2023 in a nutshell
It’s been an unforgettable year in markets, as investors have grappled with potential periods of hard landings, soft landings, and much else in between. The drama of a banking crisis, government shutdown and the horror of war have been witnessed, whilst AI-mania has sparkled, with Apple becoming the first official three trillion-dollar company. All the while, central bankers have played out their own fight with elevated and sticky inflation as the “higher for longer” interest rate theme has finally given way to disinflation and policy loosening. The hope of more abundant liquidity has fueled risky assets, with new monikers like the “Magnificent Seven” being invented to demonstrate the extraordinary leadership of the tech megacaps.
Of course, although markets have been driven by these themes through the course of 2023, most participants initially expected an economic slowdown, with even perhaps some 1970s-style stagflation. This was set to be caused by central banks staying the course with continued policy tightening, which has been the most aggressive in decades.
However, the world’s biggest economies have coped admirably with higher interest rates, confounding many who expected recession and worse. “Good news is bad news” has been a familiar phrase on trading desks, as resilient growth in the US sometimes meant the Federal Reserve (Fed) would need to continue raising rates, to the detriment of equities.
The market narrative has now shifted towards the prospect of a soft landing, something many economists thought highly unlikely and very tough to achieve. What does this actually mean? This is a scenario where the Fed has raised interest rates just enough to slow the economy and cool inflation, but without doing too much policy tightening to cause a recession. The economy is neither too hot nor too cold; in effect a “Goldilocks” environment.
Falling Treasury yields have seen support for the dollar fade, as well as the idea of US exceptionalism. But stock markets have reacted positively to these developments, with the benchmark, broad-based S&P 500 currently showing stellar gains year-to-date, sharply reversing last year’s pain. Importantly, breadth in the market has improved, with the small cap Russell 2000 index participating in the rally.
These bullish developments in risky markets have come about even though there are ongoing conflicts in both Ukraine and the Middle East. The latter has the potential to escalate at any time, but for now, markets are fairly sanguine over the outcome and comfortable that Iran and other actors will not inflame the situation. Gold has performed well in this uncertainty as a safe haven asset, whilst also enjoying a falling greenback and bond yields. The precious metal, being non-yielding, becomes more attractive when interest rates decline.
US Market Outlook
In 2023, US stock markets navigated choppy waters as tighter monetary policy and sharply higher bond yields failed to impact the leaders of the major US stock indices. Performance was dominated by the so-called “Magnificent Seven” – a new acronym of the times drawing parallels to previous stock market darlings like the Nifty Fifty in the early 1970s and the dot-com stocks of the late 1990s. The former group of companies were prized for their high growth, but their elevated valuations made them vulnerable to sharp sell-offs and underperformance through the 1980s.
The Magnificent Seven (Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, Tesla) lived up to their name with collective gains in 2023 of over 70% on a capitalisation-weighted basis. These tech titans were propelled by their above average earnings performance and the mania surrounding artificial intelligence (AI). The launch of applications like ChatGPT alerted both investors and the masses to the power of AI and the ways it is likely to shape our future. More recently, the spectacular growth has also been attributed to the increased expectation that the Federal Reserve will begin reducing its benchmark interest rates next year.
As its market share has grown, the Magnificent Seven has come to represent a gigantic 33% of the wider S&P 500 index. In turn, the remaining 493 stocks in the benchmark have risen less than 10%. Such highly concentrated markets increase risk, particularly for long-term investment strategies measured against benchmarks that require them to maintain exposure to these outsized positions. That means stretched valuations, produced by their strong performance, could leave the US tech giants vulnerable to mean reversion – the historical tendency for periods of above-average performance to be followed by sub-par returns.
US Dollar, Gold & Oil
The 2023 chart of the world’s premier reserve currency is simply a rollercoaster ride, as US exceptionalism has ebbed and flowed across the twelve months. This time last year, everyone was wondering whether the dollar had peaked. That same speculation is again with us due to Fed tightening assumed to be over and major position adjustment in late November ahead of the US Thanksgiving holiday. During the intervening months, the greenback has been battered and bruised by a US banking crisis and potential government shutdown, while shining in various times of major risk aversion like during the onset of the Israel-Hamas conflict.
Real yields – that is, nominal yields which account for inflation – climbed sharply from a very low base, making zero-yielding gold less attractive. That saw significant ETF outflows in the investment community, but that weaker demand has been more than offset by strong central bank buying. A record amount of the precious metal was bought in the first three quarters of 2023 as geopolitical concerns pushed central banks to increase their allocation towards safe assets. Gold tends to become more attractive in times of instability and uncertainty.
