Economic developments

 

December 2024 saw government bond yields rising in most developed markets, predominantly in response to slightly higher-than-expected inflation prints, uncertainty about Trump’s tariff policies, questions around the sustainability of fiscal deficits and a dialling back of future expected interest rate reductions – by Clive Beagles and James Lowen

 
In the UK and the US, bond yields rose by 20-35bps at shorter durations, and in the case of the UK, the 30-year bond yield moved decisively above 5%. Inflation in the US has continued to stay resolutely above 2%, and Governor Powell’s surprising admission at the Federal Reserve’s monthly press conference, “We had a year-end projection for inflation and it’s kind of fallen apart as we’ve approached the end of the year”, added to the bond market sell-off.

In the UK, inflation ticked higher in November to 2.6% vs 2.3% in the prior month, although most of this was due to base effects.

The latest Labour report also caused nervousness in the bond market, with average weekly earnings accelerating for the first time in a year to 5.2%, although this was also predominantly due to base effects and re-statements of previous releases.

The Institute of Director’s UK economic confidence index fell further in November to its lowest level for four and a half years and clearly shows that the Labour Party’s strategy of blaming the previous administration for the state of the public finances and continually focusing on short term challenges has backfired decisively. This has also been reflected in GDP data, which has shown an economic flat-lining in terms of growth since the election despite the strong start to 2024.

A slower economy but with somewhat sticker inflation has given the Bank of England (BoE) less room to manoeuvre. In that regard, it was noteworthy that at this month’s meeting, three of the nine members of the Monetary Policy Committee (MPC) actually voted to reduce interest rates due to the broad economic softness. This suggests that the BOE is viewing the labour market data and the wage inflation statistics, in particular, with some scepticism. Markets are currently expecting the next rate cut to be in February 2025.
 

Performance

 
After a strong year, markets ended the year on a sluggish note in December – driven by the rise in bond yields noted above, which reduced the potential scale of rate cuts in 2025. The Fund performed slightly ahead of the index. The FTSE All Share index ended down -1.08%. The Fund was down -0.53%. For the year as a whole, the Fund was up 20.68% compared to the market, which was up 9.43%.

Looking at the peer group, the Fund was the second best-performing Fund within the IA UK Equity Income sector in 2024. On a longer-term basis, the Fund is ranked in the 2nd decile over three years and is ranked in the 1st decile over five years and 10 years. The Fund has remained the best in the sector since its inception in 2004.[1]

The areas of strength in the Fund were largely stock specific. Our transport stocks performed well, with EasyJet rising 5% and IAG (British Airways) up 17%. IAG saw significant upgrades following the Capital Markets Day in November, which we attended. First Group also saw a 6% increase after reporting strong results and launching a new buyback..

Despite macroeconomic challenges, several of our retail stocks performed well – Curry’s rose by 18% relative, DFS by 2% relative and Wickes by 5% relative. These companies are gaining market share due to weaknesses or failures among competitors, such as Homebase’s bankruptcy benefiting Wickes.Curry’s also reported positive results, with an upgrade in free cash flow guidance.

Takeover rumours continued to circulate around ITV (up 4% relative). Based on a sum-of-the-parts analysis, we believe any potential offer would need to be in the range of 110-130p, representing a premium of 55-80%.

The banking sector remained robust, with Standard Chartered up 4% relative and Barclays up 3% relative. Despite these gains, both banks are still trading well below their current book values.
 

These positive trends were counterbalanced by a number of weaknesses.

 
The property sector (c. 5% of the Fund) weakened as bond yields rose. Most of our exposure is in retail property, which, due to the high net initial yields at which these properties are valued, should be more insulated from bond market fluctuations. Nevertheless, most of our names were down 5% relative.

Sthree (down 15% relative) issued a profit warning due to sluggish recruitment markets. The Board initiated a £20 million share buyback, reflecting the company’s strong balance sheet.

