Year in Review – 2023

2023 made for another very interesting year in investment markets as macro / regime driven events resulted in extreme shifts in investor sentiment on an almost monthly basis. Investors chose to shoot first and ask questions later in what can best be described as a year of maximum noise.

Whilst fundamentals are the key determinant of investment returns over the longer term, markets can and will go through bouts where they appear increasingly disconnected from reality.

In reviewing the year that was 2023, there were 6 distinct phases:

January: good news is good – the year started with a bang as positive economic data continued from the Christmas period buoyed by the previous elongated period of very low interest rates and significant government stimulus. This saw investor sentiment rise sharply as the good times rolled on.

February-March: US banks / Credit Suisse collapse – the significant increase in interest rates and reasonable reduction in the size of central bank balance sheets, saw financial conditions tighten considerably which then spilled over into a squeeze on liquidity. That squeeze provided the impetus for rising concerns on the strength of bank balance sheets, and in the days of rapid dissemination of information (whether true or not) on social media, led to runs on Silicon Valley Bank and Credit Suisse, along with a few other US banks. This risk-off event gave reason for investor pause.

March-April: central banks come to the rescue (liquidity) – following concerns of wider spread contagion on the global banking system, central banks provided the comfort investors were looking for by standing firm in their ability to backstop the banking system (injection of liquidity, in the case of the US) as they stood ready and waiting to provide whatever support was necessary. The re-organisation of Credit Suisse did throw a spanner in the works for certain parts of the bond market.

April-July: bad news is good; plus the “Magnificent 7”; significant falls in inflation – following the central bank intervention that was March, markets took off again enamoured by the recent liquidity injection (or promise of) from central banks (i.e. bad news was good for investors as it meant central bank support). Inflation, particularly in the US, fell at a rapid pace between April and June, spurring a movement in markets linked to the view that central banks were done raising rates, and even so bold to suggest that rate cuts were on their way.

At the same time, this “thing” called A.I. which had been festering in the background for more than a decade finally took off in markets, following the release of ChatGPT in late 2022. The market very quickly assessed that there were “only” 7 stocks that would benefit from A.I., and like with most things these days, a new catchphrase (“Magnificent 7”) was coined. Given the timing of the liquidity injection in markets, and reasonable economic backdrop, these 7 stocks powered ahead and left everything else in their wake. The result was a massive surge in US equity performance, with a rising tide somewhat lifting all boats. But not all were equal – given how narrow that trade was, any portfolio not holding enough of the 7 (or technology stocks in general) was left behind, which resulted in significant performance divergence across markets.

August-October: rates higher for longer, inflation path lower stalls, new conflict in the Middle East – this was a poor period for markets as the ongoing economic resiliency that surprised most economists resulted in inflation falling at a slower pace than had been the case in prior months. This shouldn’t have been surprising based on historical inflationary periods, as the easy wins on inflation (i.e. temporary / cyclical) had already occurred. A new mantra took hold of rates, “higher for longer”, which saw the market pivot rather swiftly from central banks done / rate cuts, on the way to central banks needing to take rates higher and/or maintain a reasonable period of higher rates (for longer) in order to crush more stubborn (i.e. structural) elements of inflation.

This resulted in a strong sell-off in interest rate sensitive growth assets (property & infrastructure), interest rate sensitive bonds (i.e. fixed rate government and corporate bonds), and growth stocks trading on eye-watering multiples, as asset prices got re-priced very quickly.

November-December: bad news is good, inflation beaten, Fed done raising rates – the beginning of November kicked off with a spurious US headline inflation print of 0% for the month of October which investors took as a green light that inflation had finally been beaten and they might finally see some rate cut relief in 2024. This sent markets on a tear, reversing much of the poor performance in September and October, with property & infrastructure surging, along with government bonds, small companies, and growth stocks.

This extremely positive investor sentiment was then stoked by the US central bank’s accompanying statement following their December decision not to raise rates. The statement appeared to indicate that the Fed was done raising rates with a reference of significance that some members had contemplated (later walked back to discussed) rate cuts! This gave the market a further green light that not only was the Fed done with rate rises, that we should now expect rate cuts in 2024 and for them to start sooner than previously expected.

Outlook

We are cautious about 2024, but not overly concerned. We have been progressively taking profits and taking some risk out of portfolios, mainly due to the favourable risk / return dynamics available within defensive assets (like bonds) but are avoiding any significant asset allocation changes which we think are low quality / information decisions at this point. We keenly await further economic data and company reported data so we can get a better feel as to how 2024 is likely to play out.

For now, we expect lower economic growth (with recession for some countries / regions), rising unemployment and bad debts (both off very low bases), mixed in with some resiliency at the household / corporate level (selectively for both). The key aspects from our perspective are considering fundamentals with a long-term view, right-sizing positions, ensuring plenty of diversification, and remaining focused on investment selection.

Best wishes to you and your families for the festive season. We look forward to working with you in the new year.