Oil and energy markets were hit by two major supply shocks with tensions in the Middle East to the fore, while OPEC+ endeavoured to keep prices stable and high with a variety of output cuts. The march seemingly towards $100 per barrel in the middle of the year appeared inevitable. But getting the balance in the market is obviously a tough act and wider global demand issues saw crude end the year lower.
The Economy and Fed
US exceptionalism has been an important narrative for markets as a whole, as the economic resilience of the world’s most dominant economy has surprised mostly everyone. Rewind twelve months and recession was the consensus call for the year. In its place, the American economy has defeated those pessimistic forecasts with growth likely to hit 2.5% while crucially, unemployment still remains below 4%. We have to constantly remind ourselves that the record low jobless rate in the US is 3.5%.
The most aggressive series of rate hikes in a generation should have impacted the economy far sooner, with the perilous state of other major economies adding to the gloom. Add in a Spring banking crisis and worries only intensified in the second quarter.
But the Fed has managed to find a way through the hard landing scenarios, as consumer activity surprisingly held up, fuelled by the excess of savings accrued through the pandemic. The administration’s Inflation Reduction Act has been surprisingly effective at driving investment through the year, with other western countries surely needing something similar. The housing market recovery, in the face of multi-year high mortgage rates, has also boosted construction.
The hoped-for soft landing picture is now in view stunning many fabled market watchers and us alike. The unexpectedly dovish final FOMC meeting of 2023 means there is much speculation that a year of rate hikes will simply mean the new year is one of rate cuts. Indeed, the Goldilocks scenario, with inflation falling towards the Fed’s 2% target without significant damage to the labour market and a recession, is close to a consensus call. But this would be a historical exception and so is something tough to achieve.
Money markets currently price in the high probability of a rate cut in March. Even allowing for Fed Chair Powell’s recent sharp pivot, downside surprises in both inflation and growth are probably needed to see this historic shift in monetary policy. Policymakers will be mindful of the fact that it is always much harder to volte-face once a new cycle has kicked off. But softer economic demand may cause the tailwinds for growth and risk markets to fade, meaning performance in risky assets as well as the dollar, is harder to come by.
The consensus expectations of roughly 12% earnings growth in 2024 are equivalent to over 3 times nominal GDP, according to HSBC which is decidedly optimistic in the later stages of the economic cycle . That said, the investment bank JP Morgan has looked at soft landings going back to 1965 and believes the S&P 500 typically rallies by roughly 15% on average in the 12 months after the first rate cut . As for the greenback, it normally performs well at the start of the year and would do again if rate cuts were pushed back.
Geopolitical risks will also remain real with two global conflicts still simmering, while national elections take place in over 70 countries, including the US, UK, and India. The Economist has called the US contest “Armageddon election” with a divisive unpopularity contest looming large between Biden and Trump. As such, volatility is expected to trade higher in 2024 with much depending on the timing and severity of the incoming economic slowdown. A second President Trump term would likely be dollar positive judging by his previous incumbency of loose fiscal and protectionist policies.
UK Market Outlook
The Economy and Bank of England (BoE)
The outlook for the UK was pretty bleak at the start of 2023. The country was on its fourth prime minister in as many years, after the brief rule of Liz truss ended in financial turmoil and ignominy. And that political instability was probably only a minor worry compared to a trio of headwinds in the form of high energy prices, rising interest rates and falling wages. But 2023 GDP of around 0.5% probably represents something of a result, with stagnation far better than the potential disaster that had been predicted.
The scourge of high inflation now looks to be vanquished with energy base effects crucial in bringing down the headline print from double digits to below 4% in the most recent data. The labour market is also cooling with high wage growth now consigned to the history books, though it still remains historically elevated. But labour shortages have eased considerably which means services inflation is now edging lower.
This is good news for the BoE who might now appear more confident to signal the end of the rate hike cycle. But the Chief Economist’s wonderful interest rates image of Table Mountain in contrast to the Matterhorn, was something markets took to heart for most of the year. Those rates were generally priced to be higher for longer than most other major economies in order to combat sticky inflation. That view has changed slightly due to the big downside surprise in the latest inflation data.
