investors remain following recent political volatility.
The key challenge is that government spending ambitions must be funded while remaining within fiscal rules. Markets will closely scrutinise any attempt to use accounting techniques or off-balance-sheet financing to achieve that.
The biggest potential support for the government would be lower inflation. If energy prices fall and borrowing costs decline, fiscal pressures ease significantly. If inflation remains elevated, difficult spending decisions become unavoidable.
UK gilts and portfolio positioning
Tom: We often receive questions about UK gilts. What are the attractions and risks at current levels?
Will: Ten-year gilts yielding around 5% provide a relatively attractive starting point. Investors receive an income stream that exceeds current inflation, producing a positive real yield.
The primary risk is that inflation remains stubbornly high or that fiscal discipline comes into question. In that scenario, gilt yields could move higher and sterling could weaken.
Within portfolios, we've deliberately reduced duration and focused more heavily on shorter-dated bonds, which should be less exposed to long-term fiscal concerns.
The global capex supercycle and artificial intelligence
Tom: Let's move on to the global capex supercycle. What exactly do we mean by that?
Will: It's essentially the enormous investment being made by major technology companies to build artificial intelligence infrastructure.
Since the launch of ChatGPT, companies such as Microsoft, Amazon, Alphabet, Meta and Oracle have committed unprecedented levels of capital expenditure to data centres, computing power and AI capabilities.
The scale of spending is enormous. These hyperscalers are investing hundreds of billions of dollars to ensure they have sufficient capacity to meet future AI demand. As a result, a broad ecosystem of companies involved in semiconductors, networking equipment, power systems, cooling technology and construction has benefited significantly.
Growing questions about returns on AI investment
Tom: We've also seen some volatility in technology markets recently.
Will: The key question investors are beginning to ask is whether all of this spending will ultimately generate attractive returns.
Many of these companies are reinvesting almost all of their cash flow into AI infrastructure. Some are also borrowing or raising capital to fund additional investment. Naturally, investors want to understand when this spending will translate into profits.
Demand for AI remains very strong, but there are questions around pricing, adoption rates and whether businesses can clearly demonstrate a return on investment. If spending growth slows, even modestly, it could affect parts of the market that have benefited most from the AI theme.
Portfolio resilience and risk management
Tom: One of the questions we're frequently asked is how we protect client portfolios if markets weaken.
Will: Diversification remains central to our approach. We've deliberately avoided becoming overconcentrated in areas such as semiconductors despite their strong performance.
We've also recently introduced put-option protection, which acts as insurance if equity markets decline. In addition, we've increased cash levels slightly, providing flexibility should market opportunities arise.
Alongside this, we maintain diversification through government bonds, inflation-linked securities and a range of alternative strategies designed to help portfolios remain resilient across different market environments.
Closing remarks
Tom: Thank you, Will, and thank you to everyone for listening.
If we haven't covered your question today, please get in touch or submit it via the webinar platform and we'll respond afterwards.
Thank you again for joining us, and we'll see you next time.
