Review of 2023 and Outlook for 2024

As usual 2023 was another “interesting year” and both markets and economies did not meet market consensus expectations, with equity and bond markets delivering better than expected returns. Back in January 2023, all the attention was on China’s reopening from their draconian zero Covid policy. Investors believed that pent up demand and excess savings created through lockdowns in the world’s second largest economy would lead to a strong economic rebound and corresponding market performance, whilst rising interest rates in the US would lead to a recession and corresponding poor market performance. In the end we got the opposite. This just goes to highlight the pitfalls of economic forecasting and consensus thinking.

Developed economies grappled with inflation which continued to rise in the first half of the year and Central Banks increased interest rates to levels that we have not seen for 20 years. We can now see that inflation has peaked and after initially declining rapidly, the “last yards” back to Central Banks’ target levels are getting harder. Interest rates are now in the plateau phase of the Table Mountain analogy we have referred to in previous articles. The impact of rate rises on economic activity and consumers has been muted by the prevalence of fixed rate mortgages and that companies have held onto employees, (known as “labour hoarding”), instead of making significant redundancies.

The US economy and equity market has shown remarkable resilience, with the job market cooling and the S&P500 index of large US companies delivering a 38% gain since the October 2022 low. By comparison Chinese equities have declined by c. 20% over the same period. A significant proportion of the US market’s strength can be attributed to the excitement around AI, led by Nvidia the chip maker and the so called “Magnificent Seven” tech stocks (Amazon Apple, Meta (formerly Facebook), Alphabet (formerly Google), Nvidia, Tesla and Microsoft) These make up 28% of the S&P500 benchmark. Despite this, we remain marginally underweight in US equity due to their expensive valuations and we remain tilted to quality and value companies.

For what it’s worth we did not expect the US to fall into recession in 2023 and as long as the employment situation remains benign i.e. there is not a significant rise in unemployment, we expect the US and in fact all developed countries to avoid a painful economic downturn. (We are deliberately avoiding using the “R” word in our prediction!).

However, markets are forward looking, discounting future expectations. Interest rates are now expected to fall in 2024 and bond markets have rallied sharply. We took advantage of the sell-off in bonds in 2023 to increase the portfolio’s exposure and we are pleased to say that this has benefitted clients’ portfolios. Most equity markets have performed well in 2023 and the surprise to us has been how resilient corporate profits have been despite all the challenges of rising costs.

As we move into 2024, we continue to monitor our allocation under the backdrop of an increasingly opaque world. We remain somewhat defensively positioned towards quality and value and overweight bonds and underweight equities. We may underperform in an environment where equity markets continue to rise strongly but would rather be positioned to capture a good proportion of the upside rather than run at the front of the herd should there be a surprise cliff edge.

We cannot finish without mentioning geopolitics which over the last few years has become increasingly polarised and volatile. This February will mark the second anniversary of the Ukraine-Russia conflict with seemingly no end in sight. Tensions between China and Taiwan will remain, especially following the election of a pro-independence president in Taiwan. The Hamas-Israel war risks the conflict spilling over to the rest of the Middle East and the Red Sea which could have adverse effects on oil prices and consumer confidence. Finally, we expect more than 58% of the world democratic population to vote in general elections across the world, including three key economies in the UK, US, and India. If predicting macroeconomics is hard then predicting the outcome and reaction to these elections is even harder. Therefore, our strategy to navigate these events is to remain focussed on fundamentals.