GBP was comfortably the second best performing major currency in 2023, some way ahead of the euro which was next best. The stability of the UK’s finances took away some of the prior negative risk premium in sterling associated with the Truss administration. A higher interest rate environment also acted as support for the pound, even if there were constant question marks about the weak, underlying economy. This feeling was made worse by the mortgage market as UK homeowners typically use loans which last two to five years. That means the full effects of the BoE’s tightening cycle has still to be felt, even if the Monetary Policy Committee (MPC) do not raise rates again in 2024. It will still feel for many as though monetary policy is tightening.
The major UK stock market, the FTSE 100, has dramatically underperformed the marquee US and other global indices. The former was led by the megacap tech titans, something the UK index is obviously lacking, which is dominated by interest rate sensitive companies like banks, homeowners, and insurers. Add oil majors, energy and mining companies to the mix and it is not hard to see why there have been disappointing gains.
This does mean the UK index is cheap, with a multiple of around 10 times earnings, which produces an earnings yield of 9.2% . But that implies its solid dividend yield of 4%+ a year is covered a healthy 2.3 times by earnings, which could be attractive in 2024 .
Much will depend upon the interest rate trajectory crafted by the Bank of England. Forward guidance recently re-introduced may be scrapped again if the inflation slide continues. This could signal that rate cuts will come sooner than previously thought, though again money markets have possibly got too carried away with policy easing. If those cuts do follow quite an aggressive path in the third quarter, then GBP could struggle to hold many of the prior gains from the new year.
A UK general election is likely to be held either in May or October. Recent elections have seen a risk premium built into sterling, but a change in the government, which is fancied at this stage might not damage GBP as markets take a Labour administration in its stride.
The recent fiscal stimulus in the Autumn Statement was cited by the Bank of England and could support the argument that rates need to stay higher for longer. But the current tax and spending decisions are set to take money out of consumers’ pockets. The long-term structural factors behind the UK’s economic sluggishness are also unlikely to change.
Europe Market Outlook
The Economy and the European Central Bank (ECB)
It was a challenging year for the eurozone, even if the region has may have just about avoided recession. Growth has been highly subdued with the bloc’s main engine of growth, Germany, being stuck with the unwanted “sick man” label. Access to cheap Russian energy has been curtailed while the region’s high dependence on international trade has hit manufacturing hard, especially due to the lack of a China recovery. Peak pessimism played out over several months across markets and economists. That said, more recent economic indicators – like the PMI surveys – look to be bottoming out, though they currently sit at recession levels.
The ECB hiked its policy by a total of 450 basis points through to September 2023 to combat high core inflation. Many economists believe the impact of all this tightening has yet to be felt, due to consumers extending their debt to longer-term fixed rates and solid wage growth. The latter had the ECB on guard, even though headline inflation had fallen to 2.4% in November from a peak of 10% a year before. The usual battle between the hawks and doves on the Governing Council has had to be negotiated by President Lagarde, with serious discussions about rate cuts imminent.
The euro has held up remarkably well considering the plight of the region’s economy. That concern about sticky inflation and a more hawkish stance by the ECB held sway for large parts of 2023. Much of the communication from the zone’s central bank through the middle part of the year centred on keeping rates high. Even more recently, there has been a concerted pushback against premature rate cut expectations as the risks are seen as bigger than those of keeping monetary policy tight for too long. Making policy less restrictive by the Fed was also meant to see US growth converge with the stagnant eurozone.
European stock markets generally performed well, beating the broader global indices and UK markets with growth far better and inflation much lower than feared. Value companies are widespread in European bourses and rising rates and borrowing costs added to their appeal. This is because growth companies are less attractive in this environment while value sectors became popular again. Germany’s Dax benchmark was boosted by its largest constituent, SAP, rebounding over 49%. Its next three largest blue chips, which account for 30% of the index, all jumped over 25%. Interestingly, Danish drug company Novo Nordisk became the biggest in Europe thanks to the popularity of its anti-obesity drug, which is set to grow in 2024.
With inflation now much closer to the ECB’s 2% target, policymakers should feel more comfortable changing tack and start an easing of policy. Growth will stay stagnant with the chances of a technical recession remaining high through the winter. With activity so weak, some economists cite the risk that a small accident could tip the bloc into a more protracted slowdown. Any upturn will be welcome but could prove very gradual with energy prices again in focus.
While gas storage is close to full and in far better shape than this time a year ago, a colder-than-expected winter and geopolitical tensions could revive inflationary pressures, and weigh on any prospects of growth. This all means the euro may struggle to beat other major currencies who are more aligned to lower US interest rates and could have more hawkish central banks due to their growth prospects.
