Dynamic markets in 2023 present ample investment opportunities in 2024.
After the V-shaped volatility of the pandemic and an unusual down year for both stocks and bonds in 2022, Wall Street was decidedly bearish going into 2023. Both policymakers and investors struggled to pinpoint the stage in the economic cycle given distortions driven by pandemic policy responses. Violent interest rate swings were possibly the only certainty. In a highly eventful year, monetary policy meetings were arguably the main events with all eyes squarely fixed on Powell, Lagarde and co.
Market narratives ebbed and flowed in 2023 from hard landing to crash landing, and then from soft landing to no landing, back to hard landing again, only to close the year fully in the soft-landing camp. Market sentiment was in fact even more mercurial than normal, from recession fears at the start of the year, to resilient growth over the summer, back to apprehensions about ‘higher for longer’ interest rates in the fall, and finally culminating in year-end elation over expectations for perfect economic conditions in the festive season.
The strength in the labour market along with significant accumulated consumer savings ensured ample liquidity supporting continued consumer spending. These welcome surprises were instrumental for the economy’s outperformance in a high interest rate environment. The Magnificent Seven and overall resilient earnings drove equity performance, while enthusiasm over AI and weight-loss drugs acted as an additional ballast. While equity markets, excluding China, delivered the recovery trajectory was far from straightforward. In fact, sentiment remained cautious until favourable economic data in November led to an early ‘Santa rally’. Markets closed the year in high spirits as Powell launched a ‘pivot party’ as the FED signalled 75bps of rate cuts in 2024.
The ‘almost everything rally’ that transpired took performances for the year for developed market equities to 24.4% (Q4: 11.5%) and 5.7% for global aggregate bonds (Q4: 8.1%) while interest-rate sensitive laggards real estate and small caps bounced back delivering 10.9% (Q4: 15.6%) and 16.9% (Q4: 12.6%) respectively. To the delight of long-term investors that stayed the course, market performance in 2023 represented a robust recovery with traditional 60/40 portfolios delivering circa 15% returns (FY 2022: -16.9%).
In 2023, the markets delivered a stark reminder of how influential popular narratives can be, driving strong gains but also delivering sharp turnarounds if confidence falters and crowded positions are exited. Markets have done, and always will, create their own reality leading to an ever-evolving market narrative and sentiment. We ran through the entire range of possible outcomes in 2023. With no off-season, we’re all set to do it all again in 2024.
As for 2024, this might be a crucial transition year back to normalization setting the foundation for more sustainable economic growth and steadier market returns. Markets have indeed moved to reflect a markedly more compelling macro backdrop pricing in double the cuts indicated by the FED dot plot. It is worth wondering whether the rally has got ahead of itself. The descent from peak rates has only been mapped out and Central Banks’ data-dependence mantra remains the ultimate get-out of jail free card. Investors should ask why Central Banks would be in a rush to cut rates anyway. Doing so could potentially risk throwing away a hard-won victory over inflation. It’s too early for a victory lap.
In addition to the ever-evolving monetary policy, there is the risk of (more) grey swans. Ongoing conflicts in in Ukraine and Gaza, trouble in the Red Sea, ongoing tensions between the US and China over trade and Taiwan, mounting fiscal challenges, impending legislative gridlock in the US and significant global elections make market predictions increasingly complex. In the meantime, circa 5% annualized short-term rates are appeasing investors, subtly encouraging them to become market timers.
In the near term, markets are experiencing some beneficial consolidation. The possibility of rate cuts, particularly in the EU, combined with cautious overall positioning, however suggest an upward trend throughout the year. Should policymakers successfully stick the landing, then 2024 could have a mid-cycle feel to it, despite the economy potentially being in a later stage. Stable earnings and somewhat loose market conditions could pave the way for a continuation of the bond-led equity rally as both inflation break-evens and real yields drop. At the same time, there is nearly $6 trillion sitting pretty in money markets. This substantial capital could spur an ‘everything, everywhere rally’.
Long-term investors may take this opportunity to determine their liquidity needs and consider judiciously adding appropriate investments to build up resilient core balanced portfolios as markets tend to be forward-looking and are unforgiving when it comes to timing.
The coming year is expected to offer ample investment opportunities and dispersed returns, as economic pathways and monetary policies continue to diverge. Even more so as the business cycle stabilizes and if the market broadening materializes. As demonstrated in 2023, divergent returns underscore the critical importance of portfolio diversification and highlight the tangible rewards of active management. Leveraging macro expertise via dynamic asset allocation can inspire alpha generation.
Alternatively, investors may leverage major global trends to achieve better outcomes within traditional static investment allocations. The current economic state is currently being shaped not just by normalization but also key structural factors such as decreasing workforces, increasing geopolitical divisions, and the shift towards sustainability. These significant trends represent investment opportunities now and in the future.
Markets are quick to embrace such fundamental shifts as demonstrated by AI-related gains. AI's progress rests on three pillars: computational and model infrastructure, and application software, creating a robust ecosystem and winners all around. Generative AI is poised to transform various sectors, with Tech and Communications at the forefront serving as enablers, and Financials, Consumers and Healthcare the main beneficiaries. These developments also see cybersecurity gain importance, especially with the upcoming global elections and heightened geopolitical tensions. The shift towards prioritizing economic resilience over efficiency, effectively de-globalization is inflationary but also accelerates investment in Tech, Energy, Defense, and Infrastructure.
Josef Luke Azzopardi, CPA CFA is a portfolio manager at BOV Asset Management Ltd.
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