FAS

You may well have noticed the intense media coverage of the rise in UK Government bond yields since the start of the year, which have led to Chancellor of the Exchequer Rachel Reeves coming under increased pressure. Bond markets saw weakness through the final quarter of 2024, which intensified over the first few trading days of this year, over concerns that the Government will need to borrow more money to fund their spending plans. This is not the first time, nor will it be the last, that bond market conditions move from being an investment story to headline news. Just over two years ago, bond market turmoil led to the resignation of Liz Truss in the wake of the infamous Kwasi Kwarteng budget, and in 1976, Harold Wilson’s Government was forced to borrow money from the International Monetary Fund due to the spiralling cost of debt.

How is it that bond markets can exert so much influence? The reason is that Government bond yields are a critical indicator, and have implications for the outlook for risk assets, the wider economy and personal finance.

Bond yields in focus

When Governments look to borrow money, they often do so by issuing bonds, which are known in the UK as gilts. Each gilt offers a fixed rate of interest for the life of the issue and have a redemption date, at which point the Government will buy back the gilt for a fixed price.

Take the example of a gilt issued today, with a redemption date in 10 years’ time. The gilt carries an interest rate of 5% per annum. At the point of issue, the gilt is priced at 100p and it will be repurchased in 10 years at 100p. At launch, the yield on the gilt (which is calculated by dividing the interest by the bond price) is 5%. The Government therefore knows the amount of interest payable on the debt, and investors can easily determine their rate of return if they hold the bond to redemption.

Gilts and other bonds are, however, traded securities, and bond prices will fluctuate over time, with factors such as the underlying base interest rate, the economic outlook and global conditions influencing the direction of bond prices. Low confidence in the economic outlook can lead to investors selling gilts, leading to a fall in price. Any such fall in price increases the yield. Using the example above, if the gilt price fell from 100p to 95p, the yield on the bond would increase from 5% to 5.26%.

Such a move would not impact the level of interest paid by the Government on this particular bond; however, the yield sets the market expectation at which future bonds would need to be priced. Gilts regularly redeem and indeed, gilt issuance is likely to rise to help finance the Government’s spending plans. As a result, the interest costs paid on Government borrowing would rise over time, as new issues need to offer a higher rate of interest to match market expectations.

Bond yields have wider implications

When investing in fixed interest securities, such as gilts and other bonds, the yield is clearly critically important, as it represents the return that you can achieve from holding the bond to maturity. Gilt and other major Government bond yields also set a benchmark return that you could achieve without taking significant investment risk. This has a direct impact on other investment markets, such as equities, as a higher yield makes bonds more attractive to investors relative to equities, and can lead to investors moving out of riskier assets and buying bonds instead.

Central banks also keep a close eye on Government bond yields, as the yield on key benchmark loan durations provides a temperature check on the health of the economy. Sharp increases in bond yields, as experienced in the UK and US recently, could lead to central banks raising overnight interest rates.

Pressure in bond markets not only affects investors but also impacts on other areas of personal finance. Pension annuity rates are calculated with reference to gilt yields, and rising yields can have a positive impact on annuity rates. The opposite is, of course, true, as witnessed by the very poor annuity rates offered when interest rates stood at close to zero during the Covid period.

The rates offered on fixed-rate mortgages are also sensitive to movements in gilt yields, as interest rate expectations are used to calculate rates offered by mortgage lenders. Many individuals will see cheap fixed-rate deals taken out over the last five years coming to an end in 2025, and a spike in yields could heap further pressure on borrowers whose current deal is ending. In turn, this could impact mortgage affordability and dampen demand in the housing market.

Any further constraint on the public purse can also have a knock-on effect on personal finances. If Government borrowing costs become more expensive, this may lead to cuts to expenditure on public services or could force the Government to raise taxes further.

Where next for bond yields?

The increase in yields seen over the last few months is largely a reflection of changes in interest rate expectations. Inflation has been nudging higher, moving further away from the Bank of England target rate of 2%. Investors are also nervous about the prospect of trade tariffs being imposed by the incoming Trump administration.

Given these factors, bond markets are likely to remain volatile in the short term. Whilst the spotlight has rightly been placed on the pressures on UK gilts, bond yields have also risen in the US and Europe, which lead to investment opportunities within fixed income investments. This may well be an ideal time to consider the allocations you hold in fixed income within your investment portfolio. Speak to one of our experienced team if you would like to discuss how your investments are positioned.