China Market Outlook
The Economy and the The People’s Bank of China (PBoC)
China’s stuttering recovery from the prolonged Covid-19 lockdowns continued to plague its economy. A beleaguered real estate sector, poor private sector confidence and piecemeal policy responses by the government have all combined to produce growth of around 5% in 2023. While this is much improved on the previous year’s 3% expansion, the bounce is certainly lower than most forecast.
The slowdown in the wider global economy, together with lingering trade tensions, has been a major headwind for the manufacturing sector. The domestic property market is still struggling to rebound from its overleveraged troubles, with restructuring desperately needed as the long-term fix. Chinese consumers have focused on clearing their debts in contrast to those in western economies, in what economists have called “balance sheet recession”.
All the while, the authorities’ limited stimulus measures have not proved to be a big bang for a strong bounce back. A major fiscal package has not been forthcoming but at least China hasn’t had to worry about sharp inflationary pressures like the rest of the world. This should allow policy to be kept accommodative by the People’s Bank of China in 2024.
The depreciation pressure that the CNY has seen most likely stopped the PBoC from following through with any further policy rate cuts. The last easing was seen in August when policymakers took the 7-day repo rate down to 1.80%.
The issue for financial markets is that China’s recovery is narrow based and highly exposed to setbacks in the real estate sector of the economy. That has seen the yuan supported by the local central bank in order to manage volatility. In turn, this has caused underperformance with its peers as well as of course, losing ground to the US dollar.
The main stock market index has suffered as foreign money that flowed into equities in the first seven months of 2023 has left. Global investors began the year by buying Chinese stocks at a record pace in January anticipating a rebound after the abandonment of the zero-Covid regime. But they have dumped more than $25 billion of shares across the year, which put net purchases by offshore investors on course for the smallest annual total since 2015. With other regional markets like India and South Korea vastly outperforming, market sentiment has been muted.
Growth is expected to stay around 5% in 2024 on the back of more fiscal expansion and potentially some monetary easing if it is needed to hit the target. Deleveraging and changes to the economy that are less reliant on property are the long-term fixes which may still not happen in the new year. Gains are forecast in stock markets due to higher earnings and rising valuations for Chinese companies, but much will depend on more active support for growth by the authorities.
The road ahead looks bumpy with geopolitical tensions bubbling under the surface. A potentially contentious Taiwanese election early in the year will likely spark a symbolic show of Chinese military might, while the US election is bound to see both sides of the aisle beat their chest in anti-Sino gestures and rhetoric which play to the domestic American audience.
Asia-Pacific Market Outlook
The Economy and the Bank of Japan (BoJ)
Japan’s growth in 2023 was surprisingly resilient with a resurgence of tourism and positive net exports. But with inflation still running above 2% and boosts from post-Covid reopening fading, many observers see growth slowing in the new year. The key for policymakers at the Bank of Japan will be the tight labour market conditions which may support continued solid wage growth, via the Springtime wage negotiations and beyond.
If that does happen, then markets will ready themselves for a historic shift to exit the decades-long ultra-accommodative policies of the bank. Very gradual steps should be expected after the end of yield curve control policy at the BoJ’s policy meeting last October. Policy normalisation and effective tightening while other major central banks potentially do the opposite will muddy the environment and could cause unforeseen problems. Rising rates in Japan might then see the yen surge, prompting Japanese investors to bring their money home and invest in domestic assets.
The yen suffered in the first ten months of the year as USD/JPY marched up to previous multi-year highs. These were made in October 2022 when the authorities were forced to intervene by selling $70 billion, its first such foray in the market to boost its currency since 1998. Widening policy divergence between the Fed who were in hiking mode and the BoJ who stood pat on their ultra-loose policies saw the major get close to 152. But since November, falling Treasury yields as markets look to Fed rate cuts have seen prices fall by around 10 yen.
Japanese stocks outperformed global equities by some margin in 2023 as elevated and sticky inflation saw major efforts to improve profitability and corporate governance. Demographic changes and a generally weakening currency also combined to act as tailwinds for stocks. The long-held undervaluation of the market has only been corrected modestly, which means many Japanese equities still trade at a big discount to their global counterparts.
All eyes are on the BoJ and any changes it makes to its monetary policies. While a stronger yen historically has been seen as a negative for the export-driven Japanese economy, its potential impact going forward is unclear given the positive momentum and potential for repatriated flows by domestic investors. The process of structural reforms should be ongoing and allied to a still-cheap currency, is expected to appeal especially to foreign investors.
