Investing involves the risk that your capital goes down as well as up; you may get back less than you invested. The commentary below is not intended as a recommendation for you to personally buy or sell any of the investments mentioned nor to take any investment action whatsoever.
If the year ended today, the global stock market would be up about 12% in GBP and more than 15% in USD – a good year in almost anyone’s books. However, for many investors it probably doesn’t feel so good.
For one, the stock market has been driven almost entirely by the returns of the ‘Magnificent Seven’, which are the big tech names like Microsoft, Alphabet and Nvidia. The rest of the stock market is barely up at all.
Also, government bonds have lost money again, which has dragged down the performance of supposedly safer portfolios. Certain other investments like real estate and ‘infrastructure’ have either lost money or made very little. In sum, 2023 probably feels worse for many investors than it should.
What’s going to happen next?
I think 2023 will end well and 2024 will start well, partly for reasons of seasonality (mostly but not always December and January are good months for the stock market) but also because it will be confirmed that central banks are done raising interest rates. Most of this factor is now already in the price – hence the big rally of the past 10 days – but there’s probably more room to run on this front.
I see the big risks for 2024 as twofold: either a systematic problem caused by persistently high central bank interest rates (akin to the Silicon Valley Bank collapse episode) and/or a significant economic slowdown. In both scenarios, I would expect government bonds to gain value which is why we now own a significant proportion of government bonds (having owned none at the beginning of 2022).
I would not describe either of these ‘big risks’ as our base case but I would assign something like a 30% probability to at least one occurring, which is to say it is enough of a risk to make me nervous. I think it’s more likely that, upon seeing the economy slow and inflation continue to fall, the Fed and other central banks will cut interest rates rather aggressively (say, by 1.5%-2.0% during 2024). This action, combined with a slowdown that is manageable in magnitude, should ultimately help support stock prices.
In many ways, I am again sanguine about the extent to which this recession risk materialises. Whilst it will feel painful if it does occur, the reality is that central banks now have the ammunition to re-inflate asset prices by reducing interest rates. In short, I expect any pain to be temporary.
It’s worth noting the primary risk to this relatively rosy outlook is that, for whatever reason, government bond yields shoot higher. A combination of government bond yields going up while the economy slows considerably would be a particularly bad outcome (think 2022 but probably worse). There are reasons to think this might happen not least because the amount of bonds that the US government, in particular, needs to issue in 2024 will be huge compared to previous years (as it keeps spending far more than it receives in taxes). I don’t think this risk is going to disappear in the coming years but I do think that story of, at least, the first half of 2024 will be falling inflation and interest rates rather than the panic over higher interest rates that have characterised the past two years.
So what are we doing?
Within our balanced portfolios we are now modestly overweight government bonds. We have reduced the ‘market neutral’ funds that served us so well as bonds sold off only really because we had to sell something in order to buy the government bonds we now own.
Within equities, we continue to be underweight the Magnificent Seven as I just cannot see their dominance continuing in the coming years. There are, in my view, more appealing companies that can be bought for significantly less. Indeed, I would go so far as to say that the long-term case for owning equities rests on owning far broader exposure than currently offered by the big seven.
More broadly, we remain big believers in the long-term power of equities. In fact, 2023 illustrates the point better than many other years: in a time of trouble for many asset classes, the broad global stock market has been the standout outperformer.
Those that require less risky portfolios will see their equity exposure balanced with investments that we think will either hold their value or go up when equities go down; right now, that consists of government bonds and certain ‘market neutral’ funds.