• Tentative start to 2024 for equities after strong end to 2023
• Inflation looks to be temporary after all, but ECB cautious about cutting interest rates
• Bonds relatively attractive versus equities

 

Throughout 2023, market sentiment was unusually volatile, shifting from concerns about a recession at the start of the year to resilient growth during the summer, transitioning to a view of higher (rates) for longer, and concluding the year with a focus on anticipated future rate cuts. The decline in inflation and the Federal Reserve's dovish communication effectively alleviated concerns from the previous quarter. During its last policy meeting of the year, the Federal Reserve established the foundation for easing in 2024, as indicated by the median forecast of top officials, projecting three 25-basis-point cuts throughout 2024. Growing excitement that central banks would lower interest rate earlier than initially anticipated led to an “almost everything rally”.

 

Global stocks experienced their most favorable year since 2019, propelled by optimism surrounding swift rate cuts by the Federal Reserve and expectations for a consistent, resilient economic backdrop. The MSCI All Country World Index returned 22.2% in 2023, particularly boosted by a strong performance in the last two months. The primary impetus behind this rally was the robust performance of the top tech firms and AI stocks. 

The fixed-income markets had a tumultuous year marked by shifting perspectives on the trajectory of US monetary policy. Despite the market's ups and downs, fixed-income investments yielded robust returns for the year. The final twist unfolded in the last quarter of the year, when yields on 10-year treasuries and German bunds fell close to 100 basis points. The Bloomberg US Treasury index, which had previously shown a negative return, rebounded to deliver a 4.1% return by the end of 2023.

However, the rapid global rebound at the end of 2023 may limit the momentum for 2024. As the market factors in roughly twice the number of cuts suggested by the Federal Reserve dot plot and a consensus forming around a soft landing, several segments of the market commence 2024 priced with very high expectations. Although we find the recent dovish guidance for the Fed reassuring, we remain sceptical about the optimism surrounding inflation returning to the central bank's target without harming the labor market and economic growth. Global growth continues to track below trend, with conditions showing no clear signs of improvement. At the same time, earnings estimates look overly optimistic. Inflation is likely to fall at a more gradual pace as year-over-year price comparisons become less favorable, heightening the likelihood of disappointments among investors and setbacks in the stock market.

Stock markets are off to a somewhat shaky start to the year. Such a pause for breath was to be expected, considering the rapid pace of the rally towards the end of 2023. Furthermore, despite signs of a gradual cooling of the labor market, the latest macro data do not suggest that the Fed is likely to hastily implement rate cuts. We think the market’s current pricing of a 60% chance of a first rate cut in March is too optimistic. Given the likelihood of impending rate cuts, we maintain a positive outlook on fixed income, anticipating potential gains for quality bonds as economic growth moderates and interest rates decline. However, as market expectations for interest rate easing currently overshoot to the downside, investors may find more attractive entry points, considering the possibility of temporary increases in yields.

Please find attached our last Asset Allocation Update for January.