We have previously reported on the alarming rise in financial fraud, which accounts for 4 in every 10 offences carried out against individuals in the UK. Sadly, more people are falling victim to ever more sophisticated methods used by fraudsters, who are using new technology to their advantage.

A recent report undertaken by Barclays indicates that one in five consumers have fallen victim to a scam over the last year, and one in three people know of someone who has been scammed. Further evidence of the rise in fraud is that the Financial Ombudsman Service reported that they received over 8,700 complaints relating to fraud in the first quarter of 2024, an increase of 42% on the same period in 2023, and double the number of complaints seen in the first quarter of 2022.

These grim reports are a timely reminder of the need to remain vigilant against fraud. Victims may not only face financial consequences – becoming a victim of financial fraud can also lead to considerable emotional harm.

Financial fraud can take many forms, with the most common being cases where consumers are tricked into handing over bank details to fraudsters, after being alerted that they are due to receive a fictitious refund from an organisation or business, or owe a fine or have tax to pay. Other frauds and scams, including those relating to investments and pensions, have also become more commonplace over recent years.

What can you do to protect yourself?

There are some common-sense steps you can take to help defend yourself against financial scammers.  Firstly, always remain vigilant if you receive any unsolicited communication from your bank, H M Revenue and Customs or any other company you deal with.

You should also be cautious when receiving an unexpected phone call. If you’ve been called by someone claiming to be from your bank, end the call and then phone the official bank number from a different phone. This is important, as scammers can keep the line open if you call back from the same phone. You should never disclose passwords, PIN numbers or bank details over the telephone.

Text messages or emails received from a bank or other service provider should be treated with suspicion, especially if the text message asks you to click on an email link. This could direct you to the scammer’s website, where your personal details can be collected. If in doubt, always log on to a legitimate website directly, rather than clicking a link in an email.

It is not only communications from companies and organisations that need to be treated with care. An increasingly common scam is where a scammer contacts an individual via text message, pretending to be the child of the victim, asking for funds to be sent to the child for a fictitious reason.

You should always be wary of cold callers trying to sell you an investment product or service. Don’t allow yourself to feel rushed into making a financial decision, and always take time to think about whether to take up an offer. This will give you time to seek independent advice before reaching a decision.

Unrealistic investment returns

Scam cases involving investments and pensions continue to rise, and fraudsters are using more convincing ways to make offers look and sound more plausible to unsuspecting consumers. A good rule of thumb is that you should always reject any unsolicited contact offering you the opportunity to make an investment. The contact could come via a telephone call (often from organised set-ups known as “boiler rooms”) or an email, and may offer the opportunity to purchase an investment that can provide unrealistic returns that sound too good to be true. The fraudulent offer may also try and hurry you into making an urgent decision, on the pretext that failure to act quickly would mean missing out.

Protect your pension

Pension scams usually take the form of cold calls, offering investment opportunities in high-risk investments, such as overseas property, forestry or other similar unregulated investments. Many of these offers will suggest that the individual needs to transfer their pension to the scammer to access the unregulated investments, and this is often accompanied by high pressure selling tactics.

Another potential scam is a call offering the ability for an individual to access or unlock their pension before the age of 55. This can only legitimately be undertaken in a very limited set of circumstances and treat anyone contacting you to offer such services as being highly suspicious.

Know who you are dealing with

Consumers can help protect themselves from investment fraud by checking who they are dealing with. The Financial Conduct Authority (FCA) Financial Services Register lists details of firms and individuals who are authorised to provide investment and pension advice.

The FCA also provide a list of “cloned” firms on their website, where you can check whether a fake firm has been previously reported for setting up a fraudulent operation that uses the name, address or other details of a legitimate firm.

Don’t add to the statistics

Given the worrying increase in financial fraud, everyone needs to be vigilant to the risk of falling victim to a scam or fraud. Consumers should always treat any unsolicited contact from a financial services provider, a utility company or other organisation with a degree of caution. Trust your instincts, and if something feels suspicious, then report it to Action Fraud, the UK’s national reporting centre for fraud and cybercrime.

Most investors instinctively feel comfortable investing in their domestic stock market. The FTSE100 index of leading UK shares is made up of familiar names, and within the largest quoted companies, investors can gain access to attractive dividend yields and modest valuations. The reality is, however, that investors in UK equities will have seen returns lag behind those achieved by their global counterparts over the medium term.

