A surprisingly strong year for stocks, so far
Avoided recession so far this year, but what is to come next?
2023 recession fears recede
The biggest surprise in 2023 to date has been the absence of a widely-forecast US economic recession, after the Federal Reserve raised benchmark interest rates at a speed and scale not seen in nearly 50 years since the stagflation 1970s.
Europe has not been quite as fortunate, with European Central Bank rate hikes and painfully high headline inflation translating into a sharp slowdown in economic activity. This is evident in the falls in eurozone composite PMI to well under the 50 breakeven level, highlighting a contraction in overall activity levels. We continue to believe that any recession will be modest in both depth and duration.
Thinking more about rate cuts now
With a) inflation in steady decline across both developed and Emerging Markets, and b) economic activity adjusting to higher interest rates, central banks can look to end their rate hiking cycles and contemplate rate cuts in 2024. This process has already begun in Brazil, which were early to increase interest rates in January 2021 in response to rising inflation.
Stocks rise, bonds struggle
The surprising resilience of the global economy and the ability of companies to maintain their profitability by passing through price rises has resulted in better than expected earnings momentum for US, European and Japanese companies. This has been key in the strength of stock markets since October 2022 with the MSCI World Index gaining nearly 15% in US dollars and 11% in euros since the start of 2023.
In contrast, government bonds have struggled against a backdrop of sharply higher cash interest rates, delivering a
-1% return in US dollars and -2% in euros over this period as investors have flocked to benefit from decade-high money market interest rates.
Potential reversal of longstanding trends
Over the last 12 months, we have already observed the reversal of a number of longstanding trends in (dormant) inflation and (zero) interest rates. But there are still others that could also reverse soon and damage investor portfolios. The technology-driven 13-year outperformance of US stocks over versus the rest of the world is very long, and finally showing signs of exhaustion. Given that the MSCI World Index is today 68% weighted to the US, any prolonged reversal of this trend in favour of Europe, Japan and Emerging Markets could be painful for global investors.
Equally, the predominance of stocks and bonds in a typical diversified portfolio could prove difficult over the next few years if our expectation of continued scarcity of raw materials proves correct. Note that global bonds have delivered zero returns since 2016 in US dollars; in contrast, commodities have returned a cumulative +48%.
Highlighting 3 investment themes
In this update, we revisit 3 of our 2023 investment themes: “When consistent losers become winners” examines the potential for long-term underperforming asset classes (Latin American equities, Emerging Market bonds and silver) to benefit from a robust “mean reversion” effect. We also offer fresh angles on two other themes: reinforcing the security of inputs and technology (raw materials, cybersecurity), and looking at the most attractive ways to lock in historically elevated income yields in the fixed income universe.