Reflections of the CIO… December 2023

The final month of 2023 was a strongly positive one, with a remarkably quick worldwide rally erasing any prior year to date losses across multiple asset classes. We had seen many similar swings in sentiment throughout 2023, both positive and negative, driven by everything from the price of oil to the solvency of banks. In the end, however, it was the market’s ever shifting assessment of the global inflation outlook, particularly in the crucial US economy, which ultimately caused December and the year as a whole to end on a positive note.

Prior to the final two months of the year, a series of relatively ‘hot’ US monthly inflation figures had been weighing on the market mood, as they implied that the painful increases in interest rates, which have been absorbed so far, may not be finished. This was in part fuelled by the messaging and estimates coming from the Federal Reserve, but also by real world data from which it remained frustratingly difficult to unpick a convincing trend. Markets had been sliding from the end of summer until the data trends finally began to turn more convincingly in early November.

A modest softening in US labour markets, followed by a slightly weaker than expected October inflation reading, sparked a global rally across asset classes. Investors quickly extrapolated some genuinely good news on US inflation into nearly all markets and geographies, as these US trends are assumed to be front runners for what will inevitably happen elsewhere. This process began in November and gathered pace throughout December, fuelled in particular by the December meeting of the US Federal Reserve, which kept interest rates on hold and offered dovish commentary for the year ahead.

The Bank of England behaved similarly at their December meeting and the combination of  encouraging messages from central banks prompted markets to move swiftly to price in a significant series of global interest rate cuts for the year ahead, beginning roughly around summertime.

Our own view is that there is indeed much to be cheerful about and that the positives will more than likely outweigh the negatives. However, we would also expect that the journey over 2024 will continue to be very noisy, volatile and erratic. The peak in post Covid inflation has clearly passed and interest rates have stopped increasing worldwide. Consensus forecasts from investors and central banks do indeed project a more benign macro-outlook than they did coming into 2023, and recent evidence does seem to support this view. However, as global inflation risks look to exit stage left, other more truculent issues remain and will prove harder to overcome.

There is a long list to choose from, with perhaps the most important being the level of indebtedness which governments have encumbered themselves with. This debt will need to be serviced and populations are not in the mood for cutbacks on spending to fulfil that role. In a normal year this could, perhaps, be less of an issue, but 2024 will host an unprecedented 60 elections globally, with nearly half the planet’s population voting on new administrations. How these new governments communicate their policies to bond markets, which have, in general, geared themselves up for good news, remains to be seen. The 2022 UK example with the Liz Truss administration remains a potent illustration of just how sensitive an issue this is for the many governments that spend freely and borrow heavily.

There are also some very key thematic positives which we must also include in our calculations. The potential impact of AI technology was a significant driver of global equity markets in 2023, although admittedly the benefits were only priced into an extraordinarily narrow set of big US tech firms. Nonetheless, the potential impact in improving corporate productivity is very real and increasingly something which investors think could impact profits positively within the investment horizon.

The shorter-term picture is unlikely to be much less volatile than it has been over the past few years. It will be a ‘noisy’ marketplace for some time to come, albeit one which should be a grounded on an improving underlying trend. There will undoubtedly be a period during which economic growth will be slowing and interest rate cuts will still be some way off. Similarly, we would not be surprised to see a few ‘sticky’ inflation figures testing positive sentiment. However, we think that another possible benefit of entering a more normal macroeconomic environment in the future would be the return of longer-term time horizons in markets. As central bank policy became ‘data driven’ over the past two years, market time horizons shrank accordingly, with prices swinging on monthly economic releases, with little effort given to longer-term thinking.

Our investment process, whilst keeping a necessary eye on short term issues, is built around looking for long-term opportunities, built upon durable trends. The exceptionally noisy past year has often hidden meaningful underlying change for the good. Japan exiting a period of over 30 years of low growth and deflation is one example. The twelve-year journey of Greek debt from ‘junk’ to investment grade is another. Real risks do remain – the glass is half full rather than full we would say – but with a longer-term perspective we think we can look forward to the future with more optimism than we have had for the last few years.