Diminishing influence

The story for 2024 has been all too familiar for UK equities. In the period from 1^st January to 30^th October – the day of the Budget speech – the FTSE100 index of UK shares produced a total return of 8.92%, compared to the S&P500 index of US shares, which returned 20.37% over the same period. The gap between the UK and US indices has widened further during November, as investors digested the impact of the Budget on the outlook for UK equities, and US shares enjoyed a boost from the clear Trump victory. Further evidence of a lack of investor confidence in the UK can be observed given the large outflows seen from UK equities in advance of the Budget.

The London Stock Exchange is one of the oldest known trading exchanges; however, the influence the UK can exert in a rapidly changing world is diminishing. Within the MSCI World Index, a composite index of the largest global companies, the UK now accounts for just 3.5% of the index weight, compared to 72% for the US.

The explosive growth in the largest US quoted companies has seen the market capitalisation of Apple, Nvidia and Microsoft all individually exceed the combined value of the largest 100 quoted companies in the UK.

One of the reasons for the lack of traction within UK equities is the absence of large-cap technology stocks. The market clamour for stocks involved in artificial intelligence and other high-growth areas has seen value equities, which offer solid cash flow and attractive dividend yields, fall out of favour. Indeed, the decision of British chip designer ARM Holdings, which decided to relist in New York rather than London, was further evidence that technology stocks that wish to gain wider investment exposure can do this more readily on the Nasdaq exchange.

Impact of the Budget on confidence

You could reasonably argue that the recent Budget has done little to boost the fortunes of domestic equities. Prior to the Budget speech, confidence in the prospects for the UK economy was already at a low point. Government ministers repeatedly warned of tough measures in the Finance Act and the Budget speech itself surprised many economists and commentators with the breadth of tax raised.

From a business perspective, additional costs from the hike in Employer’s National Insurance are likely to impact UK growth. Firms could look to trim expansion opportunities, or more likely pass the additional costs onto the consumer. Sectors such as leisure, hospitality and retail, where many workers receive the minimum wage, will see a direct increase in wage costs from April 2025, which will squeeze margins further.

This set of events have the potential to nudge inflation higher during 2025, and potentially force the Bank of England to re-shape the trajectory for UK interest rates. Whilst further rate cuts are expected, there is growing consensus that the pace and timing of the cuts may be slower than anticipated.

Consumer confidence remains weak, with the “cost of living” crisis still alive and kicking. The combination of mortgage rate resets for those coming off cheap fixed rate deals, higher energy costs and static tax bands, mean that consumers may shun big ticket items whilst focusing on essentials.

An improving outlook for the UK economy could increase investor appetite and boost the prospects for UK equities; however, the projected growth figures announced in the Budget suggest that GDP growth will remain subdued over the next five years. As a result, investors, who take a global approach to investment, may well look to other markets, where growth potential is more appealing.

Reasons to be cheerful

Given the current position, we have painted a rather negative picture of the prospects for both the UK economy and UK equities over the medium term. There are, however, reasons to invest in UK equities, particularly if the investor seeks a high level of dividend income. The current dividend yield on the FTSE100 is 3.70%, although companies offering yields well in excess of this level can be found. Seeking income from overseas investments can be more difficult, with the S&P500 index of US shares producing a dividend yield of just 1.19%.

UK equities are undoubtedly cheap when using certain metrics, with the FTSE100 standing at a considerable discount to the implied earnings growth of the S&P500 index. The UK also stands at a slight discount to Eurozone equities. Whilst you could argue that this suggests that the UK is attractively priced, it is entirely possible that the relative value on offer is by virtue of the modest outlook for growth. In other words, the UK could be “cheap for a reason”.

The UK still has a place

Despite the weaker outlook, it would be unwise to dismiss UK equities. We believe they command a place in a well-diversified investment portfolio, particularly for investors who are seeking income from equities, or value to counterbalance growth in a diversified approach. It would, however, be sensible to consider the composition of your investment portfolio, as holding excessive weights in the UK, without adequate global diversification, could limit the prospects for investment returns, and also introduce additional risk. Many traditional discretionary management services focus on UK equities, and we have seen examples where performance has lagged due to an overallocation to domestic positions.

