Markets have short memories on interest rates and nervous traders

In February, Warren Buffett released his annual letter to Berkshire Hathaway shareholders. The core message remained his enduring faith in the American economy, as he toasted “the American tailwind”.

And what a tailwind it has proved, as the US has continually surpassed expectations. A year ago, the world was counting down to a recession that never materialised, but this March’s employment report showed a further 303,000 jobs had been created, far exceeding expectations. Raising interest rates is designed to reduce people’s ability to spend by pushing up borrowing costs, but the US consumer proved resilient. March saw more blowout retail sales numbers, and growth expectations were upgraded yet further. The US dollar has strengthened, and Buffett’s faith in American exceptionalism seems well supported.

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Stronger growth has consequences. Concern that 2024 might herald recessions was matched with hopes that central banks might lower interest rates and offer respite for borrowers. This would propel stock markets’ valuations higher, as yields available elsewhere were relatively lower. With each growth upgrade, traders pushed back their bets for cuts, and, as the quarter progressed, US inflation accelerated – this may merely represent a bump in the road to interest rate easing, but we will be watching the data closely.

Many assumed that higher rates would weigh heaviest on the biggest growth stocks’ valuations. This includes the so-called “magnificent seven” of tech stocks, which dominated headlines in 2023. But as inflation and bond yields crept higher, many smaller companies’ shares struggled. While the profitability of the largest technology companies has allowed them to hoard colossal amounts of cash, smaller companies are more likely to carry debt, and the higher cost of borrowing continues to trouble them. We should not rule out those seven leading growth companies becoming even more magnificent yet.

Optimism also returned to the UK as it emerged from a shallow recession last year. Further positive surprises seem possible and wage growth remains strong. Elsewhere, the Chinese economy, mired in property debt and threatened by deflation, may have turned a corner towards stronger growth, while India continues to power ahead.

Markets have very short memories regarding interest rates and nervous traders, eager for rate cuts, should be careful what they wish for, especially if rates are cut to counter anaemic growth. Our view is that strong growth should be celebrated.

Market reaction to the October 7 attacks in Israel seemed muted, with oil prices far below levels seen after Russia’s invasion of Ukraine, although the recent escalation between Iran and Israel means we cannot discount a scenario where fears of further disruption cause oil to rally. In such a scenario, central banks would be left with the unenviable task of taming resurgent oil-induced inflation. Higher interest rates may prove ineffective in curbing spending: how many consumers have the luxury of paying their mortgage or putting fuel in the car?

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This is a landmark year for democracy globally. In the US, Donald Trump enjoys poll leads in key states while in the UK, a change of government seems probable, although its character remains unclear. The current Opposition’s policies are far less radical than at recent elections. However, the implications for individuals’ finances warrant further discussion.

We aim to be conscientious stewards of clients’ capital, and many of the businesses we invest in remain stable through political changes, market cycles, and conflicts. This year should be a year of normalisation, despite what the speed of the news flow would have us believe. As ever, staying invested for the long term is our preferred position.

Alan Colquhoun is director at Julius Baer International.