Equity Rebound and Bond Market Dynamics in 2023

2023 has seen something of an equity rebound after the difficult post-COVID period, and in the case of fixed-income securities (bonds), particularly since mid-October.

A third year of negative returns on bonds had been a reminder that markets can stay irrational longer than one can stay liquid; the message throughout the year had been about interest rates staying higher for longer, despite plummeting inflation. However, on October 19^th US Federal Reserve (Fed) Chair Powell spoke at a conference where he suggested that the year’s rise in bond yields (and lower prices as a result) was doing the Fed’s work for it by constraining borrowing and making financial conditions tighter, thereby cooling the economy. The implication here was that no more rate rises were necessary, and indeed that rate cuts may occur sooner than expected in 2024. Investors who were sitting in Cash on the side-lines would have noted bond funds subsequently gained between 5 and 10% in 3 weeks.

Equity markets have also seen something of a rebound, with the US up 12% in sterling terms, with Europe and Japan also seeing positive returns in excess of Cash. Despite a negative year of performance of medium and smaller companies, UK equities in general still managed over 3%. All of this has meant that the typical medium risk multi-asset portfolio has returned to form, eg Avellemy Risk 5 approaching a 6% return year to date after charges.

Reflections and Forecasts

Now December is the month when managers are not only expected to reflect on the past 12 months, but also to forecast market outcomes over the coming year, in time for publication before year-end. I have always felt the latter speculation rather daft: investment markets don’t ‘reset’ at year end, and compartmentalising continuous news flows into convenient calendar years is an artifice that distorts perception.

It can be embarrassing too. I was recently reminded of the Economist magazine’s “World in 1990” publication, which appeared in November 1989. With reform sweeping the communist bloc, the magazine rated the chances of change in what was then Czechoslovakia at 0 out of 10, and in Romania at -10 out of 10. Within a week, the ‘Velvet Revolution’ had peacefully swept the communists from power in Prague, while on Christmas Day Romanian dictator Nicolae Ceausescu and his wife were propped against a wall and shot.

With that in mind, it is perhaps wiser to think about the investment journey through 2024 rather than speculate in the destination. There are ‘known unknowns’ that will require our close attention:

• Inflation – US core inflation is already close to its 2% target. The UK is (more slowly) on its way there. Profit-led inflation may now be in reverse.

• Interest rates – The Fed and the BoE may already have overdone the hiking, ‘accidentally’ hastening a downturn, and bringing forward cuts.

• Recessions - We continue to believe a recession (defined as two consecutive quarters of negative economic growth) is more likely than not, in both the UK and US in 2024. This, and any associated rise in unemployment, will have implications for voters.

• Elections – The Fed can swing the economy, and the economy can swing elections. Chair Powell will be careful not to exhibit political bias re interest rate policy, particularly as Donald Trump has made it clear he will challenge its independent status (and that of the Justice Department amongst others) if elected in November. In the UK, an election has to be called some time in 2024. Support for the Conservatives has been falling for 3 years, and Labour now has a 21% lead, which political analysts translate into a 268-seat majority in an election. The economic outlook may dictate the election date the Conservatives choose – May perhaps, or as late as possible (January 2025).

And finally...

I was saddened to hear that Charlie Munger, Warren Buffett’s right-hand man (and half of perhaps the most consistently successful investor partnership in history) passed away in November. Still working at age 99, his pithy “Mungerisms” have over the years become almost axiomatic investment truths. I have a long list of favourites, but here is the one that best represents my own investment philosophy:

“A lot of people with high IQs are terrible investors because they’ve got terrible temperaments. And that is why we say that having a certain kind of temperament is more important than brains. You need to keep raw irrational emotion under control. You need patience and discipline and an ability to take losses and adversity without going crazy. You need an ability to not be driven crazy by extreme success.”

RIP Charlie, and however you celebrate the winter holiday, have fun and we’ll be back next year with a new look – watch this space...