Our brick stocks, Forterra and Ibstock, were sluggish, mirroring the performance of housebuilders, in which we have no holdings. We believe that Labour’s planning reforms and potential stimulus will boost housebuilding activity. To potentially double the share prices of both our brick stocks, we need around 200,000 new homes built annually. So even if Labour’s goal of 300,000 new homes per year is missed by a material amount, these stocks still have significant upside potential.

Zigup (formerly Redde Northgate) also performed poorly after releasing its results, which were in line / robust (down 13% relative).

Finally, Petrofac dropped approximately 20% following the announcement of a comprehensive refinancing. The in-month loss from this move was limited to around 2-3bps, as the stock had been declining throughout the year. The year-to-date net loss on the stock has also been partially offset by stock lending income, which generated about 20bps. We have also committed new funds to the refinancing (around 40bps), which is expected to be completed in February 2025.
 

Portfolio activity

 
As we mentioned last month, despite the strong performance in 2024, a key characteristic of the Fund as we enter 2025 is that most holdings are still clear Buys, with very few outright Sells. Additionally, the positive trend in Fund flow that began in November continued into December, with c. 8-9% added to the Fund over these two months.

The two stocks we continued to reduce were Shell and Anglo American. As we explained in last month’s update, both still have potential upside, but not as much as the other holdings in the Fund.

Several stocks that performed well during the month were reduced or adjusted to their target weights. Curry’s was marked to 225bps. EasyJet also fell into this category. TI Fluid Systems, where the bid approach was consummated, was reduced to fund other purchases. Additionally, we reduced our position in Mobico by a quarter after a spike in its share price driven by its entry into the FTSE 250..

The only other significant reduction was in the banking sector. In the first half of December, two stocks, Barclays and Standard Chartered, reached our maximum position size of 300bps. If these stocks increase by 5%, we must reduce our position by the same amount to maintain the 300bps limit.

We added one new stock to the Fund during the month – Sainsbury. We sold this stock six years ago at around 330p and have now repurchased it at a price approximately 15-20% lower, whilst at the same time, its fundamentals have significantly improved. At a system level, the growth of discounters has slowed, and the price positioning of Tesco and Sainsbury has improved, making them competitive with discounters (e.g. ‘Aldi price match’). There is also an increase in demand per unit of space, which is a positive, due to population growth, more people eating at home, and limited new retail space being added. Additionally, highly leveraged competitors like Asda and Morrisons are losing market share. These trends, combined with low system-wide margins, mean that most of the additional National Insurance costs will be passed on as higher prices. At a stock-specific level, Sainsbury is gaining market share, translating volume growth into operational leverage, and experiencing a step change in innovation that drives further volume growth.

There were numerous opportunities to add to existing portfolio holdings. We increased our positions in two stocks that recently issued profit warnings: Severfield, which announced a downgrade in November, and Sthree, which had a warning in December. Both stocks are now very cheap and could potentially double in value over the medium term. As mentioned in last month’s bulletin, we believe Severfield should undergo a strategic review to focus on realizing the value in its equity.

We also increased our holdings in Centrica following a Capital Markets event that highlighted two of its businesses – one that is misunderstood (the energy trading division) and another that is a growth driver (smart meters). Aviva’s stock slightly weakened after it agreed to acquire Direct Line. We view this acquisition as approximately 10% accretive to earnings and value, creating a strong market position with a combined market share of around 20%. This move also shifts more of the Group’s earnings towards capital-light elements. We also added to our positions in First Group, Hammerson, and Vodafone.
 

Dividend – A Strong Finish to 2024 and a Strong Outlook for 2025

 
We upgraded our guidance for 2024 Fund dividend growth towards the end of the year to +4-5%, up from a flat outlook. The final outcome was +5%, which we are very pleased with, especially given the headwinds we identified for the 2024 dividend trajectory a year ago.