Our experienced advisers can help review existing investment portfolios and provide independent advice on the current asset allocation, diversification and levels of risk. Speak to one of our advisers to discuss your portfolio in more detail.

Positive early reaction

In the immediate aftermath of the election, US equities saw strong trading, with the S&P500 index pushing through the 6,000 level for the first time. A factor boosting the short-term positivity may well be the absence of uncertainty over the election result, which brought about market volatility in the aftermath of the 2020 election.

Whilst equities have reacted positively, bond yields have risen, as investors flee from US Treasuries. This reaction is understandable, as the likely policies a second Trump term will bring, such as tax cuts and increased tariffs, may well be inflationary. This could undo the work of the Federal Reserve, who have been successful in reducing inflation, so that it rests just above the Federal Reserve target. Markets have been anticipating a series of US interest rate cuts during 2025, which would help support a slowing economy. Depending on the speed and size of expansionary plans laid out by the Trump administration, the pace of interest rate cuts could slow, meaning interest rates remain higher for longer. This impacts the US housing market and could weaken consumer confidence.

A second Trump term may well herald a series of tax cuts, including those borne by business. This could improve US corporate profitability and potentially support higher valuations. An extension to personal tax cuts introduced in 2017, which are due to expire next year, is likely, which could ease some of the cost-of-living pressures currently facing US households.

America first policies

Trump consistently proposed the introduction of international trade tariffs during his election campaign, to refocus on domestic production, employment, and growth.

The extent to which tariffs are imposed remains open to question, as some of the more extreme claims made prior to the election could simply be used as bargaining chips; however, any extension of import tariffs has the potential to drive the price of goods and services higher, leading to higher inflation and a possible fall in consumer confidence. Countries are, of course, able to retaliate by imposing their own tariffs on US goods and services, leading to a trade war. This could dampen global growth, and lead to further friction, particularly with countries with significant export markets, such as China.

It is possible that mid-sized and smaller US companies could see higher demand for domestic goods and services due to higher tariffs, although weakness in consumer confidence and higher prices could offset any benefit to US domestic suppliers.

Trump and global conflict

On balance, the second Trump term increases the potential for market volatility due to geopolitical instability. The World waits to see actions Trump could take in respect of the Russian invasion of Ukraine. Such decisions could have wider implications for the future of NATO and could see European nations increase spending on defence. Should the conflict end, this could well secure energy supplies going forward and remove the risk to potential supply shocks that caused market concern at the outset of the conflict.

Commodity prices may also be influenced by events in the Middle East. The ongoing tensions in the region have yet to cause significant concern to global equities and commodity markets over the course of this year; however, actions taken by the new administration could increase tension and any significant escalation could see oil production fall, potentially leading to higher prices.

Sector winners and losers

A range of sectors of the US economy are likely to be direct beneficiaries of policies introduced by the Trump administration, whilst others could face a more difficult future. Banks and Financials may well benefit from lower government regulation and red tape, and if US interest rates stay a little higher for longer, this could boost profitability. Oil and Gas producers may also be big winners, given the suggestions that Trump will look to expand US production. On the other hand, the renewable energy sector has already come under pressure since the election result, as Trump may well reduce tax credits and other incentives that have driven the boom in renewables across the US.

The largest US tech stocks have contributed a considerable proportion of the growth seen in US markets over the last year, and these tech giants have seen significant inflows at the expense of more traditional sectors of the economy. The difference in performance between high growth and value stocks has been clear, and this gap may well narrow following the US election result. The outcome may also benefit mid and smaller sized US companies, which have underperformed the mega-cap global giants.

Implications for portfolio asset allocation

In the wake of the US election result, equity markets have rallied on the expectation of corporate tax cuts and deregulation, coupled with relief that the election result was clear cut, without the uncertainty seen following the result in 2020. Treasury markets have given a less positive reaction to the Trump re-election. Given that policy decisions are likely to increase borrowing and fuel inflation, bonds have come under pressure, as inflationary fears have the potential to derail the Federal Reserve’s intended path for US interest rates.

2024 has proved fruitful for investors, and the outlook for 2025 appears robust; however, decisions taken by the second Trump administration in respect of both domestic and foreign policy may well increase volatility, as well as opening opportunities. As we head into more uncertainty, it would be an appropriate time to review existing investment portfolios to consider the asset allocation and strategy adopted. Speak to one of our experienced advisers to discuss your exposure to US equities and how the election result could impact market sentiment.