The year that was.

2023 made for another very interesting year in 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 be best described as a year of maximum noise.

Whilst fundamentals are the only thing that matter for investment returns over the longer term, markets can and will go through bouts where they appear increasingly disconnected from reality. Given we have now seen an extended period (i.e. 2 years plus) of these types of markets, we thought it was worth revisiting last year’s missives to reflect on whether we sound like a broken record and reflect on the accuracy (or lack thereof) of our outlook.

We did hope for a greater focus on fundamentals (wrong), but we did make clear that hope isn’t an investment strategy. We were too early in our call for a period of stability in monetary policy (about 6 months early) and a weakening economic backdrop (about 12 months early), which now looks very likely in 2024. We did say it would be a better year for bonds, which it was post US banks collapsing early in the year, though we then had a long wait until the last two months of the year for confirmation of this. We were correct on the “mixed year for growth assets with clear winners and losers and significant divergence across region, country, and sector” with US equities up more than 20% led by seven stocks (i.e. the “magnificent 7”). All this made it a tough year for active management, given the violence of the short-term moves, but remaining calm, diversified, and invested proved to be a winning formula yet again.

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

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.

(Find out more about the fall of Credit Suisse in a separate article - )

March-April

Central banks come to the rescue (liquidity).

Following concerns of wider spread of 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, done in what can only be described as a very European / Swiss way, 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 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. that 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 was 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 remained elevated for longer, disinflationary trend stalled, new conflict erupted 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 for those with a basic understanding of economics and a cursory read through of historical inflationary periods, as the easy wins on inflation (i.e. temporary / cyclical) had been had. 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 rate.

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 more rate cuts in 2024 and for them to start sooner than previously expected. Off to the races for investors.

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Outlook.

We are fairly cautious about 2024, but not yet overly concerned. Our caution stems from what we think are too optimistic expectations on central banks being able to achieve a “soft landing” / Goldilocks type of environment. Looking at history, the odds are firmly against them, but odder and weirder things have happened in markets before.

We are currently contemplating taking some risk out of portfolios, mainly due to the favourable risk / return dynamics available within defensive assets (like cash and 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 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) and hence, some stubborn last legs to inflation that still sits above central bank targets. That generally means staying invested, right-sizing positions, ensuring plenty of diversification, and remaining focused on investment selection.