Any escalation of geopolitical tensions will also need to be watched, as was the case after the 2022 shock. Japan is a net energy importer so higher crude prices do have a severe impact on the country’s current account figures and terms of trade. This can potentially hurt the yen and is something the government will take a greater interest in.
How will geopolitical factors play a part in the 2024 Global Market Outlook?
2023 was a year where geopolitics grabbed the headlines but had little impact on markets, which is consistent with historical precedent. The US flirted again with default and its credit rating was downgraded but markets continued along their way, while conflict in the Middle East barely caused a long-term ripple in the cost of crude oil. That means they will remain a source of volatility, if only in the very short term.
In the new year, the economic debate will likely move on to growth in place of defeating inflation which is what markets and central banks have been focused on for over a year. Elections across the globe will involve more than half the people on the planet, the first time this milestone has been crossed says the Economist. That’s close to 2 billion people in more than 70 countries. Undoubtedly, the US election will have the most impact on markets, with implications for Fed policy, global trade and US-Sino relations, plus ongoing dealings with Ukraine.
The latter will further strain fiscal settings in both the US and Europe at a time when fiscal and debt dynamics are increasingly restricted. Perhaps this will be more of a long-term issue for strategists and historians, who see the pre-existing trend of global fragmentation continuing at pace. The sphere of influence the US holds will be challenged as the world splits further, though markets will probably be most concerned about recession and the potential growth slowdown. However, that could mean even smaller geopolitical issues increase in importance if they have an effect on economic activity.
Market Trend estimation for 2024
Will Artificial Intelligence (AI) still be in trend?
The biggest driver of US equity indices in 2023, with outsized gains for technology stocks, will remain into 2024. Interestingly, the mania after the ChatGPT release and similar large language models has inevitably died down as investors figure out the immediate impact on stock prices and wider society. But Artificial Intelligence (AI) will continue to drive gains for investors and has the potential to profoundly alter employment, as any new technology has done in the past. Business investment is set to increase as more people realise the benefits of AI as a co-pilot and more in their day-to-day functions.
Further out, there’s no doubt the longer-term prospect of a bump in productivity via AI is material, with some economists estimating well above a 3% boost to US productivity by the end of the decade. But as with any major transformation in society, the road could be bumpy with heightened volatility that often accompanies new technology.
In the near term, the Magnificent Seven will offer a degree of support for growth due to the sheer size of the companies in the major stock indices. But as adoption evolves, so too might we see shifts in the leadership. PWC, a consulting group, valued the economic potential of AI at $15.7 trillion annually by 2030 . Compared to the current global GDP of roughly $110 trillion, the impact could be extraordinary and opportunities in automation should prove huge.
What other trends will there be?
Long term trends like decarbonisation, deglobalisation and demographics will be ever present in 2024 and beyond. These 3Ds are essentially mega themes that are forcing investors to recalibrate their view of the world as inflation stabilises and interest rates potentially remain elevated for a longer time than seen in recent years. The energy transition story is well known and one of those forces reshaping markets and the broader economy. Demographics are having a similar impact, with the some of the challenges of both set to be addressed by technology and Artificial Intelligence (AI).
Other trends include the circular economy, an alternative economic model first described in 1990. This involves products not being thrown away after use, but reused for as long as possible, and if possible, for an equivalent product. It is not just about recycling, but also about ensuring products are able to be reused. This theme appears to have great potential but is still not very widespread and will require political regulation, incentives, and co-operation.
The consensus calls for a soft landing led by the US is one that seemed very unlikely not so long ago. Victory over inflation appeared to be some way off as price pressures were deemed to be sticky, even allowing for falling energy prices. But markets are increasingly comfortable that historic policy easing will happen in the US in next few months, and certainly in most major economies during the second half of 2024. Risk recession risks have been reined in with the investment bank Goldman Sachs recently reaffirming their previous forecast of just a 15% chance of that occurring .
An economic slowdown and disinflation should be a supportive environment for government bonds and challenging for stocks. US stocks indices have been led by a very small number of tech giants but could be reliant on lower interest rates going forward. In addition, equity valuations now appear to be stretched relative to other asset classes like government bonds which currently offer relatively attractive returns with very low risk of default. The well-known acronym, “TINA” (There is No Alternative) looks to be dead.
The dollar will start the new year in depressed fashion having made fresh multi-month lows. Whether the incoming economic slowdown requires 140bps+ of rate cuts currently priced in will be key for direction. Geopolitical tensions will no doubt also ride the wave of market emotions, with the US election inevitably becoming a major event with global implications. It is set to be a fascinating 2024.
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