The Q4 2024 dividend, which has just gone ex-dividend, increased by over 40%. As we mentioned in early October, much of this increase (and the decline in Q3) was due to changes in ex-dividend dates between the two quarters.

The 2024 Fund dividend yield, which is now historic, is 4.8%

For 2025, we set our initial formal guidance for Fund dividend growth at more than 5% a month ago. This is a prudent estimate, and we remain very confident in this outlook.

Based on this guidance, the 2025 Fund dividend yield is expected to be approximately 5%.
 

Outlook

 
Whilst it is pleasing to report a positive absolute and relative year for 2024, it is noteworthy that the Fund still delivered a slightly lower return than the S&P 500. Readers will be fully aware of the narrowness of leadership in global stock market indices, and this remains a key issue for 2025. Whether US mega-cap growth stocks can continue their outperformance will have huge implications for other regional stock markets and asset classes. Valuations in the US leave little room for disappointment, but that has been the situation for some time. Rising government bond yields suggest a growing fear of inflation persistence and concerns about fiscal deficits, compounded by the uncertainty about both the short and longer-term consequences of Trump’s tariff policies.

Higher bond yields should provide some support for the merits of value stocks relative to highly rated growth names and ‘value’ as a style has performed better in 2024 outside of the US. This trend should continue in 2025 and will also help the UK market relative to other regions.

The slowdown in domestic economic activity in the last few months of 2024 has been disappointing, particularly given it has been self-inflicted. However, we should not lose sight of how strong personal and corporate balance sheets are in the UK and as interest rates are reduced, at some stage, those excess deposits will be put to work in more productive ways, stimulating economic activity, particularly consumer spending.

Valuations in the UK remain modest, and M&A and share buybacks are likely to continue at elevated levels whilst this situation pertains.

We continue to believe that the UK government and regulators need to urgently address the state of UK capital markets. Some element of ‘mandation’ for tax-advantaged investment products seems an essential part of any set of actions in this regard, and we would encourage all stakeholders to recognise why this should be welcomed rather than criticised. A functioning domestic capital market that allows companies to access capital when they need it has proven highly valuable over the last few decades, and we are in danger of sleep-walking our way into oblivion in this regard. Unpalatable as it may feel to many, some degree of ‘mandation’, combined with other market-friendly reforms, is the most effective way to make a meaningful change in the short term. 

In the meantime, the highly attractive combination of a diversified equity portfolio delivering a 5% dividend yield and having 5% of the outstanding equity retired each year via buyback activity is a very useful starting point for investors. With the likelihood of further incoming M&A to the Fund as well as strong execution from company management teams, the portfolio has the potential to continue to deliver strong returns, even if there is little help from economies in the short term.

We would like to thank our investors for their support over the last two decades. We recognise that our Fund’s returns have had some volatility but long-term investors have been rewarded for their patience.
 

 

Issued and approved in the UK by J O Hambro Capital Management Limited (“JOHCML”) which is authorised and regulated by the Financial Conduct Authority. Registered office: Level 3, 1 St James’s Market, London SW1Y 4AH. Perpetual Group is a trading name of JOHCML.

This is a marketing communication. Please refer to the fund prospectus and to the KIID / KID before making any final investment decisions.

The investment promoted concerns the acquisition of shares in a fund and not the underlying assets.
Past performance is no guarantee of future performance. The value of an investment and the income from it can fall as well as rise as a result of market and currency fluctuations and you may not get back the amount originally invested.

Investments may include shares in small-cap companies and these tend to be traded less frequently and in lower volumes than larger companies making them potentially less liquid and more volatile.

The information contained herein including any expression of opinion is for information purposes only and is given on the understanding that it is not a recommendation.

The information in this document does not constitute, or form part of, any offer to sell or issue, or any solicitation of an offer to purchase or subscribe for any funds or strategies described in this document; nor shall this document, or any part of it, or the fact of its distribution form the basis of, or be relied on, in connection with any contract.



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