2023 Year in Review
The RBA continued to increase cash rates during the year. Inflation was a stubborn foe in 2023 with five rate rises adding a further 1.25% to current cash rate of 4.35%. Inflation remained high but dropped from 4.9% in October to 4.3% in November
Global economic forecasts for 2023 by many economists predicted a recession in the United States, Europe and a rebound in China – the year ended differently with no recession in the US, Europe struggling but doing better than expected and China still battling come head winds
Australian and Global share market ended on a positive note.
While interest rates usually dampen property prices, by year end we saw a remarkable turnaround for some cities in another result that upended forecasts.
December quarter
Returns were volatile over the quarter, with falls in October more than offset by large gains in November and December for almost all asset classes as central banks worldwide announced an end to interest rate rises.
The strongest asset classes were Australian equities and property. The lagging asset classes were fixed interest and cash. Our positioning added value in property and cash. Our positioning detracted in Australian equities.
Portfolio Update
Central banks have announced an end to interest rate rises as inflation indicators are turning. Growth remains robust, but high equity valuations for fast growing companies are unattractive. However, there are opportunities in value stocks and bonds that should provide good returns for long-term investors.
The December quarter period provided a timely reminder that markets endure long periods of ‘worrying about everything’ before the narrative quickly changes to ‘actually we are muddling through well and the future looks promising’. So once again we find that it is having the discipline and emotional nerve to hold out when things look challenging, that investors then get to enjoy the benefits of strong investment returns which we experienced in November and December.
Investment Strategy
The market narrative
“Soft landing” remains the base case, with inflation at target, real GDP close to trend & robust earnings growth.
3-4 cuts are priced, commencing May for the US (slightly later for Australia), with a tail of 5-6 cuts in the event of an overshoot (to the downside).
Our view
2024 labour markets look much like late 2019, early 2020. Inflation appears to be running at trend. The cash rate in 2019 was ~2%, and the Fed had been cutting. There is no need for a ~5% cash rate in US or Australia.
As such we expect at least 150bps of rate cuts, at the least, and possibly as much as 250bps (in a recession, rates usually fall by ~500bps) over the next two years.
High risk-free rates, and stable risk premia, suggest reasonable ex-ante returns for shares. We are moderately defensive across the diversified portfolios, but mostly this is due to the strong returns on offer across defensive assets (cash, treasuries, credit) as we are “being paid to wait”
The earnings growth assumptions for equities do look a touch aggressive, for this stage of the cycle. If shares repriced, we would like to buy more!
2024 Outlook
Soft landing continues. Both stocks and bonds do well, but outcomes vary by geography (harder landings for Australia, New Zealand, and Canada). Bonds have more chance of outperforming expectations than stocks.
Both credit and government bonds should perform well as defaults remain low and rates decline. However, sub-investment grade will see higher defaults and thus a lower realised< excess bond premium.
Commodities will be highly volatile as we drift between “soft landing” and “hard landing” narratives, iron ore will weaken as Chinese steel production declines; the long-awaited lithium bounce never comes.
Property and Infrastructure recover from the 2023 sell-off as earnings grow via rent reviews or regulatory resets.
House prices will decline, but they will vary in magnitude by geography, with larger falls in Australia, New Zealand and Canada, where mortgage debt is higher, valuations dearer, and the proportion of variable rate mortgages greater.
Alternatives (hedge funds, private equity, private debt) will prove less attractive given that vastly higher bond yields reduce the need for complexity because traditional asset classes have been repriced.
US dollar will moderate from presently very high levels against most currencies. However, the AUD will remain comfortably below $0.70c on average as it continues to price tail recession risks. Euro will likewise weaken, given a weak economy and the prospect of recession brought on by tight monetary policy.
Cash will remain attractive, given the highest yields on offer in many years. However, we prefer fixed income to cash, given our expectation that cash rates will drop as inflation cools and policy shifts to a less restrictive stance.
Defensive stocks, should table a stronger performance over 2024, having underperformed over 2022-2023, as they “digest” higher rates and benefit from a “flight to quality” as and when bumps in the road emerge over the year ahead.
The market will vacillate between the bullish narrative of: “rate cuts are coming because inflation is defeated” and the bearish narrative of “rate cuts are coming because the US Federal Reserve is behind the curve and the economy is at stall speed”. In other words, 100-150bps of cuts make everyone feel good; more than 150bps of cuts in a single year will probably cause panic stations because it would imply “something broke”.
With inflation and output growth at trend we should expect more than 200 basis points worth of rate relief over the next few years.
EWK Investment Committee
This advice may not be suitable to you because it contains general advice that has not been tailored to your personal circumstances. Please seek personal financial advice prior to acting on this information. Investment Performance: Past performance is not a reliable guide to future returns as future returns may differ from and be more or less volatile than past returns
