Reflections of the CIO… November 2023

November was another wild month in what is turning out to be a rather wild year. This time the swing in market sentiment was strongly positive, driving a remarkably quick worldwide rally which had enough power to erase the losses of the last three months across multiple asset classes. We have seen similar mood changes earlier in the year and they have all been characterised by the same thing, namely a reassessment of the inflation outlook, particularly in the crucial US economy.

Prior to November, a series of relatively ‘hot’ US monthly inflation figures had been weighing on the market mood, as it implied that the painful increases in interest rates which have been absorbed so far may not be finished. Then, a modest softening in the US labour market 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.

As we write in early December, markets have assumed that the peak in inflation and interest rates has now passed, and the next moves to look forward to are interest rate cuts in the year ahead. These cuts would be global in nature and happen roughly by summertime. They would be driven by a realisation from Central Banks that, as inflation keeps falling and economies slow, a pivot to an easier monetary policy was in order, especially if a nasty ‘hard landing’ recession was to be avoided. The positive effect of these potential future cuts would be enough to offset the risks that a slowing real economy brings with it. In other words, recession risk has been trumped by lower interest rates and Christmas has, officially, come early.

When thinking about how to position portfolios in this rapidly changing landscape, we think one of the lessons of the year is that almost everyone has been almost right and almost wrong, almost all of the time. Regular violent moves in market sentiment and direction have made it very hard to keep any consistent forward momentum in portfolios over the course of 2023. However, as we look forward into 2024, we do think that, over the investment horizon (3 to 5 years), things have indeed started to change for the better. We are probably past the worst of the Covid inspired inflation and interest rate adjustments, and therefore should be moving into a more normal macro environment in the future.

However, we also think that the shorter-term picture will not be any less volatile than it has been this year. It will be a ‘noisy’ marketplace for some time to come, albeit one which should be grounded on an improving underlying trend. There are plenty of high expectations in certain assets and plenty of risks lurking in corporate and consumer balance sheets, to say nothing of the local and geopolitical risks that are never far from the headlines.

Our overall strategy will therefore likely remain quite nuanced in the very near term, with an eye to increasing risks on any pullbacks in prices. We will stick with our structural themes such as exposure to Japanese assets and less well understood frontier markets, as both continue to have valuation support and decent momentum. The most noticeable of changes will revolve around increasing exposure to those assets, mostly bonds, which could benefit from a falling interest rate environment (technically known as increasing duration). For the moment this will be via building up existing exposure to global investment grade corporate bonds, but hopefully we will be able to expand the range of investments opportunistically as sentiment waxes and wanes.

Last week, an upgrade to the outlook for Greek government bonds signalled their return to the universe of ‘investment grade’ credit. It does not seem that long ago that the bonds of Greece, Ireland, Portugal and Spain were collectively graded as ‘junk’ in the depths of the European crisis, well over a decade ago. It served as a reminder to your investment team that markets continuously adapt and evolve, and that turbulent eras eventually give way to something else. The top down outlook is most likely to be more normal than it has been for many years, allowing us (despite the usual caveats) to end 2023 with much more optimism than we began it.

With best wishes from all the team for the holiday season.